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AFM Unit 6

The document provides an overview of an investment appraisal techniques course for week 5. It includes instructions to watch an eLearning video on advanced investment appraisal, read the eLearning module on the topic, revise a previous session recording, attend the live session #5 on advanced techniques, complete a formative assessment, and participate in discussions. The document also provides information on net present value, the net present value method and pro forma, relevant costs and income for discounted cash flow analysis, internal rate of return, modified internal rate of return, merits and demerits of the NPV and IRR approaches, problems with IRR compared to MIRR, duration, modified duration, the Black-Scholes options pricing model,

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harsh singh
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40 views

AFM Unit 6

The document provides an overview of an investment appraisal techniques course for week 5. It includes instructions to watch an eLearning video on advanced investment appraisal, read the eLearning module on the topic, revise a previous session recording, attend the live session #5 on advanced techniques, complete a formative assessment, and participate in discussions. The document also provides information on net present value, the net present value method and pro forma, relevant costs and income for discounted cash flow analysis, internal rate of return, modified internal rate of return, merits and demerits of the NPV and IRR approaches, problems with IRR compared to MIRR, duration, modified duration, the Black-Scholes options pricing model,

Uploaded by

harsh singh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Advanced Investment

Appraisal Techniques
Unit 6
Harsh Singh
Week 5 05/11/2023 Advanced Investment Appraisal

Quadrant 1 1. Watch the eLearning content on “Unit 6 – Advanced Investment Appraisal


Techniques”
eContent
2. Read the eLM on “Unit 6 – Advanced Investment Appraisal Techniques”

Quadrant 2 1. Revise “Unit 5: Mergers and Acquisitions Valuation” recording of the live
session
eTutorial
2. Attend the live session #5 on “Unit 6 – Advanced Investment Appraisal
Techniques”
Quadrant 3 1. Take the formative assessment for “Unit 6 – Advanced Investment Appraisal
Techniques ( Foreign NPV Computation)”
eAssessment
2. Repeat the formative assessment for “Unit 6 – Advanced Investment
Appraisal Techniques” for self-assessment

Quadrant 4 1. Participate in collaborative learning in discussion


Discussions
Net Present Value
The idea that money coming in today is worth more than the same amount of
money coming in in 5 years time. To do this we “discount down” all future
cash flows.
This “discounting” takes into account not only the time value of money but
also the required return of our share and debt holders.
This means that if we have a positive NPV (even after discounting the future
cash flows) then the return beats not only the time value of money but it also
beats what the shareholders and debt holders require.
Thus positive NPV increases shareholders wealth and increase the value of
company.
Net Present Value method - Proforma
0 1 2 3 4
Sales x x x x
Costs (x) (x) (x) (x)
Profit x x x x

Tax (x) (x) (x) (x)


Capital Expense (x)
Scrap x
WDA x x x x
Working capital (x) (x) (x) x x
Total Cashflows (x) x x x x
Discount Factors 1 0.9 0.8 0.7 0.6
Total Cashflows (x) x x x X
DCF – relevant costs and income
The criterion for identifying costs or income that are relevant to investment
appraisal using DCF is the same as explained in the previous chapter. Simply ask:

What cash flows are changed by the decision?

So, amounts are relevant only if they are:


• Future
• Incremental
• Cash flows
NPV
WDAs - These REDUCE your tax bill!
They are the tax relief on your capital purchases.
These are normally 25% writing down allowances on plant & machinery

Calculation technique for WDA


Calculate the amount of capital allowance claimed in each year Make a balancing
adjustment in the year the asset is sold
by calculating the total tax relief that should have been given ((Cost - RV) x 30%)
less tax benefits already allowed in step 1
Other things to consider in NPV calculation is Working capital and inflation.
Internal Rate of Return (IRR)
• The minimum return required by the investors if an investment is
pursued.
• It is a guideline whether to proceed with an investment or not.
• It is the rate of return which makes the NPV zero.
• An investment should only be pursued if IRR is greater than the
minimum required rate of return.
Modified Internal Rate of Return
• Measures the economic return (yield) of the investment
• Under the assumption that any earlier cash surpluses from the projects
are re-invested at the firms current cost of capital

• MIRR : (PV of Inflows/ PV of Outlflows) ^(1/N) * (1+WACC) -1


• Directly use MIRR function in excel
Merits and De-Merits of NPV & IRR Approach
Advantages of NPV & IRR
- NPV is the most Superior Method
- NPV can be easily understood.
- Considers Time Value of Money
- Estimates are based on Discounted CF basis.
- NPV’s Re-investment assumption based on Cost of Capital.
Disadvantages of IRR & NPV
- Based on number of estimates and assumptions.
- Both NPV and IRR conveys to take decision on a now or never basis.
- IRR assumes all CF’s are re-invested in the project at calculated IRR which may be
invalid in case of high IRR.
- NPV considers only the intrinsic value of the project.
Problems with IRR Comparing to MIRR
• IRR assumes that all C/f’s are re-invested in the project at calculated
IRR which may be invalid in the case of higher IRR.

• IRR produces multiple answers in case of non-conventional cash


flows, whereas MIRR gives only single rate.
Duration
• Starting from the first positive cash flows, duration measures the
average time it takes to cover the PV of the project.
• Measures the risk of the project, the more the duration the more the
risk the project bears.

Duration : Σ PV of Cfs * Years / ΣPV ttl


Modified Duration
• Adjusted version of Duration which accounts for change in rate of
return which in turn changes the value of an investment.

Modified Duration : Duration / ( 1+R)^n


Black Scholes Option Pricing Model
Value at risk
Value at risk (VaR) is a measure of how the market value of an asset or of a
portfolio of assets is likely to decrease over a certain time, the holding period
(usually one to ten days), under ‘normal’ market conditions.

VaR is measured by using normal distribution theory.


It is typically used by security houses or investment banks to measure the
market risk of their asset portfolios.

VaR = amount at risk to be lost from an investment under usual conditions over
a given holding period, at a particular 'confidence level'.
Confidence levels are usually set at 95% (1.65) or 99%(2.33)
Question
A bank has estimated that the expected value of its portfolio in two
weeks’ time will be $50 million, with a standard deviation of $4.85 million.
Required:
Using a 95% confidence level, identify the value at risk.
Multi period capital rationing
A solution to a multi-period capital rationing problem cannot be found using PIs.
This method can only deal with one limiting factor (i.e. one period of shortage).
Here there are a number of limiting factors (i.e. a number of periods of
shortage) and linear programming techniques must therefore be applied.
Week 6 12/11/2023 Cost of capital

Quadrant 1 1. Watch the eLearning content on “Unit – 7 Cost of capital”


eContent 2. Read the eLM on “Unit – 7 Cost of capital””

Quadrant 2 1. Revise “Unit 6 Advanced Investment Appraisal Techniques (Foreign NPV)”


recording of the live Session
eTutorial
2. Attend the live session #6 on “Unit – 7 Cost of capital”.
Quadrant 3 1. Take the formative assessment for “Unit – 7 Cost of capital”.
eAssessment 2. After the live session, repeat the formative assessment for “Unit – 7 Cost of
capital”

Quadrant 4 1. Participate in collaborative learning in discussion


Discussions

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