Unit 8 Flashcards
Once we are prepared to decide whether an investment project is worth undertaking or not, we require a decision rule, that is to say, ____________. Moreover, that method can help to decide which project is _________ when we have various selective projects.
a method to conclude when an investment is worth undertaking and when it is not
preferable
When evaluating an investment/financing project, we will have to check two issues:
- Is the investment financially VIABLE?
2. Is the investment PROFITABLE?
To find out if an investment is financially viable, we need to know if _____________. If so, the project __________, because _____________.
there is any lack of cash at any time during the life of the investment
will not be feasible
it will not be possible to face all the required payments
To assess if a project is or is not financially viable, we must ____________-.
check that the balance of the cash account in the balance sheet is ALWAYS positive
To know if an investment project is profitable, we must know ___________.
if it contributes to the increase of the wealth of the investor
In an investments timeline, “A” is always ________ in C0.
** A = initial investment
negative
In a financing timeline, “A” is always _________ in C0.
** A = initial investment
positive
In a financing timeline, we pay ____________ during the life of the project.
- Div.1
- Amort.1
- Int.1
In an investing timeline, we pay _____________ at the end of the investing project.
+Qn (cash flows from revenues and costs)
+VR (Residual value)
Total cash flows can be divided into:
- cash flows related to assets/investments
2. cash flows related to financing operations
Cash flows related to assets/investments are _____________.
the cash-flows that result from the purchase/sale of an asset, as well as the operations of the company.
The three types of cash-flows related to assets are ___________.
- The initial investment (A)
- The periodical cash-flows (Qi)
- The residual value (VR)
Periodical Cash-flows come from ______________.
the revenues and costs of the operations
The initial investment comprises _____________. This is usually a cash-___flow. We will symbolize it
by __.
the payments of the fixed assets and working capital purchases.
out-flow
A
The periodical cash-flows come from __________. We will symbolize them by ____.
the revenues and costs of the operations
Qi
And the residual value is the cash-flow from ________. It is symbolized by ____. This cash-flow, however, will usually be added to _____.
the disposal of the assets
VR
the last Qi (periodical cash flow)
Cash flows related to financing operations ___________. These cash-flows can be used to compute the ____________.
are produced by the receipt of the funds of the financing operations, as well as the payments of interests, dividends and principal repayments of those operations
cost of capital of the project
Some simple criteria that are used to form an approximate idea about the convenience of the investment project are ____________, because ______________.
not very reliable for decision making
their drawbacks are stronger than their advantages
Some examples of simple criteria are:
- The payback rule
2. Discounted payback rule
The payback rule is as follows:
The shorter the payback, the better the investment.
The payback is ___________.
the time until the cash-flows are equal to or exceed the value of the initial investment
Payback =
t/A = the sum of all periodical cash flows from 1 to t.
The advantages of the payback rule are __________.
- it is a simple and intuitive method that puts emphasis on the short term.
- because it is a simple and intuitive method, it is more useful when liquidity is important or when the longer-term cash flows are of high uncertainty.
The disadvantage of the payback rule is ___________.
- it does not consider the cash-flows after the payback, the time value of money, or how the investment has been financed.
The discounted payback is _____________.
the time until the sum of the discounted cash-flows equals or exceed the value of the initial investment
The discounted payback rule states that _____________.
The discounted payback is equal to t/A = the sum of the periodical cash flows (Qi) divided by (1+k)^i
The advantage of the discounted payback rule is ___________.
it is still a simple and intuitive method (though less simple than the payback).
The disadvantage of the discounted payback rule is ___________.
except for the time value of money, it does not consider the cash-flows after the payback or how the investment has been financed.
The Net Present Value (NPV) criterion is ____________. The NPV measures ____________, measured in monetary units valued at _________.
one of the most commonly accepted criteria for
capital budgeting
the increment in the company’s wealth produced
by the investment project
the beginning of the investment
NPV =
NPV = -A + (the sum of all periodical cash flows, Qi/(1+K)^i)
** where A = the initial investment and K = the discount rate calculated from the financing cash-flows of the project
In the NPV criterion, Qi represents ____________. It is important to note that these are __________. Also, the last cash-flow (Qn) will also include _____________.
“n” is _________, and “K” is _________.
The periodical cash-flows, which come from the revenues and costs of the operations.
the periodical cash-flows related to assets (no
financing cash-flow here).
the cash flows from the disposal of the assets at the end of the investment.
the term of the investment
K = the discount rate calculated from the financing cash-flows of the project
The NPV criterion states that ______________.
- A project will be worth undertaking if, and only if, its NPV is positive.
- The investment project with a higher NPV will be preferable to the investment project with a lower NPV