P2 - C1 - Investment Appraisal

Question 1

Financing decisions

Answer 1

Equity - investment from owners / shareholders
Debt - Money from lenders such as banks or bonds
Retained earnings - Unspent / accumulated profits from prior periods

Question 2

Investment decisions

Answer 2

Net present value - the difference between the present value of cash inflows and the present value of cash outflows for a project
Internal rate of return - An investment in terms of the optimal rate of return for the company rather than the net value
Payback period - The length of time taken for an investment to make a return on the initial expenditure
ROCE - This compare’s a company’s capital with its earnings

Question 3

Features of NPV

Answer 3

Positive NPV is an increase in total company value, negative is a decrease
Other factors such as company strategy and business model should also be considered
Negative NPV projects shouldn’t always be rejected

Question 4

NPV and the time value of money

Answer 4

Takes into account time value of money by discounting future cash flows
Effective rate used is the cost of capital
NPV is considered superior compared with ARR, Payback and IRR

Question 5

NPV and the timing of cashflows

Answer 5

Outflows at the beginning are accounted for during initial setup
Outflows and inflows during a year are treated at financial year end
Unless specifically told cash movement is at start of year, include at the end of previous year
Legal fees are removed from calculations
Adjust for a specific apportionment

Question 6

NPV and working capital

Answer 6

At the end of the project the full amount invested will be released

Question 7

Tax in an NPV calculation

Answer 7

Follow the given instructions
Charged against net income and not cashflows
Consider the writing down allowance

Question 8

NPV with inflation

Answer 8

Cash flows with inflation - Future values must be added into calculations
Cost of capital with inflation - If the above is used then must copy across to inflation
Fisher Equation - (1+ real cost of capital) x (1+ general inflation rate)

Question 9

What is a perpetuity?

Answer 9

A constant and consistent cash flow that continues forever

Question 10

What is an annuity?

Answer 10

A financial instrument which is purchased for an initial sum which then pays out the same amount each year until a definitive end date