Chapter 5: The investment decision-making process Flashcards
What are the three stages in the creation phase of the capital investment process?
- Identify the orgs objectives
- Search for investment opportunities
- Identify states of nature
What are the three stages in the decision phase of the capital investment process?
- List possible outcomes
- Measure payoffs
- Select investment projects
What are the two stages in the implementation phase of the capital investment process?
- Obtain authorisation and implement projects
- Review capital investment decisions
Why would money received today worth more in the future?
Time value because:
Potential for earning interest/cost of finance
Impact of inflation
Effect of risk
How do you calculate compound interest?
V = X (1 + r)^n
V = future value
X = initial investment
r = interest rate
n = number of time periods
How do you calculate present value?
Future value x discount factor
What is net present value?
Net benefit or loss of benefit, in present value terms, from an investment opportunity
What is the internal rate of return?
Rate of return at which the project has an NPV of zero
What is the modified internal rate of return?
measures the average annual return from the investment. It assumes that cash released from the project is re-invested elsewhere
What is an annuity?
Constant annual cash flow for a number of years
What is a perpetuity?
Annual cash flow that occurs forever
When does capital rationing occur?
When there are insufficient funds available to undertake all NPV positive projects
What is the objective of capital rationing?
maximisation of the total NPV of the chosen projects’ cash flows
What is the discounted payback profitability index a measure of?
Number of times a project recovers the initial funds invested
What are the four real options in investment appraisal?
Delay/Defer
Switch/Redeploy
Expand/contract
Abandon
