Theory Flashcards
Payback definition and decision rule
Time taken for cash inflows to equal cash outflows
Accept if payback < target
ARR formula (initial investment)
(Average annual profit from investment ÷ initial investment) × 100
Profit = after depreciation
ARR formula (average investment)
(Average annual profit from investment ÷ average investment) × 100
Average investment = (initial outlay + scrap value) ÷ 2
Profit = after depreciation
ARR decision rule
Accept if ARR > target
NPV definition and decision rule
Change in wealth of investor as a result of investing in project
Accept if NPV is positive (usually)
IRR definition and decision rule
Cost of capital at which NPV = 0
Accept if IRR % > cost of capital (usually)
IRR formula
a + (NPVa ÷ (NPVa - NPVb)) × (b - a)
a = lower discount rate giving NPVa b = higher discount rate giving NPVb)
NPV discount formula
(1 + r) ^-n
r = cost of capital n = years
Cost of material - not in stock so have to buy
Current replacement cost
Cost of material - in stock, in constant use, if used must replace
Current replacement cost
Cost of material - in stock, no other use, if used no need to replace
Current resale value
Scrap value lost
Cost of material - in stock, scarce, if used cannot replace
Opportunity cost
Cost of labour and variable overheads - spare capacity
Nil labour cost plus variable overhead only
Cost of labour and variable overheads - full capacity, workforce available for hire
Current rate of pay plus extra variable overhead incurred
Cost of labour and variable overheads - full capacity, no workforce available
Opportunity cost
2 general rules for CAs
- 18% on reducing balance basis
- No CAs in year of sale (balancing allowance/charge instead)
3 tax assumptions
- Whole tax payment is made at the end of the year to which it relates
- CT is 17%
- Working capital flows have no tax effect
Fisher equation
(1 + m) = (1 + r) × (1 + i)
m = money (nominal) rate r = real (effective) rate i = general inflation rate
Discounting money method
1) Adjust individual cash flows using specific inflation rates to convert to money cash flows
2) Discount money flows using money rate
EAC formula and decision rule
NPV of one cycle replacement ÷ AF for this cycle length
Lowest EAC
Sensitivity formula
(NPV of project ÷ PV of cash flows subject to uncertainty) × 100%
CAPM formula (given in exam)
rj = rf + βj (rm - rf)
rj = expected return for security j rf = risk-free rate βj = beta of security j rm = expected return on the market portfolio
When applied to shares rj = cost of equity capital (ke)
Alpha value current return formula
Expected return ± alpha value
Spot and forward rate relationship formula
Spot rate x ((1+if) ÷ (1+iuk)) = forward
if = overseas interest rate iuk = domestic interest rate