Chapter 6 Flashcards
(20 cards)
Cash Flow
Discounted Cash Flow
Money received!
CF = Revenue - Operating Expenses - Taxes - Capital Expenditure
Calculated per period of time
Discounted Cash Flow takes into account the time value of money
Capital Expenditure
Pre-production Period
Production Period
FILLER
What is ARR?
Equation?
Name three things about it.
Accounting Rate of Return = (average annual [after tax] net income)/(average capital investment)
*Equivalent to return on total assets
*Based on accounting, not cash flows, Ignores time value of money
Ignores timing of cash flows
What is the TCF?
Name three properties
Total Cash Flow = sum of the cash flows of each period from n=0 to n=T where T is the duration of the project.
Ignores time value of money,
Ignores timing of cash flows and project life,
Does not measure investment efficiency
PP?
Discounted PP?
Two drawback.
PayBack Period. This is the time required to recover the initial investment from the production period cash flow.
Discounted PP is the same thing except the cash flow periods are discounted.
- Does not measure investment efficiency
- Does not take into account cash flow after PP
PVR?
Equation?
Two drawbacks?
Present value ratio = (NPV) / (sum of initial costs)
- Measures investment efficiency
- particularly useful when funds are limited
or NPV/CapEx
BCR?
Equation?
What it includes?
Benefit Cost Ratio = (Benefits) / (costs)
Benefits include: revenue + salvage value @ T=0
Costs include: CAPex, operating costs, taxes @ T=0
IRR
When can’t you use it?
Internal rate of return is the discount rate which when applied to the time distribution of cash flows gives a NPV = 0
- This method can only be used when cash flows do not fluctuate between gains and losses.
- To accept project, IRR >= WACC
When is incremental analysis used?
Btw what’s incremental analysis again??
When we are asked to chose between projects that are mutually exclusive
What are two limitations of discounted cash flow methods as evaluation techniques?
- Cannot deal with non-monetary aspects
- Emphasis placed on relatively short-term costs and benefits: this presents difficulties in dealing with long-term issues such are env, education etc.
What time convention is usually used for cash flows?
End of period
How is the Net Present Value (NPV) calculated?
Bring all cash flows back to time 0 with the general time value equation.
The discount rate used (i) is the cost of capital/opportunity cost
When should a project be selected? (according to the NPV)?
When NPV > 0, or NPV = 0 and provides opportunities for business expansion.
NPV drawback?
Does not measure the efficiency of an investment
PI?
Equation?
When to accept a project based on this?
**where are CFs discounted to?
Profitability Index: PI = 1 + PVR Equivalent to (Production CFs)/(pre-production CFs) *CFs are discounted *Accept project when PI >= 1
Name 3 non-discounted cash flow methods
- TCF (Non-discounted)
- ARR
- PP (Non-discounted)
Name 5 Discounted CF methods
- Discounted PP
- NPV
- PI
- PVR
- IRR
Possible CF Inflow sources? (3)
Sales
Benefits (reduction of costs - e.g. through tax deduction and depreciation)
Disposal of assets
Possible CF outflows? (4)
CAPex - Capital Expenditures
Operating Expenses
Tax Payments
Rehabilitation expenditures
Incremental IRR: Given two projects A and B, when do you calculate A - B and when do you calculate B - A?
You do whatever results in your first CFo being negative.