Search
Create
Log in
Sign up
Log in
Sign up
CFA2 Corporate Finance
STUDY
Flashcards
Learn
Write
Spell
Test
PLAY
Match
Gravity
Terms in this set (16)
28. Capital Budgeting
Testable material => Core curriculum
Capital Budgeting Principles
-Decisions based on incremental A-T (after taxes) cash flows,
not accounting income
*Sunk costs: Not incremental =>can not get back
*Externalities :Incremental
-Important point: Financing costs reflected in required return
*Treat projects as if 'all equity' financed
* Note: this is different from real estate
Incremental Expansion project CF: (3 stages)
1) Initial Investment outlay
2) After-tax operating cash flow (CF)
3) Terminal Year After-tax Non-operating Cash Flow (TNOCF)
1) Initial Investment Outlay (Outlay)
= FCInv + NWCInv
FCInv = Cost of fixed capital
NWCInv = delta non-cash C.A. - delta non-debt C.L.
Cash ouflow if > 0
Cash inflow if < 0
2) After-tax operating cash flow (CF)
= (S − C − D)(1 − T) + D
= (S − C)(1 − T) + DT
S: sales;
C: Cash operating expenses;
T:Marginal tax rate;
D: Depreciation expenses
3) Terminal Year After-tax
Non-operating Cash Flow (TNOCF)
TNOCF = Sal_t + NWCInv − T(Sal_t − B_t)
Sal_t: Pre-tax cash proceeds from sale of fixed capital
NWCInv: Recovery of NWCInv (Do not forget!!!!)
B_t: Book value of fixed capital
T: Marginal tax rate
Replacement Project CF
Same as those of expansion project EXCEPT:
*Sale of old: Reduce the initial outlay by the ater-tax proceed the sale (t=0):
Outlay = FCInv + NWCInv - Sale - T(Sale -BV)
*Depreciation: Use only the difference between old and new depreciation
*Consider only incremental cash flows from new project
Effects of Inflation
-Nominal vs. real CFs: Must match CF with correct discount rate
-Higher than expected inflation:
1) Reduces value of depreciation tax shield
2)Decreases value of fixed payments to bondholders
3)Different impact on revenues vs. costs
Projects with Unequal lLives: 2 Methods:
1) Least Common Multiple of Lives Method
2) Equivalent Annual Annuity (EAA)
1) Least Common Multiple of Lives Method
-Extends the lives of the projects so that the lives divide equally into the chosen time horizon.
-Assumed that the projects are repeated
=>Decision:Select the higher (equal-life) NPV
2) Equivalent Annual Annuity (EAA)
-Calculate Annuity payment equivalent for each NPV
=>Decision:Select the project with the higher EAA
Capital rationing
-Allocate fixed capital among to maximize shareholder wealth.
- If +NPV project > capital
=>Choose the combination with highest total NPV.
Risk analysis techniques
1-Sensitivity analysis
2-Scenario analysis
3-Simulation analysis
1-Sensitivity analysis
*Involves varying an independent variable to see how much the dependent variable changes, all other things held constant.
-Begin with the base case
-Change A SINGLE input variable
-NOTE the change in NPV
-Change other input variables
*Point: Projects with NPVs more sensitive to changes in input variables are riskier
2-Scenario analysis
*considers the sensitivity of the dependent variable to simultaneous changes in all of the independent variables.
-Uses best-case, worst-case, and most-likely case scenarios
-Calculate the mean and std of NPV
3-Simulation analysis (Monte Carlo)
*uses repeated random draws from the assumed probability distributions of each input variable to generate a simulated distribution of NPV.
Monte Carlo simulation:
-Forecast probability dist. for key inputs
-Do random draw, caluclate NPV, repeat
-Generate probability distribution of NPV
YOU MIGHT ALSO LIKE...
Series 7 Top-Off Exam Preparation | Knopman Marks Guide
KnopmanMarks
$44.99
STUDY GUIDE
fin 314 ch 9- ch 11
47 Terms
vic-n
Fin 314 Study Guide
32 Terms
davidfriedman000
Business Finance Exam 3
46 Terms
jtharrison11
OTHER SETS BY THIS CREATOR
CFA2-Formula Sheet 1
3 Terms
bmm99
CFA2 FSA: SS6-Intercorporate Investments
12 Terms
bmm99
CFA2 FSA: SS5-Long-Lived Assets
39 Terms
bmm99
THIS SET IS OFTEN IN FOLDERS WITH...
CFA 2 Corporate Finance
47 Terms
fox3008
CFA-Derivative Market and instruments
16 Terms
kadimov
CFA II Equity
24 Terms
daveqi
CFA2 Equity
21 Terms
moltovivo
;