Corporate Finance and Financial Management - investment appraisal and financing
This domain tests investment appraisal, financing structure and working-capital management in DZD, with the Algerian banking and regulatory context in the background. The examiner wants a discounted cash-flow calculation done properly and a financing decision justified, not formulas quoted in isolation.
Investment appraisal
- Free cash flows, not accounting profit: add back depreciation, deduct capital expenditure and the change in besoin en fonds de roulement, then tax the operating result.
- VAN = Σ CFt ÷ (1+k)^t − investissement initial. TRI is the rate at which VAN = 0. Délai de récupération is the payback period, discounted or not, and must be stated as such.
- Decision rules: accept if VAN > 0 and if TRI > k. When projects are mutually exclusive, VAN decides, because it measures value created in dinars.
Cost of capital
- CMPC (WACC) = E/(E+D) × ke + D/(E+D) × kd × (1 − taux d'IBS). The tax shield applies to debt only.
Worked example
A project costs 10,000,000 DA and generates 4,000,000 DA per year for four years. The discount rate is 10%. Annuity factor (10%, 4 years) = 3.1699. PV = 4,000,000 × 3.1699 = 12,679,600 DA. VAN = 12,679,600 − 10,000,000 = 2,679,600 DA. Positive, so the project is acceptable if the risk is properly reflected in the 10%. WACC illustration: equity 60,000,000 DA at 15%, debt 40,000,000 DA at 8% pre-tax, IBS 23%. WACC = 0.6 × 15% + 0.4 × 8% × 0.77 = 9.00% + 2.464% = 11.46%.
Traps
- Discounting the accounting profit instead of the cash flow.
- Omitting the change in BFR and the terminal value from the cash-flow schedule.
- Applying the tax shield to equity or forgetting it on debt.
- Comparing a TRI with the wrong hurdle rate or ranking mutually exclusive projects by TRI.
- Ignoring the effect of dinar depreciation on imported equipment costs.