Chapter 3 - Discounted cashflow techniques Flashcards
1
Q
What are the two discounted cashflow techniques in the syllabus?
A
- NPV
- IRR
2
Q
What are the three reasons for the time value of money?
A
- Potential for interest
- Inflation
- Impact of risk
3
Q
What are the 4 advantages of NPV?
A
- Takes into account time value of money
- Based on cash over profits
- Considers whole life of project
- Considers required return from investors
4
Q
What does NPV represent?
A
Increase in shareholder wealth if the investment is undertaken
5
Q
What are the 3 disadvantages of NPV?
A
- Difficult to understand and explain
- Cost of capital is difficult to determine accurately
- Difficult to forecast future cashflows accurately
6
Q
What are our two assumptions in discounting?
A
- Initial investment is at time 0
- Cashflows arise at end of accounting period
7
Q
What is the Internal rate of return? (IRR)
A
The discount factor that when applied to the cashflow of a project, results in a nil NPV
8
Q
What are the 3 advantages of IRR?
A
- Reflects time value of money
- Based on cash not profit
- % answer- makes it easier to understand and compare
9
Q
What are the 3 disadvantages of IRR?
A
-Difficult to calculate
-Can be more than one IRR for a project
-When comparing two projects, one with higher IRR may not have a higher NPV
Can be confused with ARR/ROCE
