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Level 5 Corporate Financial Management > Investment Appraisal 1 > Flashcards

Investment Appraisal 1 Flashcards

(57 cards)

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1
Q

What is capital investment

A

Capital investment is long-term, strategic spending decisions

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2
Q

What are some examples of capital investment

A

Examples of capital investment are:
- Launching a new product
- Acquiring another business
- Building new infastructure

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3
Q

Why does appraise of investments matter

A

Why Appraise Investments?
- Projects are often irreversible and require substantial capital
- Investment decisions directly impact shareholder wealth

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4
Q

What projects should be accepted and rejected

A

Accept projects expected to increase shareholder wealth and reject those that diminish it

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5
Q

What are the different investment appraisal methods

A

The different investment appraisal methods are:
- Accounting rate of return (ARR)
- Payback Period (PBP)
- Net Present Value (NPV)
- Internal Rate of Return (IRR)

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6
Q

What is the focus of ARR

A

The focus of ARR is profitability

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7
Q

Is ARR good time value of money

A

ARR is not good time value of money

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8
Q

What is ARR output like

A

ARR output is in % returns

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9
Q

What is the focus of PBP

A

The focus of PBP is liquidity and risk

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10
Q

Is PBP good time value of money

A

PBP is not good time value of money

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11
Q

What is PBP output like

A

PBP output is in time

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12
Q

What is the focus of NPV

A

The focus of NPV is shareholder value

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13
Q

Is NPV a good time value of money

A

NPV is a good time value of money

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14
Q

What is NPV output like

A

NPV output is in £ value

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15
Q

What is IRRs focus

A

IRRs focus is on rate of return

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16
Q

Is IRR a good time value of money

A

IRR is a good time value of money

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17
Q

What is the output like with IRR

A

IRRs output is a % return

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18
Q

What does ARR measure

A

ARR measures average accounting profit against investment

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19
Q

What are the two calculation methods for ARR

A

Two calculation methods of ARR are:
1. Initial Investment
2. Average Investment

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20
Q

ARR initial investment calculation

A

ARR = Average Profit / Initial Investment X 100

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21
Q

ARR average investment calculation

A

ARR = Average Profit / ((Initial + Residual) / 2) X 100

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22
Q

What are the advantages of ARR

A

Advantages of ARR are:
- Simple to calculate and understand
- Familiar to managers

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23
Q

What are the drawbacks of ARR

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A

Drawbacks of ARR are:
- Based on subjective accounting profits
- Ignores time value, risk, project size, and cash flows

24
Q

What are cash flows

Study These Flashcards
A

Cash flows = actual inflows/outflows

25
What are profits
Profits = non-cash items like depreciation, provisions, ect
26
What does investment appraisal use
Investment appraisal (except ARR) uses cash flows
27
What must adjustments strip out
Adjustments must be made to strip out: - Depreciation - Non-incremental costs - Sunk costs - Financing items
28
What may projects require upfront
Projects may require investments in working capital upfront
29
When is upfront investment usually recovered
Upfront investment is usually recovered at project end
30
What does upfront investment affect
Upfront investment affects cash flow timing and should be included in appraisals
31
What are relevant cash flows
Relevant cash flows are only those incremental to the project decision
32
What is included in relevant cash flows
Relevant cash flows include: - Capital costs - Operating cash inflows/outflows - Tax impacts - Disposal proceeds
33
What is included in irrelevant cash flows
Irrelevant cash flows include: - Sunk costs - Allocated overheads not directly caused by the project - Financing items - Depreciation
34
What is the payback period
the payback period is how long it takes to recover the initial outlay from cash inflows
35
What are the advantages of payback period
The advantages of payback period are: - Focuses on liquidity and early returns - Simple and intuitive - Favours safer, quicker projects
36
What are the drawbacks of payback period
The drawbacks of payback period are: - Ignores cash flows after payback period - Ignores project size and overall returns - Ignores time value of money - Decision rule is arbitrary
37
Why is a pound today worth more that a pound tomorrow due
A pound today is worth more that a pound tomorrow due to: - Opportunity cost - Inflation - Uncertainty
38
What is discounting used to calculate
Discounting is used to calculate the present value (PV) of future cash flows
39
What is the calculation for PV of a single sum
PV = FV / (1+ r)^t
40
What is the calculation of PV of an annuity
PV = FV X [(1 - (1 + r)^-t) / r]
41
What does PV tell us
PV tells us what future money is worth today, based on a chosen discount rate
42
What is Net Present Value
NPV is the sum of all discounted relevant cash flows, including initial investment
43
When should you accept with NPV
Accept if NPV ≥ £0
44
When should you reject with NPV
Reject < £0
45
What does a project with an NPV ≥ £0 increase
A project with an NPV ≥ £0 increases shareholder wealth
46
What does a project with a NPV < £0 do
A project with an NPV < £0 destroys shareholder wealth
47
What are the advantages of NPV
Advantages of NPV are: - Incorporates all cash flows and TVM - Reflects project size and risk - Decision rule always aligns with shareholder wealth maximisation
48
What are the limitations of Net present value
The limitations of NPV are: - Less intuitive for non-financial stakeholders - Relies on accurate estimates of: - Cash flows - Discount rates - Timing assumptions
49
Is ARR cash flow based
ARR is not cash flow based
50
Is time value considered with ARR
Time value is not considered with ARR
51
Does ARR align with shareholder wealth
ARR doesn't align with shareholder wealth
52
Is PBP cash flow based
PBP is sort of cash flow based
53
Is time value considered with PBP
Time value is not considered with PBP
54
Does PBP align with shareholder wealth
PBP doesn't align with shareholder wealth
55
Is NPV cash flow based
NPV is cash flow based
56
Is time value considered with NPV
Time value is considered with NPV
57
Does NPV align with shareholder wealth
NPV aligns with shareholder wealth

Level 5 Corporate Financial Management (6 decks)

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