Week 2 - Investment Appraisal/Valuations

Question 1

Discount factor formula

Answer 1

DF = 1/(1+r)^n

Question 2

Annuities def. and formula

Answer 2

Repeat payments of same amount for multiple periods. Multiply the payment by this formula

1 - (1+r)^-n/r

Question 3

Perpertuity def. and formula

Answer 3

Regular payment received forever. Multiply yearly payment by formula

PV of perpetuity = 1/r

Question 4

NPV

Answer 4

Add together all cash flows discounted back to present value

e.g.
PV = FV1 * DF1 + FV2 * DF2 etc…

Question 5

IRR formula and def.
MUST KNOW FOR EXAM

Answer 5

Discount rate which when applied to the cash flows of a project gives an NPV of 0

Use any discount rate to calculate NPV of a formula.

IRR = A% + NPV at A%/(NPV at A% - NPV at B%) x (B% - A%)

A% is the lower selected discount rate, B% is the higher selected discount rate. Remember, these can be randomly selected

Question 6

Real interest rate formula

Answer 6

1+r = 1+m/1+i

m = nominal interest rate
i = expected annual inflation rate

Question 7

Sensitivity Analysis def. and formula

Answer 7

NPV of project/PV of cash flows

subject to uncertainty

Low number means the project has high sensitivity so more risky

Question 8

The 5 Investment appraisal methods

Question 9

NPV 4 Steps

Answer 9

1) identify relevant Cash Flows
2) estimate discount factor
3) discount all factors back to PV
4) Select project with highest NPV