NPV

Question 1

Assumed knowledge: On NAV Only what type of costs are included

Answer 1

Only incremental relevant cash flows are included (depreciation, sunk costs, allocated costs are ignored).

Question 2

Assumed knowledge: On NPV, interest cash flows are included or excluded?

Answer 2

Interest cash flows are also ignored because the cost of finance is reflected in the discount rate.

Question 3

Assumed knowledge:

There are two approaches to deal with inflation (money (nominal) cash flows at a money (nominal) cost of capital OR real (current) cash flows at a real (current) cost of capital).

how do you deal with them

Answer 3

Money cash flows include the impact of inflation, real cash flows do not.

Where cash flows have different rates of inflation, the money approach is required. Also, the benefits of tax allowable depreciation are money cash flows.

The relationship between a money and a real cost of capital is given by: (1 + i) = (1 + r) x (1 + h) where: i = money rate, r = real rate, h = general inflation rate

Question 4

Assumed knowledge:

working capital

Answer 4

Working capital requires an initial investment and is usually assumed to be released at the end of the project. Only the movement in the working capital investment is reflected as a cash flow during the project.

Question 5

Assumed knowledge:

what is tax allowable depreciation

Answer 5

Tax allowable depreciation (TAD) reduces the amount of tax that would otherwise be payable in respect of the project.

Question 6

in AFM with NPV, what are the two assumptions on tax

Answer 6

, questions will often assume that tax allowable depreciation is available on a straight-line basis, rather than a reducing balance basis, although you will need to be able to deal with both.

Also, AFM questions will often assume that tax is settled in the year that it arises, rather than a year in arrears. However, you will need to read the question carefully to ensure that this is the case!

Question 7

IN AFM, When using the NPV functionality, what are the assumptions

Answer 7

this functionality only works if the cash flows are for consecutive years with the first cash flow at time 1. If there are delayed cash flows, annuities of perpetuities this function will not be appropriate.

The initial investment will need to be deducted from the present value of the cash flows from time 1 onwards to arrive at the NPV of the project.

To calculate the present value of the cash flows from time 1 onwards at a cost of capital of 10%, type into the cell:

=NPV(10%, C20 ….. F20)
where C20 … F20 is the range of cash flows starting at time 1.

T1/ ONE !!!!!!!!!

Question 8

what is the shortcut NPV table in AFM

Answer 8

X= T0-TN
Y=

• Sales
• (operating costs)
• (TAD)
  = Taxable
• (tax at x%)
• add back TAD
• Initial investment @ T0
• Realisable value of Initial inv at Tn
• Working capital (T0-TN with tn assuming it’s being returned in most cases)

= Net cash flow
-Discount factor
= Present value
= NPV

WE add back the tax allowable depreciation (to recognise that it is not a cash flow).

Question 9

in NPV when deducing TAD, What is an important check you must do

Answer 9

do the sum of the TAD. This must be in line with the residual value

Question 10

what is the approch for calculating working capital required

Answer 10

Use a separate working section to calculation

x = time
y=

a investment required at start of year (in positive normal terms)

b cash flow = (T1 - t2) of part a

CHECK = SUM SHOULD BE NIL