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35 Cards in this Set
- Front
- Back
Type of finance available for a project depends on |
Size, duration, risk, capital asset banking |
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Free cash flow |
Cash that isn't retained or reinvested in a business |
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What does free cash flow represent |
Cash flow available to: All providers of capital of a company To pay dividends or finance additional capital projects |
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Free cash flow formula |
Revenue less costs less investments |
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Relevant cash flows |
Those costs and revenues that are: Future Incremental |
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Which NPV costs should be ignored |
Sunk Committed Non cash Apportioned overheads |
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TAD rules |
TAD is calculated on a reducing balance basis Total TAD is dependent on the total fall in value over the period (cost less scrap) TAD is claimed as really as possible No TAD in year of disposal In the year of sale or scrap a balancing charge arises |
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IRR is sensitive to |
Increase in cost of finance Increase in investors' perception of the potential risk Any alterations to estimates used in NPV appraisal |
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What can affect returns required by investors? |
Interest rates increases: increases returns required by investors Company specific factors: actions of competitors affect viability of business model impacting the return. |
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Problems with using IRR |
The assumptions are unrealistic i.e. reinvestment at IRR Decision rule is not clear cut i.e. two IRRs possible Choosing between projects Doesn't account for changing cash flow patterns Cost of financing and return are likely to be different |
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Advantages of MIRR |
Is unique Gives a measure of returns from a project Is a simple percentage |
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Interpretation of MIRR |
Measures economic yield under the assumption that cash surpluses are reinvested at the current CoC Shows max CoC firm can sustain |
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MIRR method |
Terminal value of cash inflows at the company's reinvestment rate Present value of outflows discounted at company's cost of finance MIRR found by taking nth root of (TV inflows/PV outflows) subtract one. Where n = length of the project in years. |
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Discounted payback period |
Measures the length of time before the discounted cash returns from a project covers initial investment. |
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Concept of duration |
Measures average time to recover present value of project. Indicates when the bulk of project value will be captured. |
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Modified duration |
If discount rate changes what will be the impact on duration |
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Profitability index |
NPV/PV of capital invested Used to deal with single period capital rationing |
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What does long term capital rationing indicate |
Form should expand its capital base through issue of new finance to the markets |
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Linear programming |
A technique dealing with scarce or rationed resources. Solution shows optimum allocation of scarce resources between options being considered |
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How to formulate linear program |
Define the unknowns Formulate the objective function Express constraints in terms of inequalities including non negatives |
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Using risk adjusted WACC |
Assumes business risk of CQC and financial risk of company and I'd therefore appropriate for appraisal |
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Limitations of using CQC |
Assumes debt is perpetual whereas debt is actually finite Issue costs on equity are ignored |
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APV calculation |
Base case NPV + financing impact = APV |
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How to value base case investment element for APV |
Find project asset beta Calculate base discount rate Keu by putting asset beta in formula to reflect just business risk Calculate base case NPV |
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How to value PV of financing package APV |
Financing cash flows: issue costs and tax relief Discount at Kd or risk free rate |
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Issue costs APV |
Usually added on top so gross up funds to be raised. e.g. if 3% issue costs then sum of debt/0.97 and take 3% of that as issue costs |
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PV of debt and equity issue costs |
Equity issue costs (non tax deductible) Debt issue costs are tax deductible RTQ for timings of tax relief cash flows. |
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PV of debt issue costs formula |
Issue costs at T0 Tax relief at CT rate PV of tax relief (RTQ for timings of CFs) |
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PV of the tax replied on interest payments |
Bonds - interest paid at fixed amount each year. Annual tax relief = Total loan * interest rate*tax rate. X Annuity factor for ten years. X Year one discount factor (if tax is delayed one year) X PV of the tax shield. X |
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PV of interest payments made for bank loans |
Amount of repayment = (amount of loan/relevant annuity factor) Calculate annual interest charge (annual amount*annual interest rate) |
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APV formula |
Base case NPV plus NPV of tax shield less NPV of issue costs |
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Subsidized loan |
PV of interest saved less PV of tax relief lost Opportunity benefit of the subsidized loan |
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Debt capacity APV |
If amount of debt raised is lower than total debt capacity increase of the project then use theoretical debt capacity to calculate APV |
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Advantages of APV |
Steep by step approach gives clear understanding of the elements of the decision Can evaluate any type of financing package More straightforward than using adjusted APV |
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Disadvantages of APV |
Based on Modogliani and Miller therefore: Ignores bankruptcy risk, tax exhaustion and agency costs Assumes debt is risk free and irredeemable |