Capital Investment Analysis Methods

Question 1

Equation: Payback period

Answer 1

Initial Investment

÷

Annual after tax cash inflow

Question 2

Equation: Cash Flow for a specific year

Answer 2

CF₁

÷

(1 + r)^t

where t is the number of periods

Question 3

Cons of using payback method

Answer 3

• only looks at project until Break event point
  
  • (i.e. does not look at AFTER TAX cash flows above recovery of initial investment
• ignores TVM
• ignores firm’s cost of capital

Question 4

Equation: NPV

Answer 4

Sum of CF per period - initial cash flow, where CF is defined as:

CF₁

÷

(1 + r)^t

Question 5

Profitability index

Answer 5

Net present value of cash inflows ÷ Initial investment cost

Question 6

Hurdle Rate should be_____ or _____ to cost of capital for project to be accepted

Answer 6

>than or = to

Question 7

______ is used to discount future cash flows to net present value

Answer 7

Hurdle rate

Question 8

Concept: NPV - does it provide information on a project’s length of time before it breaks even or adds value?

Answer 8

No, NPV does not provide info on length of time before project’s breaks even or adds value

Question 9

Capital Budgeting Process considers _____ and _____

Answer 9

Cash, Net Working Capital

Question 10

Concept: In a DCF analysis, what considerations do you need to make?

Answer 10

1. Treat occurrence of Changes in NWC as CASH OUTFLOW, with X amount happening year 0
2. Treat release of changes in NWC as CASH inflow, with X amount happening for y years; use DCF for total years used and cost of capital or hurdle rate given
3. Annual net cash flows of raw income from Revenues - expenses related to those revenues
   
   1. take the annual amount

Find DCF using PV of annuity table, for total periods and cost of capital conditions

• for ex: annual inflows for 1-5 years and 20% cost of capital: use 5 for periods and 20% to get DCF of 2.991
• Annual net cash flows of raw income from Revenues - expenses related to those revenues

Question 11

How do you best decide on a project that has multiple rates of return over the years?

Answer 11

NPV and accept if at least 0 or greater