Chapter 6

Question 1

Cash Flow

Discounted Cash Flow

Answer 1

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

Question 2

Capital Expenditure
Pre-production Period
Production Period

Answer 2

FILLER

Question 3

What is ARR?
Equation?
Name three things about it.

Answer 3

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

Question 4

What is the TCF?

Name three properties

Answer 4

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

Question 5

PP?
Discounted PP?

Two drawback.

Answer 5

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

Question 6

PVR?
Equation?
Two drawbacks?

Answer 6

Present value ratio = (NPV) / (sum of initial costs)

• Measures investment efficiency
• particularly useful when funds are limited

or NPV/CapEx

Question 7

BCR?
Equation?
What it includes?

Answer 7

Benefit Cost Ratio = (Benefits) / (costs)
Benefits include: revenue + salvage value @ T=0
Costs include: CAPex, operating costs, taxes @ T=0

Question 8

IRR

When can’t you use it?

Answer 8

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

Question 9

When is incremental analysis used?

Btw what’s incremental analysis again??

Answer 9

When we are asked to chose between projects that are mutually exclusive

Question 10

What are two limitations of discounted cash flow methods as evaluation techniques?

Answer 10

• 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.

Question 11

What time convention is usually used for cash flows?

Answer 11

End of period

Question 12

How is the Net Present Value (NPV) calculated?

Answer 12

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

Question 13

When should a project be selected? (according to the NPV)?

Answer 13

When NPV > 0, or NPV = 0 and provides opportunities for business expansion.

Question 14

NPV drawback?

Answer 14

Does not measure the efficiency of an investment

Question 15

PI?
Equation?
When to accept a project based on this?

**where are CFs discounted to?

Answer 15

Profitability Index: 
PI = 1 + PVR
Equivalent to
(Production CFs)/(pre-production CFs)
*CFs are discounted
*Accept project when PI >= 1

Question 16

Name 3 non-discounted cash flow methods

Answer 16

1. TCF (Non-discounted)
2. ARR
3. PP (Non-discounted)

Question 17

Name 5 Discounted CF methods

Answer 17

1. Discounted PP
2. NPV
3. PI
4. PVR
5. IRR

Question 18

Possible CF Inflow sources? (3)

Answer 18

Sales
Benefits (reduction of costs - e.g. through tax deduction and depreciation)
Disposal of assets

Question 19

Possible CF outflows? (4)

Answer 19

CAPex - Capital Expenditures
Operating Expenses
Tax Payments
Rehabilitation expenditures

Question 20

Incremental IRR: Given two projects A and B, when do you calculate A - B and when do you calculate B - A?

Answer 20

You do whatever results in your first CFo being negative.