Investment Appraisal

Question 1

What are the 4 main investment appraisal techniques?

Answer 1

NPV, IRR, Payback Period and ARR.

Question 2

What is the the best appraisal technique and 4 reasons why?

Answer 2

NPV

• Uses relevant cash flows and not accounting flows.
• Takes account of the time value of money.
• Is an absolute measure rather than a percentage.
• Measures the change in wealth for an investor if they accept the project.

Question 3

Formula for the PV of a single cash flow?

Answer 3

Cash flow x 1/(1+r)^n

Question 4

Formula for the PV of an annuity cash flow?

Answer 4

Annuity cash flow x 1/r x (1- 1/(1+r)^n)

Question 5

Formula for the PV of a perpetuity cash flow?

Answer 5

Perpetuity cash flow x 1/r

Question 6

Formula for the PV of a growing perpetuity?

Answer 6

Cash flow at t1 x 1/(r-g)

Question 7

How would you calculate the DF for T3-7?

Answer 7

DF t1-5 x DF t2

Question 8

How would you calculate the DF for T0-5?

Answer 8

DF t1-5 + 1

Question 9

What is the DF t2 if year 1 is 12% and year 2 is 15%?

Answer 9

1/(1.12x1.15)

Question 10

If the annual rate is 12% how do you calculate the monthly rate?

Answer 10

(1.12)^(1/12)-1

Question 11

If the annual rate is 12% how do you calculate the 3 year rate?

Answer 11

(1,12)^3-1

Question 12

How would taxation affect cash flows?

Answer 12

More revenue=Outflow@17%

More expenses=Inflow@17%

Question 13

When does tax relief start if you buy the asset on the last day of the accounting period?

Answer 13

Tax relief starts at T0.

Question 14

When does tax relief start if you buy the asset on the first day of the accounting period?

Answer 14

Tax relief starts at T1.

Question 15

What does it mean if cash flows are quoted in “money terms”?

Answer 15

True expected cash flows.

Question 16

What does it mean if cash flows are quoted in “current/real terms”?

Answer 16

Today’s terms without incorporating future inflation.

Question 17

What does it mean if discount rates are quoted in “real terms”?

Answer 17

Not accounting for inflation.

Question 18

What does it mean if discount rates are quoted in “money terms”?

Answer 18

Incorporating general inflation.

Question 19

If only the real discount rate is given how do you calculate the money rate?

Answer 19

(1+r)(1+Ig)

Question 20

How do you allocate money to multiple divisible projects (2 steps)?

Answer 20

1. Rank the projects, highest PI = number 1

2. Allocate funds until all money is used.

Question 21

How do you calculate PI?

Answer 21

NPV/investment at time of rationing.

Question 22

How do you allocate money to multiple indivisible projects?

Answer 22

Trail and error to find the combo that gives the highest NPV.

Question 23

What are the 7 value drivers? (Shareholder value analysis) (Three “I”s and four “R”s)

Answer 23

• Increase sales growth rate.
• Increase operating margins.
• Increase the life of projects.
• Reduce tax paid.
• Reduce expenditure on fixed assets.
• Reduce investment in working capital.
• Reduce the cost of capital.

Question 24

What are 4 “real options” that may not be included in the cash flow analysis but can add value?

Answer 24

• Follow on options.
• Abandonment options.
• Timing options.
• Growth options.

Question 25

What 4 additional considerations does investing overseas require?

Answer 25

• Market attractiveness.
• Competitive risk.
• Political risk.
• Cultural risk.

Question 26

What are the 3 steps to calculate the cash flows of working capital?

Answer 26

1) Calculate the total amount of WC required.
2) T0 outflow the full amount of WC. T1-TN-1 incremental outflow/inflow. TN INFLOW for the full amount of working capital invested.
3) Check the running total of cash flows = 0.

Question 27

What type of option is abandonment?

Answer 27

Put option.

Question 28

What type of option is a follow on?

Answer 28

Call option.

Question 29

If inflation is 3% and you can get a return of 4% in a bank what is the effective discount rate?

Answer 29

1%

Question 30

Should you include R&D costs (prior to starting a project) in an NPV calculation?

Answer 30

No, because they are a sunk cost.

Question 31

How do you calculate the sensitivity of sales volume? (3 parts)

Answer 31

1. Do a new NPV calculation with just the contribution (plus any factor that changes with sales such as a buy out) less tax then discounted.
2. Divide the projects NPV by the NPV you just calculated.
3. The higher the percentage the less the project is sensitive to that particular factor.

Question 32

What should you mention when discussing sustainable products?

Answer 32

The company has a corporate responsibility to take the needs of their wider stakeholders into account. If they does this it may end up improving shareholder wealth by having a positive effect on its economic performance.

Question 33

When ignoring things like centrally allocated costs and R&D costs what should you always do?

Answer 33

Write a short note as to why you’re leaving them out.

Question 34

What are 3 disadvantages of sensitivity analysis?

Answer 34

1. Assumes that changes to variables can be made independently.
2. Ignores the probability of changes.
3. Isn’t an optimising technique.

Question 35

Should you include or exclude interest in a NPV calculation? And why.

Answer 35

Exclude as it’s already included in the discount rate.

Question 36

What 4 workings should you ALWAYS show when answering an NPV question?

Answer 36

WDA, Working Capital, Contribution and DF.

Question 37

What should you always make clear at the top of your answer?

Answer 37

£,000

Question 38

If there’s a maximum output for a product how should you change you workings?

Answer 38

Limit all the potential outcomes to that figure when calculating the expected sales.

Question 39

If inflation rates change (say from 0 to 5%) what will be affected?

Answer 39

Only the working capital increments. The rest is cancelled out by the increased discount factor.

Question 40

Does lost contribution go above or below tax in an NPV calculation?

Answer 40

Above so you can calculate the tax saved on the lost contribution.