Lecture 05

Question 1

Cost vs Price

Answer 1

• cost = expense that a busniess incurs in bringing a product or service to market
• price = the amount a customer pays for the product or service → willingness to pay
• difference beween price that is paid and cost that is incurred is the mark up or profit the business makes when item is selled

Question 2

Economic Perspective vs Financial perspektive

Answer 2

• both perpectives important→ converge in the long term
• but long term is diff. to forecast

Question 3

Source of financing

Answer 3

• debt providers (lenders) =finance part of a project in return for promise that loans will berepaid with interest from “Cash Flow Available for Debt service ”= sure unless company bankrupt
• equity providers (investors) = finance part of a project, in return for what’s left of Cash Flow Available for Debt Service when debt has been serviced= return only in case of profit = unsure

Question 4

debt financing - lender charges (Kreditgebühren)

Answer 4

1. Base rate/plus margin:
   
   1. base rate quarterly London Interbank offered Rate (LIBOR)
   2. LIBOR is average interest rate which leading banks borrow funds from other banks.
   3. moste widely used reference rate for short term interest rates
   4. margin depends on project
2. commitment fee
   
   1. fee charged by lender to boworrer due to commitment to make a loan
   2. fee on undrawn amount charged by lender
   3. …

Question 5

Gearing ratio

Answer 5

= measurement of a projects financial leverage, which dempnstrates the degree to which a project is funded by debt financing vs. Equity capital

= (Lagterm debt+ shortterm dept ) /shareholders’ equity

= investor like low gearing ratio ( want to do as many projects as possible )

Question 6

what means high gearing ratio

Answer 6

lenders be concerned about loans at risk so they

1. require covenants that prohibit the payment of dividends
2. require that excess cshflow be applied to dept repayment
3. place restrictions on alternative uses of cah
4. require investors to put more equity into the project

Question 7

Traditionla financing structure

Answer 7

Question 8

WACC equation

Answer 8

• WACC = weighted average Cost of Capital
• cost of each capital component multiplied by its proportional weight and the summing
• cost of dept alway lower than cost of equity

Question 9

contractor point of view - revenues

Answer 9

• Down payment :10-15 % by signing contract
• periodical invoices for the remaining part of the work, based on executed WP
• retention money
• counter trade

Question 10

contracter point of view - costs

Answer 10

• Project start: initial financial effort connected to the need of obtaining the goods required for the project
• periodical financial events(labor/lease cost)
• not periodical financial events(maintance/travel cost)
• periodical fiancial events during a certain supply(payments for supplier material/service/ subcontractors)

Question 11

Financial outline contractor point of view

Answer 11

• down payment not enough to cover all start up cost
• Financing of the currency until the payment of the executed WP
• use of the guarantee

Question 12

financial outline - client point of view

Answer 12

• large down payment for long time until project starts to pay back
• down payment and adjustment with the payment for executed work progress
• finding of financial sources

Question 13

where does discount rate come from ?

Answer 13

societies grow wealtheir→ dollar today is worth than dollar tomorrow

Question 14

Economic equivalence

Answer 14

• Economic equivalence exists between cash flows that have the same
  economic effect and could therefore be traded for one another.
• Even though the amounts and timing of the cash flows may differ, the
  appropriate interest rate makes them equal in economic sense.

Question 15

Equation Actualisation and capitalisation

PV = present value

FV= final value

Answer 15

Question 16

Capital budgeting

Answer 16

= process an organization undertakes to evaluate potential major projects or investments

= also known as investment appraisal

Question 17

Pav back time (PBT)

Answer 17

= is the lenght of time it takes to recover the cost of an investment

• shorter paybacks mean more attractive investments (longer less desirable)
• link between companysize, ownership and PBT

Question 18

Pros and cons PBT

Answer 18

+ simple

– looks only at times and not on profiability

– doesn’t consider the change in money value through time

Question 19

Net present Value (NPV)

Answer 19

= the difference between the present value of cash inflows and the present value of cash outflows over a period of time (all cashflows )

• used in capital budgeting and investment planning to analyze profiability of project investment
• is the result of calculations used to find today’s value of a future stream of payments

Question 20

accaptance rules for NPV

Answer 20

NPV > 0

NPVA>NPVB the investment A is better than investment B

Question 21

What means NPV = 0

Answer 21

means that the investment is returning exactly the amount of the discount rate.

Question 22

when project NPV < 0 are reasonable

Answer 22

strategic project, public project …

Question 23

when NPV is meaningless

Answer 23

when there is no positive cashflow (vaccine, water to house)

Question 24

pros and cons of NPV

Answer 24

+ takes int account the profiability of project

– extremly dependent on i hardly predictable parameter

Question 25

Internal Rate of Return (IRR)

Answer 25

= interest rate at which the net present value of all cash flows (+/-) from a project or investemnet equal zero → evaluate the atractiveness of a project or investment * discount rate at which NPV = 0

Question 26

Beispiel IRR berechnung

Answer 26

Question 27

pros cons IRR

Answer 27

+ gives a relative measure + it is dependent from the cost of capital – difficult to calculate – sometimes impossible to calculate

Question 28

Project balance(PB)

Answer 28

= progressive balance of income and expenditures * represents in each period the equivalent net present value pawned in the project * evaluate the financial solution during project devekopment

Question 29

EXAM: What is the time value of money principle and how does it apply to project selection?

Answer 29

-money earned today is worth more than money exprected in future 1. impact of inflation 2. inability to invest money → can be applied to see, which PJ has the greatest return to an investment of the Company

Question 30

What is an internal rate of return and what advantages and disadvantages are accrued by using it to evaluate projects?

Answer 30

-method to evaluate the expected outlays and incomes associated with a new PJ invest opportunity. If IRR greater than current rate → PJ is worth funding + ability to compare alternatives in terms of expected ROI -suffers from difficulty in conflicting situations, when cash flows follow outflows ???

Question 31

What is the social discount factor?

Answer 31

-reflect social view of how future benefits/costs are valued against presend ones → puts present value of costs/benefits of the future - How much society should invest to limit impacts of climate change in future - e.g. how much guarding carbon emission are worth right now, weighing up against benefits of future generation compared to todays costs

Question 32

speaking about debt financing, which are the lender charges?

Answer 32

1. **Commitment fee** - up-front fee charge by lender to borrower 2. **Annual Fee charged by lender to borrower** 3. **Costs paid by borrower** to lender prio to an at financial close (agreement fee)

Question 33

Speaking about financing, what is the Gearing Ratio? And what can a lender do, if his capital is at risk?

Answer 33

-measurement of a PJ financial leverage, which demonstrates degree of fundedment by Debt/Equity financing → (long term debt + short term debt) / shareholders equity Require covenants that prohibit the payment of dividends o Require that excess cash flow be applied to debt repayment o Place restrictions on alternative uses of cash o Require investors to put more equity into the project