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48 Cards in this Set
- Front
- Back
Incremental Cash Flows
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Any changes in the firms future cash flows that are a direct consequence of taking on the project
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What is the main cash flow we are interested in?
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Unleveraged Free Cash Flows to Capital (FCF)
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What does unleveraged mean?
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No debt
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What are the four main components of FCF?
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- Operating Cash Flow (OCF)
- Change in NWC (Net Working Capital) - CAPEX (Capital Expenditure) - Tax Effects |
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What is the formula to calculate FCF?
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OCF - Change in NWC - CAPEX + Tax effects
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What is the stand alone principle?
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The assumption that evaluation of a project may be based on the project's incremental cash flows
- Evaluated in isolation from other projects, like a mini-firm |
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Are we interested in before or after tax cash flows?
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After tax cash flows
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Sunk Cost
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A cost that has already been incurred and cannot be gotten back upon accepting or rejecting the project and thus should not be considered in the investment decision
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Sunk Cost E.g.
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Consultancy Fee, Market research
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Opportunity Cost
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The most valuable alternative that is given up if a particular investment is undertaken
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Opportunity Cost E.g.
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Building on a piece of land you own instead of selling it.
Cost is what you could sell it for today, not what you bought it for. |
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Erosion
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The cash flows of a new project that come at the expense of a firm's existing projects
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Financing Costs
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Interest Paid, Dividends Paid, Principal repaid
- These are a component of cash flow to creditors and we only deal with cash flows from assets. - EXCLUDE |
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A pro forma
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Projected Financial Statement - a statement projecting future years' operations
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OCF formula
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Revenue
- Fixed Costs - Variable Costs - Depreciation ---------------------- EBIT - Taxes ----------------------- EBIAT + Depreciation ------------------------ OCF |
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What can EBIAT also be referred to as?
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Net Income
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EBIT
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Earnings before interest and taxes
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EBIAT
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Earnings before interest after taxes
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What is depreciation?
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An asset losing value over time
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What is depreciating 'straight-line to zero'?
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An equal amount of depreciation occurs each year, until the book value is zero
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How would we calculate depreciation?
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Original value of asset/life (number of years) of asset
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What is Net Working Capital?
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The money spent at the beginning of the project (capital supplied) to do such things as build up inventory
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What does NWC do over the life of a project?
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Negative at start
Constant throughout duration Recovered at the end |
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Change in NWC equation:
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Current Assets - Current Liabilities
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What happens to the NWC if the project is entirely cash?
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The only change is in the inventory as there are no accounts payable or receivable.
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What is CAPEX?
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-Capital Expenditure
- The amount spent on PPE (Property, Plant and Equipment) at the beginning of the project |
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What does CAPEX include other than PPE?
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Shipping or installation costs
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What is the CAPEX formula?
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NET PPE (current)
- NET PPE (prior) + Depreciation |
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What is CAPEX often?
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Just a large outflow of cash at t=0
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Book value
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The price calculated
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Market value
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The actual price offered when buying or selling (i.e. in the market)
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Book value equation
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Initial cost - accumulated depreciation
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What is the tax effect?
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The after- tax salvage value
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What is the salvage value?
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The price you could sell the asset to someone else for
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What is the after-tax salvage value equation?
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After-tax salvage = salvage(selling price) - T x (salvage - book value)
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What is the T x (Salvage - book value) part of the after-tax salvage value equation?
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The tax credit
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What is the alternative way to calculate OCF?
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The depreciation tax shield
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Depreciation tax shield equation:
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OCF = (Sales - costs) x (1-T) + Depreciation x T
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What is Component 1 of the Depreciation tax shield equation?
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(Sales - Costs) x (1-T) = project's cash flow if there were no depreciation expense
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What is Component 2 of the Depreciation tax shield equation?
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Depreciation x T = Depreciation Tax Shield
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Forecasting Risk
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The possibility that errors in projected cash flows will lead to incorrect decisions
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What are the two main approaches to resolving forecasting risk?
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- Sources of Value
- Analysis |
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Sources of Value
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Look at what the main source is that leads to a positive NPV
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Scenario Analysis
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Asking what-if questions and looking at the all-round best and worst case scenarios by setting upper and lower limits
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Sensitivity Analysis
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Investigation of what happens to NPV when only one variable is changed
- Useful in pinpointing areas where forecasting risk is especially severe |
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What do the two types of analysis' show?
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Useful in pointing out where forecasting errors will do the most damage but NOT what to about it
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Interest Payments on Debt
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ARE tax-deductible
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What is the benefit of paying tax on debt?
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It lowers the cost of debt
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