# Corporate Finance: Course Notes

**Topics:**Net present value, Internal rate of return, Discounted cash flow

**Pages:**26 (2404 words)

**Published:**October 29, 2013

Evaluate the potential value added to a firm arising from a

specified capital investment project or portfolio using the net present value model. Project modelling should include explicit treatment of:

(a) Inflation & specific price variation

(b) Taxation including capital allowances and tax exhaustion (c) Single & multi-period capital rationing to include the

formulation of programming methods and the interpretation

of their output

(d) Probability analysis and sensitivity analysis when adjusting for risk and uncertainty in investment appraisal

(e) Risk adjusted discount rates (covered in chapter 7)

Outline the application of Monte Carlo simulation to investment appraisal. Candidates will not be expected to undertake

simulations in the exam but will be expected to demonstrate

understanding of

(a) simple model design

(b) the different types of distribution controlling the key variables in the simulation

(c) the significance of the simulation output and the assessment of the likelihood of project success

(d) the measurement and interpretation of project value at risk Establish the potential economic return using IRR and modified IRR & advise on a projects return margin. Discuss merits of NPV & IRR.

Discounted cash flow

techniques are also

extensively examined

in the context of

business valuations

(business valuations

are covered in

chapters 9-12).

Slow Fashions

- 20 marks, June 09

Your business

- 28 marks, June 09

Seal island

- 24 marks, June

2010 Q1i,ii,iii

Seal island - 4

marks, June 2010

Q1iv

Tisa Co- 4 marks,

June 2012 Q4c

Tisa Co- 8 marks,

June 2012 Q4b

Neptune- 6 marks,

June 2008 Q5b

5: DCF TECHNIQUES AND THE USE OF FREE CASH FLOWS

Maximisation of

shareholder wealth

Investment decision

DCF techniques & the use of free

cash flows

Estimating the potential value

added to a firm from a capital

investment project

Financing decision

Dividend decision

Impact of capital rationing on

project appraisal

Impact of a capital investment

project on dividend capacity

5: DCF TECHNIQUES AND THE USE OF FREE CASH FLOWS

Lecture example 2 (from day 1)

Avanti plc is considering a major investment programme which will involve the creation of a chain of retail outlets throughout the United Kingdom. The following cash flows are expected. Time

Land and Buildings

Fittings and Equipment

Gross Turnover

Direct Costs

Marketing

Office Overheads

0

£000

3,250

700

1

£000

2

£000

3

£000

4

£000

1,800

750

170

125

2,500

1,100

250

125

2,800

1,500

200

125

3,000

1,600

200

125

(a)

60% of office overhead is an allocation of head office operating costs.

(b)

The cost of land and buildings includes £80,000 which has been spent on surveyors fees.

(c)

Avanti plc expects to be able to sell the chain at the end of year 4 for £4,000,000.

Avanti plc is paying corporate tax at 30% and is expected to do so for the foreseeable future. Tax is paid one year in arrears.

The company will claim capital allowances on fittings and equipment at 25% on a reducing balance basis. Capital allowances are not available on land and buildings. Estimated resale proceeds of £100,000 for the fittings and equipment have been included in the total figure of £4,000,000 given above.

Avanti plc expects the working capital requirements to be 15% of turnover during each of the four years of the investment programme.

Avantis real cost of capital is 7.7% p.a. Inflation at 4% p.a. has been ignored in the above information. This inflation will not apply to the resale value of the business which is given in nominal terms.

Solution to NPV

Net Present Value working (All figures £'000s)

Year

1

Sales

1800

Direct Costs

(750)

Marketing

(170)

(50)

Office overheads (40%)

Net Real Operating flows

830

Inflated at 4% (rounded)

863

Taxation at 30% in arrears

0

Tax relief from capital...

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