Finance Flashcards
Discounted vs. Undiscounted
Cash Flows
- Incremental cash flows (excluding financing elements) should be discounted to recognize the time value of money for the purposes of making a decision regarding accepting or rejecting a project
- Incremental cash flows (including financing elements) should be analyzed year over year, without discounting, to determine if a certain cash position would be met by a certain time
Incremental Cash Flows
- Incremental cash flows comprise the additional cash flows from taking on a new project, incorporating the tax-affected initial outlay, annual revenues & expenses and terminal value (or cost) associated with the project, in accordance with the scale and timing of the project
- When determining incremental cash flows from a new project, consider:o Sunk Costs – These are the initial outlays that cannot be recovered even if a project is accepted. As such, these costs will not affect the future cash flows of the project and are not considered incrementalo Opportunity Costs – These represent any potential loss of current cash flows due to accepting a new project and are considered incrementalo Cannibalization – This is the opportunity cost where a new project takes sales away from an existing producto Working Capital Changes – These represent changes in receivables, payables and inventory due to accepting a new project and are therefore considered incremental
Capital Budgeting –
Buy vs. Lease
• Calculate NPV of each option and compare to determine which option is cheapest
• NPV of buy option – consider:
o Cost of asset
o PV of tax shield
o Maintenance costs
• NPV of lease option – consider:
o PV of after tax lease payments
• Other factors to consider:
o Impact on covenants
o Cash flows (leasing lessens the current cash burden)
o Leasing may be easier to come by if company has trouble obtaining financing
o Purchasing the asset might provide more flexibility (ownership of asset)
o Leasing might insulate company from severe declines in asset value
o Possible tax advantages (no capital leases for tax purposes – CRA sees all leases the same so cash payments would be deductible, however no CCA)
Financing Options – Debt vs. Equity
• Debt financing options:
o Loan- consider loan term, and security/collateral required
o Lease
o Government assistance
• Equity financing options:
o Angel investors- can be friends or family looking for a return on investment;
generally passive investors
o Venture capitalists- professional investment funds, looking for superior returns
(>30%); active participants in management, with a clear exit strategy
o Private equity- tends to participate later in business lifecycle, hence lower risk
o Public markets
What is the order in which the dilute shares must be calculated?
IFRS 33. 44
options and warrants first as there is no impact on the numerator
When are options and warrants dilutive?
When the average market price of ordinary shares exceeds exercise price of options
IFRS 33.47
For convertible bonds , how must the EPS be calculated
Must take into account the after tax impact of the interest that was paid on the convertible bonds.
What is Capital Budgeting? How is it used?
Managerial Accounting technique used to evaluate different investment options
Helps management make decisions Uses both accounting and non-accounting information Internal focus GAAP is not mandatory
What values are used in Capital Budgeting?
Capital Budgeting ONLY uses Present Value tables.
Capital Budgeting NEVER uses Fair Value.
What is Net Present Value (NPV)?
A preferred method of evaluating profitability.
One of two methods that use the Time Value of Money : PV of Future Cash Flows - Investment
How is NPV used to calculate future benefit?
NPV : PV Future Cash Flows - Investment
If NPV is Negative- Cost is greater than benefits (bad investment)
If NPV is Positive- Cost is less than benefit (good investment)
If NPV : 0- Cost : Benefit (Management is indifferent)
What is the rate of return on an investment called?
The Discount Rate.
What does the Discount Rate represent?
The rate of return on an investment used.
It represents the minimum rate of return required.
What are the strengths & weaknesses of the Net Present Value system?
Strengths:
- Uses the Time Value of Money
- Uses all cash flows- not just the cash flows to arrive at Payback Takes risks into consideration
Weaknesses:
- Not as simple as the Accounting Rate of Return.
What is the Internal Rate of Return (IRR)?
It calculates a project’s actual rate of return through the project’s expected cash flows.
IRR is the rate of return required for PV of future cash flows to EQUAL the investment. Investment / After Tax Annual Cash Inflow : PV Factor
