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Chapter 2 Flashcards

1
Q

Payback period

A

Time taken for cash inflows from a project to equal outflows

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2
Q

Accounting rate of return initial investment

A

Average annual profit from investment / initial investment * 100

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3
Q

ARR average investment

A

Average annual profit from investment / average investment

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4
Q

Average investment

A

(Initial Outlay + Scrap value ) /2

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5
Q

NPV definition

A

the maxima an investor would pay for a given set of cash flows compared to the actual amount they are being asked to pay. The difference represents the change in wealth of the investor.

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6
Q

IRR definition

A

A cost of capital at which the NPV of a project would be zero

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7
Q

Payback period benefits

A

Simple to understand,
quick for initial screening
considers risk (Crudely)

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8
Q

Payback period issues

A

Unsophisticated
Doesn’t take account of TV of money
Ignores CF after payback period

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9
Q

ARR Benefits

A

Using profit consistent with ROCE and EPS
Use of BS values (asset backing)
relative score easy to understanding

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10
Q

ARR Issues

A

Not consistent with wealth maximisation
Ignores TV money
investment decisions should be based on CF not accounting profit
Percentage may be misleading when choosing between alternatives
Profits can be manipulated

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11
Q

NPV benefits

A

Takes TV Money into account
Absolute measure
Allows comparison of projects
considers all CF

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12
Q

NPV Negatives

A

Need to estimate cost of capital
Difficult to estimate all relevant cost/benefit
assume CF occur annually

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13
Q

IRR Benefits

A

TV Money,
Represents breakeven point so don’t nee exact COC
Considers all CF of projects

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14
Q

IRR Negatives

A

May conflict with NPV decision for mutually exclusive projects - projects may have lower NPV than another but higher IRR
Assumes cash invested at IRR
Easy to use and communicate practically

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15
Q

Adjustments to make if income statement information is provided

A

Depreciation
Working capital

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16
Q

Definition of relevant cash flow

A

Future incremental cash flows arising from the decision being made

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17
Q

Opportunity cost definition

A

Cash flow foregone if a unit of resource is used on the project instead of in the best alternative way

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18
Q

Relevant cost of material if not in stock

A

Current replacement cost

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19
Q

Relevant cost of material in stock in constant use

A

Current replacement cost

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20
Q

Relevant cost of material in stock with no other use

A

Current resale value / scrap value lost

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21
Q

Relevant cost of scarce material that cannot replace

A

Opportunity cost

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22
Q

Relevant cost of labour if spare capacity

A

Nil labour + variably OH

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23
Q

Relevant cost of labour if full capacity and workforce available for hire

A

Current rate of pay plus extra OH incurred

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24
Q

Relevant cost of labour if full capacity and no workforce available

A

Opportunity cost

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25
Deprival value is the
Lower of replacement cost and recoverable amount
26
Recoverable amount is the higher of
Value in use (PV CF) NRV
27
Money rate calculation
(1+m) = (1+r) * (1+i)
28
Discount current terms CF using effective rate calculation
1 + e = (1 + m) /(1+is)
29
Benefits of understanding environmental costs (5)
Ethical reasons Can help with pricing which in turn improves profitability Poor behaviour can result in fines and damage reputation Recording is important as some require compliance
30
Benefits of understanding environmental costs (5)
Ethical reasons Can help with pricing which in turn improves profitability Poor behaviour can result in fines and damage reputation Recording is important as some require compliance Saving energy may leave to saving costs
31
Environmental prevention costs definition
Costs required to eliminate environmental impacts before they occur
32
Environmental appraisal cost definition
Costs involved with establishing whether activities are complying with environmental standards and policies
33
Environmental internal failures costs
Costs of activities that must be undertaken when contaminants and waste have been created by a business but not released into the environment
34
Environment external failure costs
Costs arising when business releases harmful waste into the environment, which could damage reputation
35
The optimal replacement cycle is
The one with the lowest equivalent annual value
36
PV of annuity
Annuity * annuity factor (DCF)
37
Annual equivalent =
ANNUITY * ANNUITY FACTOR
38
Limitations of replacement analysis - Changing tech
Changing technology - machines can become obsolete and shorten cycle, when replaced not replacing identical
39
Limitations of replacement analysis - Inflation
Alters costs of assets over time means optimal replacement cycle can vary If affects all variables equally, best to exclude and discount at real rate Different inflation rates means optimal cycle varies over time
40
Limitations of replacement analysis - tax
Effects of taxation are ignored but could be incorporated
41
Limitation of replacement analysis - use of machines
Unlikley to continue in perpetuity
42
Divisible projects are ranked using
NPV per £ of scarce capital
43
Indivisible projects are ranked using
Trial and error to maximise NPV
44
Hard rationing definition
External capital market limits supply of funds
45
Soft rationing definition
Firm internally imposes own constraint on the amount of funds raised
46
Shareholder value analysis
The process of analysing the activities of a business to identify how they will result in increasing shareholder wealth
47
7 value drivers of SVA
Life of projected CF Sales growth rate operating profit margin tax rate Investment in NVA Investment in WC Cost of capital
48
How does sales growth rate benefit sharheolders
If more sales can be generated than expected, more cashflows should be created and therefore more value.
49
How does operating profit margin benefit shareholders
Operating profit margin is ratio of net profit (before interest and tax) to sales. Higher ratio more CF from each £1 of sale
50
How does corporation tax rate benefit shareholders
Affects cash flows, ability to affect the tax rate tends to be marginal, but can avoid some
51
How does investment in NCA benefit shareholders
Normally cash needs to be invested in additional NCA to enhance SH value. if can limit outlay without limiting effectiveness of business often enhance shv
52
How does investment in working capital benefit shareholders
Steps that can be taken to reduce working capital required will bring CF forward and generate cost
53
How does COC benefit shareholders
Cost of funds used to finance activities of business will usually be big determinant in SHV. If can find cheaper source of LT finance value tends to be achieved
54
How does life of CF benefit Sh
Longer life of any cash generating activity, greater potential to generate value
55
Real option - follow on
Launching the first effectively gives the right to invest in the later versions.Right to invest/buy is a call option
56
Real option - abandonment option
Right to sell is known as a put option, beneficial if can abandon and sell
57
Real option - timing options
Projects where commencement can be dealyed are often attractive. Longer delay, more valuable Only valuable if offsets any loss from delaying
58
Real options - Growth options
Choices may be full investment, wait and see and acquire a growth option, start with small capacity and expand later if market good, joint ventures and strategic alliance as entry to emerging markets.
59
Real options - Growth options
Choices may be full investment, wait and see and acquire a growth option, start with small capacity and expand later if market good, joint ventures and strategic alliance as entry to emerging markets.
60
Real options - flexibility options
Use asset for different things - must include the value of flexibility in the evaluation
61
Political risk
The risk that political action will affect the position and value of a company
62
Examples of political risks
Quotas Tariffs non-tariff barriers Restrictions Nationalisation Minimum shareholding
63
Factors to take into account when assessing political risks
Government stability political and business ethics economic stability / inflation degree of country's international indebtedness financial infrastructure level of import restrictions remittance restriction evidence of expropriation existence of special taxes and regulations on overseas investors or investment incentives
64
Strategies to limit effects of political risk
Negotiations with host government insurance production strategies Management structure
65
cultural risk important areas
Cultures and practices of customers and consumers Media and distribution system Different ways of doing business degree to which national cultural differences matter for the product concerned

FM (11 decks)

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