Flashcards in Week 1 - Introduction To Capital Budgeting Deck (12)

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1

## What are the two main ways projects are evaluated? And what falls under each category?

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Accounting based

- Average Accounting Return

Cash flow based

- Payback period

-Net Present Value (NPV)

- Internal Rate of Return (IRR)

- Profitability Index (PI)

2

## What is Net Present Value (NPV)? And what is the investment rule regarding NPV?

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Net present value is the sum of cash flows discounted at a given rate.

Invest if NPV is greater than 0

Abandon if NPV is less than 0

3

## What is the ‘Cost of Capital’?

### The money an investor/firm requires in return for investing in a capital budgeting project such as building a new factory

4

## What is the ‘Internal Rate of Return’ (IRR)?

### A measure of the annual rate of return given as a percentage for each year of the project

5

## What is the ‘stand alone principle’?

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The principle that focuses on the projects RESULTING incremental cash flows ONLY.

It does not take into account cash flows that would exist without the project

6

## What is the ‘rule’ in capital Budgeting?

### If our decision doesn’t affect cash flow, then the cash flow should not affect our decision

7

## What are the three steps to evaluating a proposed project?

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1) Get a set of Pro-forma financial statements.

2)Compute future cash flows from the figures on the pro-forma.

3)Evaluate the project using the ‘Decision rules’. (NPV, IRR, PI).

8

## Three things to look out for when appraising a project

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- Incidental effects. (Cannibalisation/Erosion).

- Opportunity costs.

- Allocated costs (Costs incurred but not directly related to the project)

9

## What is ‘Net Working Capital’ (NWC)?And What is the equation for Net Working Capital (NWC)?

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Net working capital is the money left in a business after Current liabilities and Current Assets have been subtracted.

NWC= Current Assets - Current Liabilities = (Cash + Inventory + Receivables - Payables)

10

## What is Free Cash Flow (FCF) and What is the equation for Free Cash Flow (FCF)?

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Free Cash Flow (FCF) is the cash flow available to all investors and creditors within a company.

Free Cash Flow (FCF) = Operating cash flow (OCF) - Capital Expenditure - Net Working Capital (NWC)

11

## What is ‘Operating Cash Flow’ (OCF)? And What is the equation for Operating Cash Flow (OCF)?

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Operating Cash Flow (OCO) is the cash flow generated by a companies normal business operations

Operating cash flow = Gross Profit - Tax

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