BEC 3.3

Question 1

Opportunity Cost

Answer 1

Cost of foregoing the next best alternative

Question 2

Net initial Outflow

Answer 2

Step 1: Invoice + shipping + installation
+ increase in Working Capital
- any cash proceeds on the sale of the old asset net of tax
= Net initial outflow

Question 3

Tax on sale of asset

Answer 3

• If a gain take the gain x the tax rate and subtract it from the proceeds of the sale of the old asset to get the net value of proceeds
• if the item is sold at a loss take the loss x the tax rate and add it to the proceeds from the sale of the old asset to the get the net value of the proceeds

Question 4

NPV

Answer 4

• takes into account interest rate adjustments for required return
• superior to IRR since it accounts for risks from changes in rates over time

Question 5

Profitability index

Answer 5

= PVFCF / initial outflow

• if the numerator is bigger it means you should accept the investment

Question 6

IRR

Answer 6

• does not tell you the dollar value added(bad news)
• tell you the expected rate of return on a project (i.e 10% or 15%)
• determines the discount rate at which the PVFCF equals the present value of initial outlfows
• accept a project when the IRR is greater then the hurdle rate

Question 7

Payback period method

Answer 7

Net initial investment / increase in net annual net after-tax cash flow

Question 8

Discounted payback period method

Answer 8

• uses the payback period while taking into account the discount on future cash flows(time value of money)