Finance Theory and Practice - Investment Appraisal

Flashcards covering key concepts from the lecture notes on Investment Appraisal, Capital Rationing, Tax, and Inflation.

Capital Allowances

A type of tax relief for businesses, allowing deduction of some or all of an item's value from profits before tax.

Interest Payments

These are not relevant cash flows because they are included in the discount rate.

Relevant after-tax cost of capital

After-tax cash flows must be discounted with this.

Writing Down Allowance

A tax allowance that lets you deduct a percentage of the value of certain items from your profits each year.

How is Capital Allowance calculated in the example?

25% of the reducing balance.

What is Scrap Value?

Estimated cost that a fixed asset can be sold factoring in full depreciation.

How is annual profit calculated in the exercises provided?

Sales - Labour - Materials - Direct overhead - Allocated overhead - Depreciation - Interest

Nominal Terms

Nominal cash flows are discounted with a nominal cost of capital.

Real Terms

Real cash flows are discounted with a real cost of capital.

Nominal Cash Flows

Cash flows inflated with specific or general inflation.

Real Cash Flows

Nominal cash flows deflated by the general rate of inflation.

Fisher Equation

(1+ Real Interest Rate) * (1 + Inflation Rate) = (1 + Nominal Interest Rate)

Inflation

Can have a serious effect on capital investment decisions by reducing the real value of future cash flows and increasing uncertainty.

How to calculate NPV

Nominal cash flows are discounted with a nominal cost of capital. Real cash flows are discounted with a real cost of capital.

Allocated overhead

Costs that are incurred with or without the project.