FREE DCF Analysis Question and Answers

Question 1

Calculates the present value of future cash floes of a project - Four steps needed to complete a NPV analysis of a investment proposal.
1. Prepare table showing cash flows during each year
2.Calculate present value of each cash flow using the required rate of return
3.Calculate NPV = sum of present values of the cash flows in each period
4.NPV if positive means project is acceptable on financial grounds, higher NPV more acceptable the project. Other strategic and quantitative issues need to be considered in decision

Accepted Answer

Discounted cash flow analysis methods
Net Present Value (NPV) Method

Answer

Discounted cash flow analysis

Answer

Assumptions under lying Discounted Cash flows Analysis

Answer

Discounted cash flow analysis limitations

Question 2

Tangible - Physical / Real can be readily measured and quantified e.g Inventory reduction, overtime reduction, direct materials reduction
Intangible - Harder to quantify e.g increased flexibility, reduced lead time, greater reduction of throughput

Accepted Answer

Tangible and intangible benefits of technology investment

Answer

Time value of money

Answer

Internal rate of return (irr) method

Answer

Payback method

Question 3

- unrealistic status quo
- Hurdle (discount) rates are to high
- Time horizons are to narrow
- difficulty of gaining approval for large projects
- exclusion of benefits that are difficult to quantify
- greater uncertainty about operating cash flows of new untested technology investments

Accepted Answer

Discounted cash flow analysis limitations

Answer

Discounted cash flow analysis

Answer

Discounted cash flow analysis methods
Net Present Value (NPV) Method

Answer

Assumptions under lying Discounted Cash flows Analysis

Question 4

- reinvestment assumption that cash flows be reinvested
- Year end timing of cash flows - NPV and IRR both assume and are treated as though they occue at year end. The error introduced is generally not large enough to cause concern
- Certainty of cash flows - DCF Analysis treats the cash flow associated with an investment project as if they are known with certainty. Risk adjustments can be made under NPV analysis to help account for cash flow uncertainty

Accepted Answer

Assumptions under lying Discounted Cash flows Analysis

Answer

Tangible and intangible benefits of technology invesment

Answer

Discounted cash flow analysis limitations

Answer

Discounted cash flow analysis methods
Net Present Value (NPV) Method

Question 5

- both methods will usually support or not support the proposal
FOR NPV
- NPV is easier to calculate - can use spreadsheet or calculator
- Can adjust for risk - for later cash floes by adjusting the discount rate
- NPV yields one answer - IRR can be calculated more than once where NPV is either positive or negative over cash flow periods
-NPV makes a more realistic assumption that cash flows are reinvested at firms required rate of return - IRR assumes investment at the projects rate of return.
- Ranking of projects under IRR can lead to sub optimal decisions
NPC is usually regarded superior to IRR when evaluating capital investment proposal

Accepted Answer

NPV ( net present value ) Vs IRR (internal rate of return)

Answer

Discounted cash flow analysis limitations

Answer

Discounted cash flow analysis methods
Net Present Value (NPV) Method

Answer

Assumptions under lying Discounted Cash flows Analysis

Question 6

Calculates payback period of investment. Calculate amount of time for cash inflows to accumulate to an amount that covers original investment.
payback period = Initial investment / annual cash flows
Payback period basic calculation will not work for projects with uneven cash flows ( have to manually calculate accumulated cash flows to find payback period

Accepted Answer

Payback Method

Answer

Payback Period

Answer

Net Present Value Method

Answer

Internal Rate Of Return (irr) Method

Question 7

- Simplicity - easy to calculate, easy to understand
- Screening Investment projects - provides a tool for rough screening of investment proposals
- Risk of project - provides insight into risk of the project - earlier cash flows are considered more certain that later years.

Accepted Answer

Payback Method Advantages

Answer

Time value of money

Answer

Payback Method Limitations

Answer

Discounted cash flow analysis limitations

Question 8

Discounted cash flow analysis

Accepted Answer

a technique used that adjusts for time value of money making cash flows over time comparable

Answer

- unrealistic status quo
- Hurdle (discount) rates are to high
- Time horizons are to narrow
- difficulty of gaining approval for large projects
- exclusion of benefits that are difficult to quantify
- greater uncertainty about operating cash flows of new untested technology investments

Answer

calculates the present value of future cash floes of a project - Four steps needed to complete a NPV analysis of a investment proposal.
1. Prepare table showing cash flows during each year
2.Calculate present value of each cash flow using the required rate of return
3.Calculate NPV = sum of present values of the cash flows in each period
4.NPV if positive means project is acceptable on financial grounds, higher NPV more acceptable the project. Other strategic and quantitative issues need to be considered in decision

Answer

- Payback ignores time value of money
- Payback ignores cash flows beyond the payback point

Question 9

Payback Method Limitations

Accepted Answer

- Payback ignores time value of money
- Payback ignores cash flows beyond the payback point

Answer

Calculates actual economic return earned by the project over it's life

Answer

- Simplicity - easy to calculate, easy to understand
- Screening Investment projects - provides a tool for rough screening of investment proposals
- Risk of project - provides insight into risk of the project - earlier cash flows are considered more certain that later years.

Answer

a technique used that adjusts for time value of money making cash flows over time comparable

Question 10

Concept that if offered 1 dollar today or 1 dollar in 1 year most people will take the 1 dollar today. Time value of money is the value of the dollar that could be earned in 1 year.
DCF Analysis "discounts" the cash flows of future years to make them equivalent to those in the current year

Accepted Answer

Time value of money

Answer

Future value

Answer

Capital budgeting

Answer

Present value