Apr 19, 2016

# Finance English practice: Unit 41 — Financial Planning

16 cards
• Complete the sentences below. Use the key words if necessary.
• Financing new investment

key words
Financial planning      ○      rate of return      ○      cost of capital

Alia Pahal works in the financial planning department of a large manufacturing company:

involves calculating whether new projects would be profitable. We have to calculate the probable — the amount of income we’d receive each year from the investment, expressed as a percentage of the total amount invested. If we’re going to finance a project with our own money, the rate of return must be at least as high as we could get by depositing the money in a bank instead, or by making another risk-free investment, like buying government bonds.

If we need to borrow money to finance a new investment, its projected rate of return has to be higher than the — the amount we have to pay to borrow the money.’

Discounted cash flows

key words
discounted cash flow value      ○      discounting      ○      purchasing power      ○      opportunity cost      ○      time value of money

‘We usually calculate the of an investment. This means or reducing future cash flows to get their present values — in other words, calculating the present value of money to be received in the future. This is because the value of money decreases over time. Firstly, there’s nearly always inflation, so cash will have lower in the future: you’ll be able to buy less with the same amount of money. And secondly, if you had the money now, you could get income by using or investing it. The return we could get by investing the money in other ways is the of capital. So waiting for money is also a cost. This is the — how much more it is worth to receive money now rather than in the future.’

Comparing investment returns

key words
net present value      ○      discount rate      ○      capitalization rate      ○      opposite      ○      discount factor      ○      internal rate of return

‘If we have to choose among possible investment in new projects, we work out the (NPV) of each project by adding up all the expected cash flows, discounted to their present value, minus the initial investment. To do this, we have to select a or . This is usually the interest rate we pay for borrowing the capital, but we could increase it if there’s a lot of uncertainty or risks.

Discounting sounds complicated, but it isn’t. It’s the of compounding interest. For example, if you invest \$1,000 at 10% for five years, it will yield 1.61 times its original value. So you get back \$1,610, including \$610 compound interest. A discount rate of 10% has a of one divided by 1.61, which is 0.62. So \$620 invested now will be worth \$1,000 in five years if it’s invested at 10%.

When we’re comparing alternative investments, we also calculate the (IRR). That’s the interest rate or discount rate that gives a net present value of zero in today’s money values. In other words, the present value of the cash that we’re going to receive from an investment is the same as the present value of borrowing that cash. We normally choose the investment with the highest IRR.’

• Match the definitions with the word combinations below.
• a series of future earnings converted to their value today —  . . .
discounted cash flow
• time value of money
• internal rate of return
• discount rate
• discounted cash flow
• rate of return

• the annual percentage amount of income received from an investment —  . . .
rate of return
• rate of return
• internal rate of return
• discount rate
• discounted cash flow
• time value of money

• the interest rate an investment earns when the present value of all costs equals the present value of all returns —  . . .
internal rate of return
• internal rate of return
• discounted cash flow
• discount rate
• time value of money
• rate of return

• the difference between the value of money held now, and its value if it is received in the future, because it could be invested during that period —  . . .
time value of money
• time value of money
• discounted cash flow
• internal rate of return
• rate of return
• discount rate

• the value of money, measured by the quantity (and quality) of products and services it can buy —  . . .
• discount rate
• internal rate of return
• time value of money
• discounted cash flow
• rate of return

• the interest rate used to calculate the present value of future cash flows —  . . .
discount rate
• discounted cash flow
• internal rate of return
• discount rate
• rate of return
• time value of money

• Are the following statements true or false?
• If a company uses its own money for a new project, there is no opportunity cost of capital. clue
— The return we could get by investing the money in other ways is the opportunity cost of capital.
• false
• true

• A project financed by borrowed money requires a rate of return higher than the cost of capital. clue
— The rate of return must be at least as high as we could get by depositing the money in a bank instead, or by making another risk-free investment.
• true
• false

• Because of inflation, money will usually be worth more in the future than at the present. clue
— There’s nearly always inflation, so cash will have lower purchasing power in the future: you’ll be able to buy less with the same amount of money.
• true
• false

• The longer you have to wait for investment returns, the less their present value is. clue
— The value of money decreases over time.
• true
• false

• Match the two parts of the sentences.
• Future cash flows are usually discounted  . . .
by the cost of the capital involved in the investment.
• business look for the one with the highest internal rate or return.
• by the cost of the capital involved in the investment.
• it can earn interest in that time, and there might be inflation.
• you can increase the discount rate you use in your calculations.
• discounted to their current value.

• If a project seems to be particularly risky or uncertain  . . .
you can increase the discount rate you use in your calculations.
• discounted to their current value.
• by the cost of the capital involved in the investment.
• you can increase the discount rate you use in your calculations.
• it can earn interest in that time, and there might be inflation.
• business look for the one with the highest internal rate or return.

• Money you possess now is worth more than money received in the future, because  . . .
it can earn interest in that time, and there might be inflation.
• business look for the one with the highest internal rate or return.
• discounted to their current value.
• you can increase the discount rate you use in your calculations.
• by the cost of the capital involved in the investment.
• it can earn interest in that time, and there might be inflation.

• The net present value of a project is the sum of all the returns it is expected to provide,  . . .
discounted to their current value.
• business look for the one with the highest internal rate or return.
• by the cost of the capital involved in the investment.
• discounted to their current value.
• you can increase the discount rate you use in your calculations.
• it can earn interest in that time, and there might be inflation.

• When choosing among potential investments,  . . .
business look for the one with the highest internal rate or return.
• discounted to their current value.
• it can earn interest in that time, and there might be inflation.
• business look for the one with the highest internal rate or return.
• by the cost of the capital involved in the investment.
• you can increase the discount rate you use in your calculations.