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Financial Management > Week 7 > Flashcards

Week 7 Flashcards

1
Q

What is investment appraisal?

A

Known as capital budgeting.
Prices of evaluating and selecting long-term investments that would contribute towards the goal of increasing the firms value

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2
Q

What is the main motives for capital expenditure?

A

Expansion
Replacement
Renewal

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3
Q

What are the two types of projects?

A
  1. Independent projects
  2. Mutually exclusive projects
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4
Q

What are independent projects?

A

Projects whereby the acceptance of one does not preclude others from being considered

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5
Q

What are mutually exclusive projects?

A

Projects that serve the same function. The acceptance of one project in a group prevents all other projects from being chosen

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6
Q

What is cash flows?

A

Net amounts of cash received for a project

Formula:
Net cash flow = cash inflows - cash outflows

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7
Q

How do you calculate profit?

A

Net cash flows - depreciation

If depreciation not given, calculate it using straight-line method

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8
Q

What is deprecation?

A

Loss in the value of an asset

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9
Q

How do you calculate the straight line method?

A

Two ways:

(Cost price-scrap value) x %

Or

(Cost price-scrap value)/useful life

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10
Q

What are three investment appraisal techniques based on cash flow?

A
  • pay back period
  • bet present value
  • internal rate of return
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11
Q

What is the one investment appraisal based on profits?

A

Accounting rate of return

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12
Q

What is the payback period?

A

Measures how long will it take for the investment to pay for itself out of net cash inflows which it is expected to generate

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13
Q

What are the advantages of the payback period?

A

Easy to apply

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14
Q

What are the disadvantages of the payback period?

A

Ignored cash flows beyond the payback period

Ignored the time value of money

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15
Q

What is the accounting rate of return method?

A

Compares the average cost of the investment
It uses profits instead of cash flow

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16
Q

How do you calculate the average investment?

A

Initial investment + end investment/2

17
Q

How do you calculate the AAR

A

Average annual profit/average value of investment

18
Q

Advantages of AAR?

A

Simple to calculate

Looks at the whole life of the project

19
Q

Disadvantages of AAR?

A

Ignores time value of money

Uses profits instead of cash flows

Ignored taxation and capital allowances

20
Q

What is the bet present value method?

A

Takes into account the time value of money. Makes use of a principle called discounting.

21
Q

What is annuity?

A

It is a stream of similar receipts or payments that are receivable or payable in regular intervals

22
Q

How do you project evaluate?

A

Net present value is the difference between discounted future cash outflows and discounted future cash inflows from an investment period.

NPV = 0 : accept

Project rate of return = business’s required rate of return

NPV = positive : accept

Project rate of return is greater than required rate of return

NPV = negative

Project rate of return is less than required rate of return

23
Q

What is internal rate of return?

A

Represents true interest rate earned on an investment during its economic life

It’s the maximum cost of capital that can be applied to finance a project without causing harm to shareholders

24
Q

When does interns rate of return happen?

A

When NPV = 0

25
Q

Discount rates relation to NPV?

A

Higher discount rate means lower NPV
Lower discount rate means higher NPV

26
Q

What is the method to IRR?

A
  1. Find 2 %’s that IRR lies between
  2. Use payback period to detains the 2 %’s via discount factor tables
  3. Afterwards, calculate NPV for each
  4. Make sure you have 1 positive NPV and 1 negative NPV
  5. Calculate IRR with formula
27
Q

How do you calculate IRR?

A

Look at textbook

Financial Management (7 decks)

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