Chapter 9 - Investment appraisal

Question 1

Key terms

Answer 1

Discounted Cash Flow (DCF)
Time value of money (consumption preferences, inflation, risk of future cash flows)

Compounding interest

Discounting

Cost of capital

Question 2

Capital investment appraisal

Answer 2

NPV
IRR
Payback periods
ARR (accounting rate of return - incl. sunk costs, related to accounting)
Payback period (does not factoring time value of money, does not consider CF beyond payback period)
Annuity factor
Perpetuity
Changing discount rates
Non annual periods

Question 3

MIRR

Answer 3

simpler than IRR

MIRR = [PVreturns/PVinvestments]^(1/n)*(1+r)-1

r = WACC

Question 4

Capital investment process

Answer 4

1. objectives
2. search opportunities
3. identify states of nature
4. list possible outcomes
5. measure payoffs
6. select projects
7. authorise and implement
8. review decision

Question 5

Post completion audit benefits

Answer 5

1. more accurate assumptions and plans
2. mid term audits might improve outcome through intervention
3. identify weakness in the forecasting technique
4. motivation to meet targets
5. shows reliability of contractors and partners
6. provides learning experiences for future projects

Question 6

Project abondonment

Answer 6

Only consider future cash flows

Stop project if project economics changed and result in a negative NPV for the remainder of the project.