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Investment decision - Coggle Diagram
Investment decision
NB for discussions
Financing of the projects
Tax losses
Changes in working capital
Recoupment / scrapping
Only incremental costs & revenue
Tax allowances
Only relevant cost taken into account
Other qualitative factors
Methods to evaluate
NPV
Superior method
Discount @ target WACC
If + then accept
Net present value index
1 or more = accept
< 1 = reject
(Initial investment + NPV) / initial investment
Discounted payback period
Same as payback period, only payments discounted @ WACC
IRR
IRR > WACC = accept
IRR < WACC = reject
Payback period
Downside
ignore inflation
ignore cash flow after payback
Longer it takes = higher the risk
Estimate of how long it will take to pay back investment
Different project life cycles
Also known as replacement chains
NPV to infinity = NPV / [PV(annuity) x r]
PV (annuity) = period equal to cash flow years
r = discount rate
Essence of investment decision
Estimate future sales, demand & cost
Length of time
Determine target WACC
Value of asset @ end
Capital budget
If NPV + then accept
All future cash flows & discount @ TARGET WACC
Depreciation = not part of cash flow, but is part of tax
International capital budget
Indirect quote - R1 = $0.1429
Always keep cash flow in foreign currency & discount @ rate appropriate to that currency to get NPV. Then convert NPV to rand using spot rate
Direct quote - $1 = R7
Risk / uncertainty
Decision trees
Use probabilities
Keep vs replace
Determine marginal revenue & cost from replacement
Determined that replacement is better
consider whether it's preferable to discontinue production altogether
FIRST INVESTMENT DECISION THEN FINANCING DICESION