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2nd Year - Finance 2 > Lecture 4 - Investment Appraisal Further Aspects of Discounted Cash Flow Techniques > Flashcards

Lecture 4 - Investment Appraisal Further Aspects of Discounted Cash Flow Techniques Flashcards

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1
Q

A project’s present value depends on the…

A

Extra/incremental cash flows that is produced.

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2
Q

Incremental cash flow equals…

A

Cash flow with the project minus cash flow without the project.

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3
Q

To estimate incremental cash flows you have to…

A
  • Get the cash flows if the project is undertaken and then get the cash flows if the project is rejected. After this you will be able to get the difference (with versus without principle).
  • Sounds easy but in practice mistakes can be made.
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4
Q

Incremental cash flows arise as a consequence of…

A

Selecting a project. Seems like a simple task, but there are many pitfalls in identifying incremental cash flows.

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5
Q

Opportunity costs are the…

A

Benefits or cash flows forgone as a result of an action.

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6
Q

Resources are almost never free, even when…

A

No cash changes.

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7
Q

Suppose a new manufacturing operation uses land that could otherwise be sold for $1m. The $1m is the…

A

Opportunity cost. By using the land, you pass the opportunity to sell it. There is no out of pocket cost, but there is an opportunity cost which is the value of the forgone alternative use of the land.

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8
Q

When the resource can be freely trade, the opportunity cost is simply the…

A

Market price. In practice, not all resources can be freely traded in a market and so it is very difficult to estimate opportunity cost.

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9
Q

What are sunk costs?

A

Costs that have been incurred and are not relevant to a current decision. They are past and irreversible outflows. They remain the same whether or not you accept the project.

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10
Q

Overhead costs include…

A

Rent, heat or electricity. Allocation of overhead costs should not be considered in investment decision making.

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11
Q

Overhead costs may not be related a particular project, but they must be…

A

Paid for nevertheless. Therefore, when the accountant assigns costs to the firm’s project, a charge for overhead is usually made.

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12
Q

Allocated costs are only relevant if the project…

A

Increases or decreases the overhead costs of the entire firm.

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13
Q

What is inflation?

A

A general increase in prices leading to a general decline in the real value of money.

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14
Q

What is the main inflation rule?

A

Be consistent.

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15
Q

Use nominal cost of capital to…

A

Discount nominal cash flows.

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16
Q

Use the real cost of capital to…

A

Discount real cash flows.

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17
Q

Whether you use nominal or real figures, you will…

A

Get the same results.

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18
Q

Interest rates are usually quoted in…

A

Nominal terms.

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19
Q

In times of inflation, the fund providers will require a return made up of two elements…

A
  • Real return for the use of their funds.

- Additional return to compensate for inflation.

20
Q

The overall required return is called the…

A

Nominal rate of return (or money rate of return).

21
Q

When cash flows have not been increased for expected inflation, they are described as…

A

Being in current/today’s prices, or real cash flows.

22
Q

Where cash flows have been increased to take account of expected inflation, they are known as…

A

Nominal cash flows, or money cash flows.

23
Q

Cash flows are assumed as…

A

Nominal cash flows unless told otherwise.

24
Q

In practice, inflation does not affect…

A

All costs to the same extent.

25
Q

In some investment appraisal questions, there may be…

A

More than one inflation rate.

26
Q

Specific inflation rate impacts…

A

Individual cash flow items.

27
Q

General inflation rate impacts…

A

Investors’ overall required rate of return.

28
Q

When valuing a project, you need to discount…

A

After tax cash flows.

29
Q

Operating cash inflows will be taxed at the…

A

Corporate tax rate.

30
Q

Operating cash outflows will be taxed…

A

Deductible and attract tax relief at corporate tax rate.

31
Q

Investment spending attracts…

A

Tax allowable depreciation.

32
Q

The company is earning…

A

Net taxable profits overall (this avoids any issues of carrying losses forwards to reduce future taxation).

33
Q

Depreciation is not a…

A

Cash outflow but it affects the amount of tax.

34
Q

Tax shield from depreciation is a…

A

Relevant cash flow. It is a incremental cash flow.

35
Q

If a business buys a capital asset in one year and sells it several years later, the total tax shield is the…

A

Tax on the cost of the asset less its eventual disposal value. The time value of money has not been considered.

36
Q

The tax impact of depreciation equals…

A

Each year’s depreciation times the corporate tax rate.

37
Q

In practice, the effects of taxation are complex and are influenced by a number of factors such as…

A
  • The taxable profits and tax rate.
  • The company’s accounting period and tax payment dates.
  • Tax allowable depreciation.
  • Losses available for set off.
    Many of these issues are ignored or simplified for the purposes of NPV investment appraisal.
38
Q

Net working capital is…

A

Current assets minus current liabilities.

39
Q

Most projects entail an additional investment…

A

In working capital.

40
Q

Initial investment is a…

A

Cash outflow at the start of the project.

41
Q

If the investment is increased during the project, the increase is a…

A

Relevant cash outflow.

42
Q

If the investment is decreased during the project, the decreases is a…

A

Relevant cash inflow.

43
Q

At the end of the project all the working capital is…

A

Released and treated as a cash inflow.

44
Q

When identifying cash flows from a project…

A

Ignore how the project is financed.

45
Q

We should neither subtract the debt proceeds from the required investment…

A

Nor recognise the interest and principal payments on the debt as cash outlfows.

46
Q

We should view the project as if it were all…

A

Equity financed. Focus exclusively on the project cash flows. We ignore the cash flows associated with financing decisions such as interest and principal payments.

2nd Year - Finance 2 (10 decks)

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