Investment Decisions and the Enterprise Value

Question 1

Why is it important to know the object of investment?

Answer 1

It affects the accuracy of the analysis and valuation. If incorrect, brings an incorrect quantification of future cashflows-> estimation of cashflows of a different project.

Question 2

What time horizon should we consider for the analysis?

Answer 2

Time of the project as a whole, specially for which solid cash-flow forecasts are possible, and to ensure a solid analysis

Question 3

What elements of a specific project do we need to identify for the analysis?

Answer 3

-The object of investment - for an analysis and valuation with accuracy
-Time horizon - the necessary to ensure a solid analysis
-Future cash-flows
-Residual value - when the time horizon of cash-flow projections is shorter than the technical/economical horizon of the project.
-Cost of capital - weighted average cost of the funds used to finance the project.

Question 4

What do we need to add in the last year of project?

Answer 4

We need to add the residual value of the investment (amount expected to be recovered from the investment made) and the residual value of the working capital.

Question 5

What should the company do if a project is creating value for the promotor but not for the company?

Answer 5

They should not take the project.

Question 6

When considering the NPV, for mutually exclusive projects, what project should we choose?

Answer 6

We should choose the one with greater NVP.

Question 7

When considering the IRR, for mutually exclusive projects, what project should we choose?

Answer 7

We should choose the one with the IRR higher than the cost of capital.

Question 8

What is the biggest problem when using the IRR?

Answer 8

We can have different IRRs through the project, and it can lead to different conclusions when comparing projects of different sizes and different cash-flow patterns.

Question 9

Between NPV and IRR, what seems to be the safer option?

Answer 9

NPV

Question 10

When considering the payback period, when should we decide to invest?

Answer 10

We should invest when the payback period is lower than the reference value for that.

Question 10

In what consistes the payback period?

Answer 10

Number of periods needed so that the sum of cash-flows generated by the project is equal to its cost

Question 11

Is the payback period a good valuation method?

Answer 11

No, it’s conceptually worng but still very much used since it’s easier to calculate, and might be good for companies with a lot of investment opportunities but little capital.

Question 12

When considering the profitability index, when should we decide to invest?

Answer 12

We should invest when the profitability index is higher than 1.

Question 13

When considering the profitability index, for mutually exclusive projects, what project should we choose?

Answer 13

For mutually exclusive projects, we invest in the projects with the highest probability index (NPV stops being the main indicator - we pick, from the ones with NPV positive, the one with the best profitability index

Question 14

When do we use the profitability index?

Answer 14

We may use the profitability index when there is not money available to invest in all the NPV positive projects - we need to see which project will generate higher returns per € invested.

Question 15

What are relevant cash-flows?

Answer 15

Cash-flows that will only happen if the project is taken, if we go foward with it.

Question 16

What are the relevant cash-flows to have in mind? (4)

Answer 16

-Sunk costs - costs that already happend and cannot be recovered
-Opportunity costs - result from an alternative use of the assets
-Collateral effects - reduction an investment project generates in cash-flows of other projects
-Cost allocation - when costs regard different projects must be rightfully allocated

Question 17

What are the specific problems in project evaluation? (4)

Answer 17

Relevant cash-flows;
The effects of inflation;
Depreciation costs and tax benefits;
Projects with different time horizons;

Question 18

What should we do to regard the effects of inflation? And not to

Answer 18

Discount nominal cash-flows using nominal discount rates and real cash-flows using real discount rates.

Question 19

Why must depreciation costs be considered in the calculation of earnings before taxes?

Answer 19

Because they generate a tax benefit.
C - F = (Sales - Costs) * (1 - Tc) + Depreciation * Tc

Question 20

Regarding projects with different time horizons, what is the best to do when comparing costs?

Answer 20

Calculate the costs per period

Question 21

what are the different analysis and simulation we learn regarding the evaluations made for the projects?

Answer 21

• Sensitive analysis;
• Analysis of scenarios;
• Break-even analysis;
• Monte Carlo Simulation

Question 22

What is our main goal with the sensitivity analysis?

Answer 22

Determine the sensitivity of NPV to changes in assumptions

Question 23

What do we intent with the analysis of scenarios?

Answer 23

Considering a set of variables for each scenario, to see how each set is affected by certain factors;

Question 24

What is the goal of the break-even analysis?

Answer 24

Is to determine the minimum amount of annual revenues so that the project generates a return at least equal to the cost of capital.

Question 25

What can we do with the Monte Carlo Simulation?

Answer 25

Find out in what way the different values of the variables affect NPV.

Question 26

What do we achive choosing the specific set of financing solutions that minimise both the implicit cost of capital and the taxes and
transaction costs associated with each financing transaction?

Answer 26

We achive the maximisation of firm value and the reduction of the impact of the market inefficiencies on the
financial value of the company

Question 27

What are the factors that will influence the decisions regarding the medium- and long-term financing
solutions/instruments?

Answer 27

• Company’s awareness regarding financial innovation.
• Ownership’s structure of the company.
• Cost of capital.