Discounted cash flow - further aspects

Question 1

What are the two ways of approaching an NPV with inflation?

Answer 1

Real method Money method

Question 2

The….. cost of capital reflects the return that investors require and includes the return that investors want to compensate for inflation.

Answer 2

Money

Question 3

The …… cost of capital reflects the return that investors require over and above the rate of inflation that exists in the economy

Answer 3

Real

Question 4

If there is a single rate of inflation applicable to all cash flows, the NPV in real terms will be … the NPV in money terms

Answer 4

equal to

Question 5

Which approach should be used if there is more than one inflation rate?

Answer 5

Money method

Question 6

What is the relationship between the real and money cost of capital?

Answer 6

(1+i) = (1+r)(1+h)

Question 7

Which two areas of taxation need to be incorporated in to NPV calculations?

Answer 7

1. Corporation tax 2. Tax allowable depreciation

Question 8

What assumptions should be made in FM regarding Tax?

Answer 8

1. Tax payable in arrears
2. An asset is purchased at the beginning of the year
3. Net operating cashflows are taxable
4. A balancing allowance or charge arises in the year an asset is sold.

Question 9

Working Capital =

Answer 9

current assets - current liabilities

Question 10

What is the pro-forma for a NPV calc?

Answer 10

Operating CF

Inflow

Outflow

Opportunity/saving costs

Net operating cash flow before tax

Taxation

Net operating cash flow after tax

Initial investment

Scrap proceeds

CA/TAD

Working capital (change)

Net cash flow

discount factor

Present value

NPV

Question 11

Why is an NPV superior to all other IA methods?

There are 9 reaons

Answer 11

1. Considers cashflows
2. Full life of the project
3. Time value of money
4. Abolsute mesasure
5. Links to objective of SH wealth
6. Always offers correct advise
7. Can accomodate changes in DR
8. Sensible reinvestment assumption
9. Can accomodate non conventional cashflows