Flashcards in Q3 Deck (8)
Explain the problems caused by inflation in NPV analysis, and how it can be incorporated into NPV models
Inflation is uncertain and therefore hard to predict
Firstly, money cash flows can be estimated and discounted at the money discount rate
Secondly, real cash flows can be estimated and discounted at the real discount rate
Identify 3 disadvantages of payback
Is not concerned with maximising wealth
Does. It consider all cash flows
Can encourage short termism
Why does money have a time value?
Risk, money in the hand is certain, future cash is uncertain
A smaller current investment can produce a larger future value
Subjective rate of time preference, human nature is prefer consumption now than in the future
Explain what is meant by sensitivity analysis
Sensitivity analysis looks at how sensitive the expected outcome of a project is to changes in the various components of the model. The components of the model will be stress tested to see how much they change before the project becomes unattractive
What is a deterministic model?
Does not allow for risk and the figures are the actual figures expected with no allowance for and deviation from those figures
What is a probabilistic model?
Allows for a range of outcomes by introducing probability. Each figure will be assigned a probability distribution which will be defined by the range of possible figures and the nature of the probability distribution within that range
What is risk?
An estimate of the probability distribution can be made because the probability distribution is know