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FIN20040 - Foundations of Finance > Investment Project analysis > Flashcards

Flashcards in Investment Project analysis Deck (28)
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1
Q

Define a relevant cash flow for a project

A

Change in firm’s overall future cash flow that comes about as a direct consequence of the decision to take that project - These are incremental cashflows

2
Q

Define a stand alone principle

A

Assumption that evaluation of a project may be based on the projects incremental cash flows. Looks at projects independently

3
Q

Define incremental cash flows

A

Difference between a firm’s future cash flows with a project and those without the project. These cash flows for a project consist of all changes in firm’s future cash flows that are a direct consequence of taking the project.

4
Q

Define irrelevant cash flows

A

Exists regardless of taking/not taking project

5
Q

Define a sunk cost

A

Sunk cost is a cash flow that has already occured and cannot be recovered. In evaluating a new project sunk costs are ignored ex: asset’s historical cost

6
Q

Define opportunity costs

A

Lost revenues you forego making the proposed investment. In evaluating a new project you incorporate opportunity cost as these resources will not be used elsewhere

7
Q

Give an example of an opportunity cost

A

Asset owned that will be used in projects: If not used you will sell so the opportunity cost = market value

8
Q

Name two side effects for a project and are they included or not?

A

Erosion, Synergy - you include side effects in evaluating a project

9
Q

Define erosion

A

When a new product reduces cash flow of existing products. (relevant when it would not have been lost anyways)

10
Q

Define synergy

A

Occurs when new product increases cash flows of existing products

11
Q

How does NWC work for a project?

A

It is considered part of incremental cash flow and the firm supplies it at the beginning of a project, recovering it at the end

12
Q

Formula for NWC

A

Current assets- current liabilities

Usually cash + inventory + receivables - payables

13
Q

Why are financing costs not included in evaluating a project

A

Dividends/principal repaid. We only consider cashflows generated by assets of a project

14
Q

Define pro forma statements

A

Projecting future years operations needs estimates

15
Q

What is the formula for operating cash flow

A

Net income + depreciation - Increase (+decrease) in NWC

16
Q

What is the formula for a project cash flow

A

Operating cash flow - project capital spending

17
Q

What is an increase in NWC in relation to project cash flows

A

negative - cash outflow

18
Q

What is an decrease in NWC in relation to project cash flows

A

positive - cash inflow

19
Q

Why is depreciation added to find operating cash flow

A

its a non cash item

20
Q

Define reducing balance method of depreciation

A

Method allowing for the accelerated write off of assets under various classifications - depends on residual value of previous year

21
Q

Define straight line depreciation

A

Method allowing for linear write off of assets over their lifetime. - Divide value of asset by no. of years of life

22
Q

After depreciation what does the difference between the sale price and book value tell you about tax

A

Sale price < book value - company obtains tax savings

Sale price> book value - salvage company pays tax difference

23
Q

Define forecasting risk

A

Possibility that errors in projected cash flows will lead to incorrect decisions - estimation risks. Is estimated NPV reliable? You must answer questions like the source of value of the NPV, why is a product better, why is NPV > 0

24
Q

Define scenario analysis

A

Determination of what happens to NPV estimates when we ask what-if questions. Changes all variables to analyst best and worst case
Best and worst case must be reasonably likely

25
Q

Explain paralysis of analysis in relation to scenario analysis

A

Looking at more and more possibilities but still won’t tell you what to do.

26
Q

Explain sensitivity analysis

A

Investigation of what happens to NPV if one variable changes. Useful in pinpointing which forecasting error will do most damage looking at best and worst case scenario

27
Q

What are the benefits and weakness of sensitivity analysis

A

If there are many NPV < 0 you know investigation is needed
Analysis identifies the influential variables - these must be estimated with more accuracy
Weakness: each variable is in isolation and it is still not conclusive

28
Q

Define simulation analysis

A

Mixed scenario and sensitivity analysis