Chapter 10 - Further aspects of investment appraisal

Question 1

Dealing with risk

Answer 1

Adding a risk premium
Payback period
Sensitivity charts
Probability distribution
Monte Carlo simulation

Question 2

Relevant cash flows

Answer 2

Sunk costs: not relevant
Opportunity cost: should be included
Fixed costs: only extra or incremental fixed costs
Depreciation: not relevant

Question 3

Other capital items

Answer 3

depreciation affecting taxes
timing of taxes
changes in working capital (DSO and DPO)
inflation (real vs. nominal)

Question 4

Comparing investments with different useful lives

Mutually exclusive options

Answer 4

lowest common multiplier

NPV over these years

Question 5

Comparing investments with different useful lives

Optimum replacement cycles

Answer 5

Optimum replacement cycles

consider PV of CF
divide by cumulative annuity factor

Question 6

Capital rationing

Answer 6

use ProfitabilityIndex = NPV/(capital)
and rank it

combine projects within the capital limitations resulting in the highest NPV within budget (use PI factor as a starting point)

Question 7

Quantitative and Qualitative factors of CAPEX

Answer 7

Cost: acquisition, install
Benefit: lower labour, scrap, stock
Quality: lower development time, improved quality or service, increase in mfg flexibility (volume changes)

Question 8

Flexibility adds value to an investment: types of options

Answer 8

Delay, defer: call investment
Switch, redeploy: change asset
Expand/contract: change scale
Abandon: project with stages, allowing abandoning