Objectives & Investment Appraisal Flashcards
What might you need to use if deciding whether it is economically more desirable to pick one project or another?
Asses EACh project separately
EAC (Equivalent Annual Cost)
Esp. when projects are different lengths
NPV/Annuity factor
(Annuity factor is the long formula)
Limitations of NPV/EAC
Assumes the present value of the fleece goats produce is always the same…
- Flow: Cashflow
- Goods: Change in goods
- Price: Changes in price
(When thinking about limitations of NPV)
Why might leasing be better than outright payment
Because if you haven’t paid outright, then you haven’t lost all your money when you get to the property and inside you find cheerful foxes chasing cats chanting round the fire
- Cash Flow (Small & predicable)
- Cost of Capital (Can be lower)
- Capital rationing (Security on loan)
- Tax (Benefits for leasing)
- Flexibility
Will there be running costs in T0?
NO!
How do you work out the (money) discount factor when you have real and inflation rates?
Multiply them all together
The 1+…. rates
For the all the periods up to the one being discounted
(1 + m) = 1/( (1+I1)(1+D1) (1+I2)(1+D3) (1+I4)*(1+D4) ) …
Sensitivity to change in factor
NPV of project / NPV of relevant factor including TAX
Whole project on top
What are real options, in general?
‘strategic implications’ of taking on project
Follow-on optoin
Opportunity to acquire even more later
(economies of scale/market share)
Growth option
Range of services offered
Systematic risk i.e.
market risk
I.e. the risk in the system as a whole
What is beta?
The systematic risk of an investment vs the market
I.e. its sensitivity to market movements
What is Rm - Rf
Equity risk premium
MIGHT GIVE THIS IN THE EXAM, NOT RF
What to take into account for sensitivity to sales volume?
Sales price
Variable costs
(Tax)
How to work out the sensitivity to discount rate?
IRR of undiscounted cashflows
(Because want to know the discount rate)
How to work out the sensitivity to project life?
Easy one!
It is just the amount of time (months) from payback the project lasts
(Because sensitivity is the amount the factor can change before NPV becomes zero, so must be)
What is the change in wealth for new shareholders after a share issue?
( No. new shares X TERP ) - Amount paid for shares
DON’T FORGET NEW SHAREHOLDERS PAY FOR THEIR SHARES!
Why does inflation have to be accounted for in NPV?
So investor appropriately compensated for that loss in value
As negative impact on real value of money
Other word for actual cash flows
Nominal cash flows
Which is preferable: Matching real cash flows with real interest/rate, or matching nominal cash flows with an inflated discount rate?
Matching nominal to inflated discount rate
Because inflation assumptions don’t compound
Why is calculating the wrong CoC detrimental to shareholder value?
Too high? Missing +ve project
Too low? Taking -ve projects
How else can you describe real options?
Financially, (e.g. abandonment = put & growth = call)
How to calculate NPV when given 2 (equally likely) scenarios?
Average them
How to calculate taxable cashflow from contribution?
IT IS CONTRIBUTION
SELLING PRICE DOESN’T MATTER
Using the ‘real @ effective’ method
This method is a short cut for the money method. It can be used for perpetuities or
long annuities.
Cash flows are left in real terms.
A specific ‘effective’ discount rate is calculated for each given cash flow.
With ‘1+’ rates:
Effective = Money / Specific inflation rate
How to add the effect of inflation to an NPV calc?
Adjust discount rate to include inflation (i.e. * (1+inflation)
Include the effect of inflation in the cashflows
What will happen to contribution in an inflationary environment
It will remain the same, as sales will increase by inflation and then loose value by the same amount of inflation
What will happen to working capital in an inflationary environment?
It will increase
Because not linear cashflows (think of a graph)
How to treat depreciation in an NPV calc?
IGNORE because NOT A CASH FLOW
