Investment Appraisal 2 Flashcards
(45 cards)
What does ignoring inflation lead to
Ignoring inflation leads to underestimated costs and overvalued returns
What are the two approaches to ignore inflation
The two main approaches are:
- Real terms
- Nominal terms
What happens with real terms
Real terms: Ignore inflation and use a real discount rate
What happens with nominal terms
Nominal terms: Inflate future cash flows and use a nominal discount rate
How can you convert real to nominal cash flows
FVn = FVr (1 + i)↑t
Where:
- FVn = future value in nominal terms
- FVr = real value
- i = inflation rate
- t = time
What do you use to convert real discount rate to nominal
Use the Fisher Equation to convert real discount rate to nominal
What is the fisher equation
Fisher equation = (1 + Rn) = (1 + Rr)(1 + i)
What are the key tax items affecting cash flows
Key tax items affecting cash flows are:
- Corporation tax on profits
- Capital allowances
- Timing
How long are tax impacts delayed by
Tax impacts are delayed by one year
When is tax year settled
Tax year is settled after the financial year ends
What does WDA allow companies to deduct
WDA allows companies to deduct a % of asset value annually
What does WDA reduce to create
WDA reduces taxable income, creating tax savings
What should you adjust WDA based on in the final year
In the final year, adjust WDA is based on residual value
Final WDA =
Final WDA = Disposal proceeds - TWDV (tax written down value)
What is IRR
IRR is the discount rate at which NPV = 0
What does IRR show
IRR shows the expected rate of return for a project
How do you calculate IRR
IRR = Rl + (NPVl / NPVl - NPVh) (Rh - Rl)
What are the advantages of IRR
Advantages of IRR:
- Uses cash flows
- Incorporates time value of money
- Output is a percentage
What are the drawbacks of IRR
Drawbacks of IRR:
- Doesn’t consider project size
- Assumes reinvestment at IRR
- Multiple IRRs if cash flows change signs multiple times
- Can give misleading signals when compared to NPV
What does NPV always align with
NPV always aligns with shareholder wealth maximisation
Does IRR always have to align with shareholder wealth maximisation
IRR does not always align with shareholder wealth maximisation
What are the different types of investment project types
The different investment project types are:
- Independent
- Mutually exclusive
- Mutually dependent
- Divisible
- Indivisible
What are independent projects like
Independent projects don’t affect each other
What is the decision rule with independent projects
The decision rule for independent projects are: Accept all with NPV ≥ 0
