Chapters 5-6 Flashcards
4 phases that a capital expenditure committee goes through
idea creation
screening
financial analysis
review
definition of a relevant cash flow
a future incremental cash flow caused by a decision (eg to invest in a project)
4 examples of non relevant costs
non cash flow ( depn)
sunk or committed costs
historic costs of materials
finance costs
what is the payback period
a measure of how long it takes for the cash flows affected by the decisions to invest to repay the cost of the original investment
problems with payback
ignores the timing within the payback period - only looks at how long it will take but not when then cash flows come in during
ignores the time value of money
may lead to an excessive investment in short term projects
ROCE for investments
average annual profit / initial investment
or
average annual profit / average investment
problems with ROCE / ARR
doesn’t consider cash flow
ignores time value of money
average investment
initial outlay + scrap value / 2
what does annuity mean
a series of equal cash flows
what does perpetuity mean
an annuity that occurs for the foreseeable future
what does NPV positive mean
return from investments cash flows in excess of cost of capital
what does NPV negative mean
return from investments cash flows below cost of capital
what does internal rate of return mean
a discounted cash flow technique that calculates the percentage return given by a project.
formula for IRR
a% + (NPVa/ (NPVa+NPVb) x (b%-a%)
what is a in the IRR formula
lower discount rate
what is b in the IRR formula
higher discount rate
advantage of IRR over NPV
percentage is easier for non finance managers to understand
advantage of NPV over IRR
because its a percentage wrong choices get made as doesn’t consider the size of the cost or return
what are the 2 tax cash flows
tax payments on profits
tax benefits from tax allowable capital expenditure
3 steps to identifying tax allowable depreciation
calculate amount of TAD claimed in a year
remember the balancing allowance in the year the asset is held
calculate tax saved
what will an increase in working capital do
cause a cash outflow
what will a decrease in working capital do
cause a cash inflow
what does real mean in terms of cash flow
based on current price levels
what does nominal mean in terms of cash flow
cost of capital after adjusting for inflation
what does the fisher formula do
shows the relationship between real and nominal rates of interest
what is the fisher formula
(1+i) = (1+r)(1+h)
what is h in the fisher formula
general rate of inflation
what is i in the fisher formula
nominal rate of interest
what is r in the fisher formula
real rate of interest
