Discounted Cash Flow Analysis Considerations in Analysis

A set of flashcards covering key concepts related to Discounted Cash Flow Analysis and considerations in financial investment evaluation.

Accelerated Depreciation

Methods that reduce net income through earlier recognition of expenses compared to straight line depreciation.

MACRS

Modified Accelerated Cost Recovery System, a method of accelerated depreciation.

Depreciation Tax Shield

The reduction in taxable income due to depreciation, leading to earlier cash flow benefits.

NPV (Net Present Value)

A financial metric used to evaluate the profitability of an investment by calculating the present value of expected future cash flows.

Capital Rationing

The process of limiting the amount of capital invested in projects.

Sensitivity Analysis

Test various individual assumptions to see the result on NPV. pros: identifies critical assumptions. cons: When various OCC are used, it is difficult to interpret the result. Limit to the amount of sensitivity analysis that can be meaningfully used.

Scenario Analysis

Test particular combinations of assumptions. Measure the change in NPV given an entirely new set of interrelated assumptions based on some alternative business environment. pros: Scenario analysis is appropriate when assumptions are interrelated. 

Simulation Analysis

Estimate of the probabilities of different possible outcomes. Expanded version of Scenario Analysis using statistical tools to test multiple scenarios to look at the distribution of possible outcomes. Method is highly quantitative and often involves hundreds of scenarios. pros: Identifies risk that is not apparent using traditional Scenario Analysis. cons: Requires definition of probability distributions of inputs. Requires a model that defines the interaction of the various assumptions.

Break-Even Analysis

Analysis of the level of sales (or other variable) at which the company “breaks even.” Accounting Break-Even focuses on the point where Net Income becomes positive. Economic Break-Even focuses on the the point where NPV is greater than zero.

Decision Trees

A diagram representing decisions and their possible consequences, including chance event outcomes.

Option to Delay

The option to postpone an investment to increase the expected NPV.

Abandonment Option

The option to withdraw from a project if it does not perform as expected.

Option to Expand

The option to increase production or project size after initial launch depending on success.

State of Inflation

Economic condition where inflation impacts the nominal rates used in cash flow analysis.

Cannibalization

A situation where a new product reduces the sales of existing products.

Incremental Benefits

Additional benefits from a new product that increase sales of related products or accessories.