Week 9 - Financing a Business & Investment Appraisal Flashcards
What are Sources of INTERNAL FINANCE - LT and ST
- ST - Reducing Inventories level, delaying payments to suppliers
- LT - Retained Profit
What are Sources of EXTERNAL FINANCE - LT, MT and ST
LT - Shares, Debentures, Long Terms, Bank Loans, Grants
MT - Leasing, Hire Purchase, Loans
ST - Bank Overdraft, Debt Factorin
What are 3 Key Types of Debt Financing
1) Preferences Shares
2) Loans
3) Debentures
Explain the Type of Debt Financing - PREFERENCES SHARES
- Usually Treated as a NCL in the SoFP
- Contain the Right to Recieve a Dividend before an Ordinary Shareholder i.e. thy take preference
- the Dividend will be of a fixed % each year, providing the company choosers to offer the dividend
Explain the Type of Debt Financing - DEBENTURES
- offered by a Company to Potential Investor
- Form of Security that a Company Grants to a Lender in Exchange for Funding
- offers a Consistent Rate of Return, therefore Less Risky than Purchasing Shares
What are the 2 Types of Cost of Capital
- Cost of Equity
- Cost of Debt
What is the COST Of EQUITY?
- the Rate of Return Expected from Shareholders –> this is More Difficult to Assess, but is Based Upon their Expectations for Dividends and Increase in Investement
What is the COST of DEBT?
Cost the Company Incurrs Through the Debt Financing –> usually Be the Rate of Interest Being Changed on the Debt
Why is it Important to Know the Cost of Capital?
- Plays Key Role in Decision Making of Financial Management
- Helps Design the Capital Structure Considering the Cost of Each Source of Financing
- Represents the Minimum Return a Company Needs to Achieve in Order to Justify the Cost of a Capital Project
What is the Weighted Average Cost of Capital (WAAC)
- Method to Work Out their Cost of Capital if they’re Financed Through a Mix of Debt & Equity
What is the Weight Average Cost of Capital (WACC) Formula
(E/V X Re) + (D/V x Rd x (1-Tc))
What is the Meanings of the LETTERS in the WAAC Formula
E = Market Value of Firm’s Equity
D = Market Value of the Firm’s Debt
V = E + D
Re = Cost of Equity
Rd = Cost of Deby
Tc = Corporate Tax Rate
What is INVESTMENT APPRAISAL
- a Process of Analysing Whether an Investment Project is Worthwhile or Not
- Justifies the Investment in a Project Providing the Rationale for Spending Limited Resources
What are the 4 INVESTMENT APPRAISAL METHODS?
- Accounting Rate Return (ARR)
- Payback Period (PP)
- Internal Rate of Return (IRR)
- Net Present Value (NPV)
Explain the IA Method - ACCOUNTING RATE RETURN
- expresses the Average Accounting Operating Profit that the Investment will Generate as a Percentage of the Capital Investment
Explain the IA Method - PAYBACK PERIOD
- Expresses the Time for the Initial Investment to be Repaid
Explain the IA Method - INTERNAL RATE of RETURN
Represents the Yield from a Parrtiuclar Investment but the term Internal Reacts to the Fact the Calculation Excludes external factors, e.g. inflation
Explain the IA Method - NET PRESENT VALUE (NPV)
works out the NPV of the Cash Inflows and Outflows of a Capital Investment Project
- helps Managers Make Sensible Investment Decisions and to Analyse the Probability of a Project of Investment
Explain the NPV Concept - The Time Value of Money
- Concept that the Current Value of Money is Higher than its Future Value, Given it’s Potential to Earn in Years to Come
- Present Value of Money : Money that could be Invested when in hand for a better returns in future
- Future Value of Money : the Same Amount of Money is Subject to Uncertainties and Loses of Money in Future
What is the DISCOUNT FACTOR Formula for NPV?
Dn = 1 / (1+r) ^n
- r = discount rate
- n = number of years ahead
