Capital investments Flashcards
What are the 2 reasons to make a capital investments?
- To maintain the existing business
- To grow the current business
What are the 2 types of business maintenance projects? Describe them
- Going concern: projects necessary to continue current operations and maintain the existing size of the business or to improve business efficiencies.
- Regulatory/Compliance: projects typically required by a third party such as the government regulatory body to meet specified safety and compliance with standards.
What are examples of going concern projects?
PP&E replacement, or IT modernization.
What are examples of regulatory/Compliance projects?
Factory pollution control installation, performance bond posting to guarantee satisfactory project completion.
What are the 2 types of business growth projects? Describe them.
- Expansion: projects that expand the business size and typically involve greater degrees of risk and uncertainty than going concern projects.
- Other: projects that should include high-risk investments and new growth initiatives outside the company’s conventional business lines.
What are examples of expansion projects?
New product or service development, M&A activities.
What are examples of other projects?
Exploration of invention into a new innovation, business model, or idea.
What are the steps in the capital allocation process? Describe them.
- Idea generation: ideas can come from anywhere within the organization or from outside.
- Investment analysis: forecasting CF and evaluating the investment’s profitability.
- Capital allocation planning: organizing profitable proposals to best fit the company’s strategy, considering the relevant constraints.
- Monitoring and post-audit: comparing actual results to those that were forecast.
What is the IFAM abbreviation?
- Idea
- Forecasting
- Allocation
- Monitoring
What is capital allocation?
It is the process of the issuer’s management making capital investment decisions. It is one of the most important tasks of management.
What are the 6 principles of capital allocation?
- Decisions are based on CF.
- Measure incremental CF.
- Timing of CF is crucial.
- CF is analyzed on an after-tax basis.
- CF is not accounting for NI or operating income.
- Financing costs are ignored.
On what would be based the decisions to or not to invest?
It should be made on discounted CF, given that all projects involve risk.
What is a sunk cost?
- Cost that has already been incurred.
- Decision take sunk cost out of the process.
What is incremental CF?
CF with the decision minus CF without the decision.
What is an externality?
It is the effect of an investment on things other than the investment itself.
What are positive vs negative externality?
- Positive: cost synergies or revenue synergies.
- Negative: cannibalization, where the investment takes customers and sales away from another part of the company.
What is a conventional CF pattern?
An initial outflow is followed by a series of inflows.
What is a nonconventional CF pattern?
- The initial outflow is followed not only by inflows.
- They are common among projects that need heavy maintenance.
What are independent projects?
- CF independent of each other.
- Require little management effort.
What are mutually exclusive projects?
- They compete directly with each other.
- They create significant organizational disruption that limits the company’s ability to take on additional projects.
What is project sequencing?
Many capital projects are sequenced over time.
What are fail-fast and minimum-viable products?
They are examples of management breaking up a large project into smaller successive projects and then performing something similar to project sequencing for these intermediate projects.
What is the net present value?
It is the present value of the future after-tax CF minus the investment outlay.
What is the internal rate of return?
It is the discount rate that makes the present value of future after-tax CF equal to the investment outlay.
