Chapter 11 Flashcards
1. Explain a company’s capital allocation process. 2. Identify qualitative factors to consider when making investing decisions. 3. Calculate the net present value of an investment. 4. Evaluate the attractiveness of investments, considering qualitative and quantitative factors. 5. Make a recommendation to proceed / not proceed with an investment.
what is capital allocation
or sometimes referred to as capital budgeting, is the process of determining how to use and invest a company’s cash to maximize shareholder value.
how can a business allocate their capital
- investing decision: invest in new assets
- investing decision: invest in ESG initiatives
- investing decision: purchase another company
- financing decision: repurchase shares or pay dividends
what is a qualitative analysis
management consider the pros (i.e., advantages) and cons (i.e., disadvantages) of the investment. It is important to understand a company’s strategy, goals and objectives and assessing whether the investment is consistent with this strategy.
what is the net present value
is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.
what is the time value of money
The time value of money considers the fact that receiving a dollar today is worth more than receiving a dollar a year from now.
what is a discount rate / weighted average cost of capital
is a company’s cost of obtaining cash from lenders and shareholders, expressed as a percentage. A company will only make a return if it invests in projects that produce a return that is higher than the company’s cost to obtain cash.
financial metric that represents the average cost of financing a company’s operations through a combination of debt and equity. It is used to determine the minimum return that a company must earn on its investments to satisfy its investors, both debt and equity holders.
what is an upfront investment
(cash outflow)
This is the initial cash required today to purchase equipment or assets that will generate future cash flows
All cash flows to deliver and install the equipment or asset are part of the up-front investment
One-time upfront cash flows, such as one-time upfront marketing expenses
what are future cash flows
These are recurring or one-time cash inflows and outflows that occur after the investment is made
what is a Relevant one-time upfront costs
Incremental one-time upfront costs that are incurred along with the initial investment
ex. training costs to operate new equipment
- one time outflow
what is relevant working capital
Incremental working capital or cash tied up to operate a business on a day-to-day basis
ex. keeping a certain amount of inventory on hand
- one time outflow
what is the release of working capital
Incremental working capital is released at the end of business operations
ex. Once the asset is fully utilized (i.e., it reaches the end of its useful life) and the manufacturer no longer produces new product inventory, all incremental working capital would be released
- one time inflow at end of operations
what is Relevant repair and maintenance
Incremental cash outflows to maintain and repair the equipment or assets purchased
ex. maintenance for equipment
- one time cash outflows as required
what is salvage value
The cash received from the sale of the equipment or asset at the end of its useful life
ex. The manufacturer plans to sell the equipment at the end of its useful life, resulting in an incremental one-time cash inflow at the end of the asset’s useful life
- one time cash inflow
what are the steps of calculating NPV
- identify relevant cash flows as upfront or future
- separate inflows and outflows
- identify timing of cash flows
- discount the cash flows from NPV formula
- sum NPV
