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Accounting and Entrepreneurship > Making Long-term Investment Decisions > Flashcards

Making Long-term Investment Decisions Flashcards

1
Q

what are long term investment decisions

A

projects with long term implications (more than one year)

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2
Q

long term investment for profit seeking firm

A

new non-current asset, IT system, advertising campaign, accquisitions

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3
Q

long term investment in the public sector

A

new transport, hospital

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4
Q

what type of expenditure is relevant to long term decisions

A

capital expenditure
capital spent on NCA’s with depreciation applied

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5
Q

what are the four stages of the investment appraisal process

A

identify possible investment projects
carry out initial screening
evaluate and approve the project
monitor and review the project

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6
Q

what are some of the considerations of the investment appraisal process

A

alignment with company direction
is the project possible
are there better alternative investments
are there non-financial factors to consider

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7
Q

what are the four methods of investment appraisal

A

payback period
net present value
internal rate of return
accounting rate of return

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8
Q

what is the payback period

A

the time for the cash inflows to equal the initial cash investment

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9
Q

what are some advantages of the payback period

A

simple to use and understand
it focuses on early payback which is better for liquidity
the risk is reduced when early cash flows are emphasised

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10
Q

what is associated with large later cash flows

A

more risk and uncertainty

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11
Q

what are some disadvantages of the payback period

A

cash flows after the payback period are ignored
these could be substantial and potentially large

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11
Q

what is discounted cash flow

A

the time value of money
£1 today is not worth the same as £1 in one year

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11
Q

what does discounted cash flow do

A

converts a future cash flow to a present value

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11
Q

rate of return/discount value/cost of capital

A

chosen as the minimum expected return

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12
Q

how do you calculate future value

A

investment(1+rate of return)^number of years

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12
Q

how do you calculate present value

A

future value/(1+rate of return)^number of years

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13
Q

what return would the shareholders expect

A

a comparison against the return from an alternative risk free investment

14
Q

equity capital

A

alternative investment rate or expected return

15
Q

debt capital

A

interest rate on the loan used for investment

16
Q

what do you record in year zero when discounting cash flows

A

the initial investment

17
Q

what does net present value (NPV) do

A

takes account of the time value of money using all cashflows
calculates the present value of expected future cash outflows and inflows and compares them to the initial investment

18
Q

if NVP is positive

A

company financially better

19
Q

if NVP is zero

A

acceptable but creates no value

20
Q

if NPV is negative

A

company is financially worse

21
Q

NPV =

A

sum of all present values (FV/(1+r)^n) less the initial investment

22
Q

what is the internal rate of return (IRR)

A

the discount rate where NPV = zero
the return internally generated by the project

23
Q

if IRR > cost of capital

A

project is financially accepted

24
Q

if IRR < cost of capital

A

project is financially rejected

25
Q

how do you calculate the IRR

A

trial and error using different discount rates until NVP = 0
IRR = lower discount rate + (NVP using lower rate/(NVP lower rate - NVP higher rate))(lower discount rate - higher discount rate)

26
Q

advantages of IRR

A

accounts for all cash flows in all years
assumes the time value of money
percentage returns can be easily understood

27
Q

disadvantages of IRR

A

takes no account of the size of the investment
difficult to apply if a project has non-conventional cash flows

28
Q

what is different about the accounting rate of return (ARR)

A

it is profit based not cash based

29
Q

what does ARR compare

A

average profit and average investment

30
Q

ARR =

A

average profit/average investment x100%

31
Q

average profit =

A

(cashflow-depreciation)/life of project

32
Q

average investment =

A

(investment + residual value)/2

33
Q

how is ARR interpreted

A

compared with a minimum required ARR
acceptable if it is greater than the required limit

34
Q

advantages of ARR

A

easy to calculate and understand
returns over the whole life of the project considered
similar to RoCE which is often monitored as an overall assessment of business performance

35
Q

disadvantages of ARR

A

no account of the time value of money
it is a percentage so doesn’t account for different sizes of investments
based on accounting profits which are subjective and affected by accounting policies

36
Q

what are PB, NVP and IRR based on

A

forecast cash flows

Accounting and Entrepreneurship (9 decks)

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