Financial Management - Valuation
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- Created by: kayleigh.aston6
- Created on: 18-05-21 13:40
What are irrelevant cash flows, for the purposes of an NPV?
- Depreciation
- Sunk Costs - anything already spent
- Unavoidable costs, such as centrally allocated fixed costs
- Finance Costs - interest is already included in the cost of capital discount rate
- Sunk Costs - anything already spent
- Unavoidable costs, such as centrally allocated fixed costs
- Finance Costs - interest is already included in the cost of capital discount rate
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How do you calculate the Money rate using Fishers Equation?
(1+m) = (1+r)(1+i)
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What is the formula for Equivalent Annual Cost?
EAC = NPV of one cycle length/Annuity Factor for cycle length
3 of 30
What is the 3 step method to calculate Replacement Analysis
1. Calculate NPV for each replacement strategy
2. Calculate the EAC of the NPV for each strategy
3. Choose the strategy with the lowest equivalent annual cost
2. Calculate the EAC of the NPV for each strategy
3. Choose the strategy with the lowest equivalent annual cost
4 of 30
What are the limitations of replacement analysis?
RA assumes that a business is replacing like for like, and a once-and-for all replacement cycle. This is unlikely to be the case due to:
- Changing technology which can mean greater obsolescence, shortening replacement cycles.
- The use of machines is unl
- Changing technology which can mean greater obsolescence, shortening replacement cycles.
- The use of machines is unl
5 of 30
Name and define the 2 types of rationing
1. Hard Rationing: Where external factors limit funds (e.g. caps on borrowing, covenants etc)
2. Soft Rationing: Internal constraints are imposed (e.g budgets, policies)
2. Soft Rationing: Internal constraints are imposed (e.g budgets, policies)
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How do you ration projects for single period (divisible projects)?
Rank the projects by NPV per £ of capital outlay - PROFITABILITY INDEX
Once ranked, you can choose projects starting with the highest NPV per £ capital, until your budget is gone, as the projects are divisible, you can use a portion of a project.
Once ranked, you can choose projects starting with the highest NPV per £ capital, until your budget is gone, as the projects are divisible, you can use a portion of a project.
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How do you ration projects for indivisible projects?
You must use trial and error to find the optimal combination of projects.
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How do you ration mutually exclusive projects?
Work out the NPV per £ capital employed for each GROUP of projects.
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What is the definition of SVA?
Shareholder Value Analysis: The process of analysing the activities of a business to identify how they will result in increasing shareholder wealth.
10 of 30
Name the 5 Real Options
Follow-on options
Abandonment options
Timing options
Growth options
Flexibility options
Abandonment options
Timing options
Growth options
Flexibility options
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What are the risks of investing overseas?
Political Risk: Caused through government action, which can limit the ability to expatriate cash. Caused by quotas, tarrifs, taxation.
Cultural Risk: Risks relating to customs, tastes, laws and language. Products or services may be unacceptable e.g the sa
Cultural Risk: Risks relating to customs, tastes, laws and language. Products or services may be unacceptable e.g the sa
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What are the methods of assessing risk?
- Probability Distributions
- Expected Values
- Simulation
- Portfolio Theory
- The Capital Asset Pricing Model
- Risk adjusted discount rates
- Expected Values
- Simulation
- Portfolio Theory
- The Capital Asset Pricing Model
- Risk adjusted discount rates
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What are the techniques for handling uncertainty?
- Setting a minimum payback period for projects
- Making prudent estimates to assess the worst possible outcome of a scenario
- Assessing the worst and best possible situations to obtain a range of outcomes
- Using sensitivity analysis to measure the 'mar
- Making prudent estimates to assess the worst possible outcome of a scenario
- Assessing the worst and best possible situations to obtain a range of outcomes
- Using sensitivity analysis to measure the 'mar
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How do you calculate sensitivity?
Sensitivity = NPV of project/PV of cashflows subject to uncertainty
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What are the strengths of Sensitivity Analysis?
- It is simple to understand
- It identifies the areas which are critical to a project, so they can be more closely monitored
- Information is presented to management in a format that facilitates subjective judgement
- It identifies the areas which are critical to a project, so they can be more closely monitored
- Information is presented to management in a format that facilitates subjective judgement
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What are the weaknesses of Sensitivity Analysis?
- Only one factor at a time can be analysed
- Ignores probability: it simply states how much a factor would have to change, but does not look at the probability of it doing so
- Independence; It assumes variables can change independently of others
- There
- Ignores probability: it simply states how much a factor would have to change, but does not look at the probability of it doing so
- Independence; It assumes variables can change independently of others
- There
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What is the main difference between Sensitivity and Simulation?
Sensitivity only allows you to change one factor at a time, whereas simulation allows the affect of more than one variable changing to be assessed.
18 of 30
What are the advantages of Simulation?
- It gives more information about possible outcomes and their relative probabilities
- It is useful for problems which cannot be solved analytically
- It is useful for problems which cannot be solved analytically
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What are the limitations of simulation?
- It does not make a decision, but gives more information about possible outcomes
- It requires a computer
- It can be expensive to design and run a simulation for complex projects
- Monte Carlo techniques require assumptions to be made about probabilitie
- It requires a computer
- It can be expensive to design and run a simulation for complex projects
- Monte Carlo techniques require assumptions to be made about probabilitie
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What are the advantages of expected values?
- The information is reduced to a single number for each decision option
- The idea of an average is easy to understand
- The idea of an average is easy to understand
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What are the limitations of expected values?
- The probabilities may be difficult to estimate
- The expected value may not correlate to any of the possible expected outcomes
- It ignores risk: the average gives no indication as to the spread of possible results.
- The expected value may not correlate to any of the possible expected outcomes
- It ignores risk: the average gives no indication as to the spread of possible results.
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What is the portfolio effect?
The idea that by diversifying your risk (i.e. having a portfolio), you are obtaining the maximum rewards from a set amount of risk.
An investor who is well diversified, will only be subject to SYSTEMATIC risk
An investor who is well diversified, will only be subject to SYSTEMATIC risk
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Define Systematic Risk
- MARKET risk, which cannot be diversified away.
- Caused by macroeconomic variables such as interest rates, exchange rates, taxation and inflation.
- Caused by macroeconomic variables such as interest rates, exchange rates, taxation and inflation.
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Define Unsystematic Risk
- Unique or SPECIFIC risk, which can be diversified away.
- Related to factors specific to that particular investment, e.g. the labour force of that particular firm might strike, or the IT systems might fail.
- Related to factors specific to that particular investment, e.g. the labour force of that particular firm might strike, or the IT systems might fail.
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Generally, how many securities do you need to hold to eliminate unsystematic risk?
- It is not necessary to hold the 'whole market portfolio'
- 15-20 randomly selected securities will be enough to diversify away the majority of the unsystematic risk
- 15-20 randomly selected securities will be enough to diversify away the majority of the unsystematic risk
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Which model do you use to calculate the systematic risk of investments?
The Capital Asset Pricing Model (CAPM)
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Explain the CAPM model with reference to Rm
and Rf, and the Beta
and Rf, and the Beta
1. Rf- Investors require a return on their investment to reflect the time value of money (the risk free rate of return)
2. On top of this, investors also require a premium for systematic risk (Rm-Rf)
3. The Beta is the level of individual risk for that pa
2. On top of this, investors also require a premium for systematic risk (Rm-Rf)
3. The Beta is the level of individual risk for that pa
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What are the weaknesses in CAPM?
- The companies shareholders may not be diversified.
- CAPM depends on a perfect capital market
- There may be errors in the statistical analysis used to calculate the Beta.
- CAPM depends on a perfect capital market
- There may be errors in the statistical analysis used to calculate the Beta.
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What are the alternatives to CAPM?
- Alpha Value
- Arbitrage Pricing Model (APM)
- Farma-French three-factor model
- Bond-yield plus premium approach
- Fundamental Beta
- Arbitrage Pricing Model (APM)
- Farma-French three-factor model
- Bond-yield plus premium approach
- Fundamental Beta
30 of 30
Other cards in this set
Card 2
Front
(1+m) = (1+r)(1+i)
Back
How do you calculate the Money rate using Fishers Equation?
Card 3
Front
EAC = NPV of one cycle length/Annuity Factor for cycle length
Back
Card 4
Front
1. Calculate NPV for each replacement strategy
2. Calculate the EAC of the NPV for each strategy
3. Choose the strategy with the lowest equivalent annual cost
2. Calculate the EAC of the NPV for each strategy
3. Choose the strategy with the lowest equivalent annual cost
Back
Card 5
Front
RA assumes that a business is replacing like for like, and a once-and-for all replacement cycle. This is unlikely to be the case due to:
- Changing technology which can mean greater obsolescence, shortening replacement cycles.
- The use of machines is unl
- Changing technology which can mean greater obsolescence, shortening replacement cycles.
- The use of machines is unl
Back
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