D Rote Flashcards
1
Q
Rule for relevant cash flows?
A
Future and incremental cash flows
2
Q
What is meant by incremental cash flows?
A
Those that change because a project is undertaken
3
Q
What are example of incremental cash flows?
A
Cash from sales
Operating costs (materials and labour)
4
Q
Are financing cash flows relevant?
A
No, because cost of finance measured in discount rate
5
Q
Are sunk costs (money already spent) included or not included in relevant cash flows?
A
Not included
6
Q
Are non-cash costs (depreciation) included or not included in relevant cash flows?
A
Not included
7
Q
Are book values (FIFO inventory values) included or not included in relevant cash flows?
A
Not included
8
Q
Are unavoidable fixed costs included or not included in relevant cash flows?
A
Not included
9
Q
Are finance costs such as interest included or not included in relevant cash flows?
A
Not included
10
Q
Example of unavoidable costs?
A
Money already committed and apportioned fixed costs
11
Q
Are opportunity and revenues included or not included in relevant cash flows?
A
Included
12
Q
Is lost contribution included or not included in relevant cash flows?
A
Included
13
Q
What years does ROCE take account of?
A
All years of operation of an investment project
14
Q
Main issue with payback period?
A
Doesn’t measure the potential impact on shareholder wealth
15
Q
Why should salary not be included in the project appraisal?
A
It is not incremental
16
Q
What are the advantages of IRR (TVM)
A
Time value of money
17
Q
What are the advantages of IRR (whole)
A
Considers the whole project
18
Q
What happens to IRR when there’s an increase in the cost of capital?
A
No change
19
Q
What happens to NPV when there’s an increase in the cost of capital?
A
Decrease
20
Q
What does the decision rule depend on in IRR?
A
The shape of the IRR curve
21
Q
What is meant by the reinvestment assumption in IRR?
A
No reason to suppose that funds generated early on in a project are reinvested at IRR after that point. Funds may be distributed elsewhere
22
Q
How many NPV calculations are needed to estimate IRR using linear interpolation?
A
Two NPVs
23
Q
What slope would an unusual project with an initial large inflow followed by years of outflows have?
A
A positive slope
24
Q
What is the inflation figure included in the money cost of capital?
A
It is expected general inflation suffered by the investors
25
What is meant by the expected NPV?
Value expected to occur if an investment project with several possible outcomes is undertaken once
26
What is meant by the discounted payback period?
Time taken for the cumulative NPV to change from negative to positive
27
How is soft capital rationing brought about?
By internal factors and decisions by management
28
When can ranking using the profitability index be used?
If projects are divisible
29
When is a lease is better than buy?
Saved outlay is a benefit of the lease so if it outweighs the present value of the costs relevant to the lease then lease is financially worthwhile
30
Why should interest not be included as a cash flow?
As it is part of the discount rate
31
When is the profitability index be suitable for?
Handling single-period capital rationing problems if projects are divisible
32
Is investing in a machine likely to be divisible for a project?
No
33
Is buying a chain of shops likely to be divisible for a project?
Yes, as it might be possible to buy half the chain for half the cost and expect half the NPV
34
What is tax exhaustion?
When a business has negative taxable income so it cannot benefit from tax relief such as tax-allowable depreciation
35
Is avoiding tax exhaustion a benefit to the lessee?
Yes
36
Is attracting lease customers that may not have been otherwsie possible a benefit to the lessee?
No, the lessor
37
Is exploiting a low cost of capital a benefit to the lessee?
No, the purchaser
38
Is potential future scrap proceeds a benefit to the lessee?
No, the purchaser as the lessee is not entitled to scrap proceeds
39
When is depreciation higher?
In earlier years
40
Benefits of a shorter replacement cycle (scrap)
Higher scrap value
41
Benefits of a shorter replacement cycle (company)
Better company image and efficiency
42
What decision is the cost of capital used for?
Asset replacement decisions
43
When would the after tax cost of debt be used in?
A lease vs buy decision
44
When will the profitability index be used to?
Rank divisible projects
45
What is the relevant cash flow in tax allowable depreciation?
Tax saving
46
What do government restrictions on bank lending?
Represent hard capital rationing
47
Where does hard capital rationing stem from?
Sources external to the business that needs the capital
48
A company is considering a project that has an initial outflow followed by several years ofcash inflows, with a cash outflow in the final year
How many IRR could there be for this project
Up to two IRRs as project's cash flows have two sign changes
49
The lower risk of a project can be recognised by increasing ...
The estimates of future cash inflows from the project
50
What is independent of the risk of the project?
IRR and cost of the initial investment
51
The lower risk of a project can be recognised by decreasing ...
The required rate of return of the project
52
What principles is IRR based on?
Discounted cash flow principles
53
Does IRR include depreciation?
No
54
Does IRR consider TVM?
Yes
55
Why is IRR not useful if liquidity is poor?
As timings of cash flows are hidden within the calculation
56
Can a project have a high IRR even if cash flows are weighted towards the end of the project?
YES
57
How is IRR calculated?
Using linear interpolation
58
What is the payback period?
The number of years that it takes a business to recover its originalinvestment from net returns
59
How is the payback period calculated?
Before depreciation and after cash flow
60
Are sale proceeds affected by inflation
No as they represent a flow of money
61
Are revenue flows subject to inflation?
Yes
62
What is the payback method based on?
Project's cash flows
63
Benefit of a requirement for an early payback?
Can increase a company's liquidity
64
What is payback method based on?
Cash flows
65
What is ROCE method based on?
Accounting profit
66
Does ROCE and payback period relate to cost of capital?
NO
67
What period of life does ROCE look at for a project?
The entire life
68
What sort of analysis/simulation is affected by changing one variable at a time?
Sensitivity analysis
69
What does simulation give?
More information about investment decision but does not point to correct result or assess likelihood of a variable changing
70
What is meant by standard deviation?
A measure of the variability of a distribution around its mean
71
When there's a tighter distribution (standard deviation)?
The lower the standard deviation
72
When tehre;s a wider dispersion in standard deviation?
The riskier the situation
73
What value is the weighted average of all possible outcomes in standard deviation?
The expected value
74
Risks and rewards in a long-term lease?
All risk and rewards of ownership transfer to the lessee
75
Where are asset and lease obligation in a long-term lease recorded?
In the SFP
76
What period does the lease period cover (long-term lease)
Cover almost all of the leased asset's sueful economic life
77
What is lessee responsible for in a long-term lease?
For repairs and maintenance of the leased asset
78
What years does ROCE take into account?
All years of operation of an investment project
79
Discounted or profit based for cash flow decisions?
Discounted are better
80
Where is the ROCE calculation compared to?
A ROCE-based percentage target that is unrelated ot the cost of capital
81
Where is a decision under ROCE compared to?
A target set by management rather than to existing ROCE levels
82
WHy does capital budgeting require management's evaluation of an uncertain future?
When it involves acquisition of long-term assets which will produce uncertain revenues and operating costs
83
When does accepting investment projects with a ROCE greater than the WACC only apply?
If the mix of finance for the investment project is the same as the WACC
84
Years taken into account and ROCE?
Project's ROCE sh ould exceed the project-specific cost of capital
85
What is the minimum required rate of return for capital budgeting decisions?
WACC
86
Does decreased tax-allowable depreciation available on the investment (increase or decrease IRR)
Decrease IRR
87
Does decreased working capital requirements (increase or decrease IRR)
Increase IRR
88
Does decreased cost of capital (increase or decrease IRR)
No effect on IRR
89
Does using reducing balance, instead of straight-line depreciation for financial reporting purposes (increase or decrease IRR)
No effect on IRR
90
Does increased contribution per unit (increase or decrease IRR)
Increase in IRR
91
Does increased initial investment (increase or decrease IRR)
Decrease in IRR
92
Does NPV take into account TVM?
Yes
93
Why does NPV consider compounding?
Assumes that surplus cash flows are reinvested at the minimum required rate of return
94
What normally affects a project's NPV?
Estimated scrap value of the asset
95
Net present value in investment decision-making is based on which cash flows?
Investing and operating. Not finance costs as they are implied in the discount rate
96
What is the IRR on a project?
The discount rate at which the net present value of the project equals zero
97
Why is wrong to assume funds can be reinvested at the computed IRR?
It may not be realistic if the IRR is particularly high compared to the company’s normal rate of return
98
Limitations with capital rationing (divisible)
It cannot deal with non-divisible projects
99
Limitations with capital rationing (period)
It cannot deal with multi-period capital rationing
100
Which of the following decision-making models equates the initial investment with the present value of the future cash inflows?
IRR
101
A possible formula for calculating the profitability index of a project?
PV of net cash infows / the initial investment in the project
102
Does the discounted payback method takes into account cash flows for all periods?
No
103
Does the payback method ignores all cash flows after the investment cost has been recovered?
Yes
104
If weighted average cost of capital is greater than the internal rate of return in IRR. Is project accepted or rejected?
Rejected
105
Is the IRR indepedent of the cost of capital?
No
106
What happens if the cost of capital is reduced in IRR?
The PV of future inflows would rise; therefore, the DPP will decrease
107
"A company wants to know how many years it will take before the accumulated cash flows from an investment equal the initial investment cost, without taking the time value of money into account"
Which method should company use?
Payback period as it ignores TVM
108
How must the sensitivity of NPV to a change in sales volume be calculated?
Based on contribution
109
How are the riskless equivalent amounts under certainty equivalent approach are discounted?
At the risk-free rate of return
110
What is a simulation model?
Using random numbers to generate possible values of project variables
111
What does the payback period determine?
Number of years that it will take for an investment’s operating cash flows to recover the cost of investment
112
Does payback method consider TVM?
No
113
What does NPV estimate?
The absolute change in the value of equity due to an investment
114
Which investment appraisal method is most likely to result in the maximisation of shareholder wealth?
NPV
115
Are profits and cash flows affected by accounting policies?
Profits are, cash flows are not
116
What is a balancing allowance?
A tax loss on disposal
117
When does a balancing allowance occur?
When the disposal proceeds are below the tax written down value of the asset
118
The profitability index is a variation of which of the following capital budgeting models
Net present value
119
A company should accept all positive NPV projects when?
It has unlimited resources for capital investment
120
What is the common disadvantage of all capital budgeting models?
Their reliance on forecast data. Since long-term capital investment decisions are subject to greater levels of uncertainty
121
What is the certainty equivalent approach?
Requires that riskless equivalent amounts are discounted by a riskless discount rate, that is risk-free rate of return
122
What is a CAPM derived project-specific cost of capital?
A rate of return that reflects the systematic risk of a particular investment project
123
What does IRR ignore?
The relative sizes of investments
124
Weakness of PI (size)
Does not take into account size of individual projects
125
Weakness of PI (returns)
Does not highlight the projects which are slowest in generating returns
126
Weakness of PI (certainty)
Assumes there is complete certainty about each outcome
127
When is equivalent annual cost method most conveniant to use?
In a period of no inflation
128
Weakness of EAC method?
Assumes that machine can be replaced by exactly the same machine in perpetuity
129
ROCE and purchasing a machine?
ROCE needs to be higher than target ROCE
130
Can mutually exclusive projects be compared using ROCE?
Yes
131
Does IRR ignore relative sizes of investments?
Yes
132
Do IRR and NPV sometimes conflict?
Yes
133
When discount rates are expected to differ over the life of the project (NPV)
Incorporated easily for NPV
134
When discount rates are expected to differ over the life of the project (IRR)
Can't be incorporated with IRR
135
What happens top NPV and IRR when there are unconventional cash flow patterns?
There may be multiple IRRs and so NPV and IRR decisions may not be the same
136
When is a project financially viable under IRR?
If it exceeds the cost of capital
137
Main advantage of using simulations to assist the appraisal?
More than one variable can change at a time
138
Is it possible to have a negative real discount rate to apply to the cash flow estimatesmade in current terms when making investment decisions?
Yes, it will happen if the rate of inflation exceedsthe money cost of capital
139
Input variables and distributions are what in simulations?
Estimates
140
What is deflation likely to increase for cash flow estimates?
To increase thechance of having a positive real discount rate
141
What does EAC assume?
The same type of machine is going to be used into the foreseeable future and two machines's capabilities are identical
142
What does simulation require for probabilities?
Probabilities of estimates subject to risk to be known
143
How do simulations deal with risk?
Help quantify the effects by producing a range of possible NPV and an idea of the probability distribution of those NPVs
144
What does a replacement analysis model assume?
Replaces like with like each time it needs to replace an existing asset
145
What is meant by hard rationing?
The limit on the amount of finance imposed by the lending institutions, so from external factors
146
Does soft rationing relate to external or internal factors?
Internal factors
147
Example of soft rationing?
The decision to save some cash for a later project or the unwillingness to tieup all available cash for many years
148
What does linear interpolation provide for IRR?
An estimate and IRR is not a measure of absolute profitability
149
Are reported profits affected by tax-allowable depreciation?
No
150
Does payback period provide clear advice?
No
151
Does payback period ignore TVM?
Yes
152
Does payback period have a risk-focused approach in decision-making?
Yes
153
Does ROCE incorporate TVM?
No and it can't be directly compared to cost of equity
154
How should riskier projects be evaluated?
With shorter payback periods
155
What does payback period ignore?
Timing of cash flows within payback period
156
What should amangerial reward schemes of listed companies encourage?
Achievement of stakeholder objectives
157
Is ROCE more for profitability or shareholder wealth?
Profitability
158
What does linking financial rewards to a target return on capital employed encourage?
Short-term profitability and discourage capital investment
159
Benefits of a share option scheme for directors'?
Directors' objectives in line with shareholders' objectives
160
Weakness of sensitivity analysis? (interdependence)
Ignores interdependence between project variables
161
What does probability analysis assess?
The risk of a project
162
Where does a new issue of loan notes take place?
In the primary market
163
How is the interest rate paid on new issue of debt influenced by?
Market rates and risk level the investors perceive that the company has
164
What are scale economies an advantage of?
A monopoly and oligopoly
165
What are social cost or externalities an example of?
Economic inefficiency arising from market failure
166
Why is a monopoly discouraged?
Because it can lead to inefficiency and excessive profits
167
Why managers may reduce theamount that they are willing to invest as part of soft capital rationing? (projects)
Managers believe that better quality projects will shortly be available
168
Why managers may reduce theamount that they are willing to invest as part of soft capital rationing? (motive)
The precautionary motive
169
The managers have decided that they will hold on to $600,000 of the available investment cash for 3 months, as they know that another very good project will become available at that time.
Which of the following investments would be suitable to make use of this cashover this period? (Certificates)
Certificates of deposit
170
The managers have decided that they will hold on to $600,000 of the available investment cash for 3 months, as they know that another very good project will become available at that time.
Which of the following investments would be suitable to make use of this cashover this period? (Instant)
Instant access bank deposit account
171
Are unlisted company shares easy or difficult to sell?
Difficult to sell
172
What is an example of imperfect information?
Where consumers are not well informed of their rights.
173
Decreasing interest rates in order to stimulate consumer spending (fiscal or monetary policy)
Monetary policy
174
Reducing taxation while maintaining public spending (fiscal or monetary policy)
Fiscal policy
175
Using official foreign currency reserves to buy the domestic currency (fiscal or monetary policy)
Monetary policy
176
Borrowing money from the capital markets and spending it on public works (fiscal or monetary policy)
Fiscal policy
177
When should nominal after-tax WACC be used to estimate the project's NPV?
When the project is affected by both tax and (different rates of) inflation
178
Is a rights issue possible for an unlisted company?
No
179
Is commercial paper short-term or long-term finance?
Short-term
180
Are treasury bills short-term or long-term finance?
Short-term
181
What does a balancing charge refer to?
Taxable gain on disposal
182
When does a balancing charge refer to?
If the trade-in value exceeded the tax written down value
183
Issue with replacing laptops too often?
Environmental damage
184
What do tangible assets provide? (debt)
Good potential security for providers of debt finance
