Bec 3 - Financial Modeling For Capital Decisions

Front 1

How to calculate NPV?

Back 1

1. calc after tax cash flows=annual net cash flow x (1-tax rate)
2. add depr benefit =depr x tax rate
3. multiply result by appropriate PV of an annuity
4. subtract initial cash outflow
Result=Net Present Value

Front 2

How to calculate payback period?

Back 2

net initial investment/incr in annual net after-tax cash flow

Front 3

What are the two advantages of the Payback method?

Back 3

1. easy to use and understand
2. emphasis on liquidity

Front 4

What are the four limitations of the payback method?

Back 4

1. time value of money is ignored
2. projected cash flows after initial investment is required are not considered
3. reinvestment of cash flows is not considered
4. total project profitability is neglected.

Front 5

Describe the Discounted Payback Method.

Back 5

Computes the payback period using expected cash flows that are discounted by the project's cost of capital (also referred to as "breakeven time method" or BET)

Front 6

What are the two advantages of the NPV method?

Back 6

1. flexible
2. can be used when there is no constant rate of return required for each year of the project

Front 7

What is the limitation of the NPV method?

Back 7

Does not provide the true rate of return on the investment.

Front 8

What are the 5 steps to determine IRR?

Back 8

1. determine life of asset (#periods)
2. calc payback period
3. determine which table to use PV of annuity or PV of $1
4. find closest factor to payback period using the number of periods
5. interest rate that correspons is IRR.

Front 9

What are the three limitations of IRR?

Back 9

1. unreasonable reinvestment assumption
2. inflexible cash flow assumptions
3. evaluates alternatives only based on interest rates

Front 10

What is the profitability index?

Back 10

PV net future CF/PV net initial investment