Corporate Finance Fundamentals - Week 2

NPV = Present Value of Benefits - Present Value of Costs.

The NPV was £0.97.

Opportunity costs reflect the potential benefits foregone from alternative investments.

<p>IRR may give multiple values for non-conventional cash flows and does not account for the scale of projects.</p> Signup and view all the answers

<p>The Discounted Payback Period is the time it takes for the discounted cash flows to repay the initial investment.</p> Signup and view all the answers

<p>The discounted payback period is determined by calculating the time it takes for the accumulated discounted cash flows to equal the initial cash outlay, which in this case is 5.20 years.</p> Signup and view all the answers

<p>The formula for ARR is ARR = (average accounting profit) / (Investment).</p> Signup and view all the answers

<p>The average income from the investment in the machine is $1,000 annually.</p> Signup and view all the answers

<p>The Accounting Rate of Return must exceed a predetermined target return for a project to be accepted.</p> Signup and view all the answers

<p>The salvage value of the machine is zero.</p> Signup and view all the answers

<p>The Accounting Rate of Return (ARR) is a method used to evaluate the profitability of an investment by comparing the average annual profit to the initial investment.</p> Signup and view all the answers

<p>One strength is that it is a simple return-based measure. One weakness is that it does not take into account cash flows.</p> Signup and view all the answers

<p>The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero, reflecting the project's cash flows' intrinsic value.</p> Signup and view all the answers

<p>A firm should accept the project if the discount rate is below the IRR and reject it if the discount rate is above the IRR.</p> Signup and view all the answers

<p>Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows, calculated using a discount rate.</p> Signup and view all the answers

<p>The NPV is approximately £0.94, calculated as £107 / 1.06 - £100.</p> Signup and view all the answers

<p>The IRR represents the discount rate at which the Net Present Value (NPV) of an investment becomes zero.</p> Signup and view all the answers

<p>When the discount rate is below the IRR, the NPV of the project is positive.</p> Signup and view all the answers

<p>The target accounting return mentioned is 10%.</p> Signup and view all the answers

<p>When the discount rate is above the IRR, the NPV becomes negative.</p> Signup and view all the answers

<p>The main rationale for using IRR is that it provides a single, intrinsic return percentage for projects, independent of external interest rates.</p> Signup and view all the answers

<p>The interpolation method uses two discount rates between which the NPV changes from positive to negative.</p> Signup and view all the answers

<p>One key issue is that IRR may not always be reliable for projects with non-conventional cash flows.</p> Signup and view all the answers

<p>The IRR is determined by solving the equation where the sum of discounted cash flows equals zero.</p> Signup and view all the answers

<p>Relying solely on IRR can lead to misleading investment decisions, as it may not account for the scale of different projects.</p> Signup and view all the answers

<p>The IRR rule coinciding with the NPV rule is important as it ensures consistent decision-making regarding project acceptance.</p> Signup and view all the answers

<p>IRR ignores the scale of the investment, potentially favoring smaller budgets with higher IRR despite lower overall returns.</p> Signup and view all the answers

<p>The problems can be addressed using incremental IRR or by relying on the NPV method.</p> Signup and view all the answers

<p>A positive NPV suggests that the incremental investment will add value and is worthwhile.</p> Signup and view all the answers

<p>The Profitability Index (PI) is calculated as the present value of cash flows from an investment divided by the initial investment.</p> Signup and view all the answers

<p>Incremental analysis must be carried out to determine the more favorable investment option.</p> Signup and view all the answers

<p>It implies that the incremental investment is justified, as the IRR exceeds the cost of capital.</p> Signup and view all the answers

<p>NPV is preferred because it accounts for the size of the investment and provides a clearer measure of value addition.</p> Signup and view all the answers

<p>Applying incremental cash flows helps isolate the additional benefits of a new investment relative to existing projects.</p> Signup and view all the answers

<p>IRR stands for Internal Rate of Return, and it is important because it helps determine the profitability of an investment by indicating the rate at which the net present value (NPV) of cash flows equals zero.</p> Signup and view all the answers

<p>Project A should be accepted if the market rate is below 30%, as its IRR is 30%.</p> Signup and view all the answers

<p>For Project B, it should be accepted if the market rate is above 30%, since it represents a financing project with negative cash flows initially.</p> Signup and view all the answers

<p>Multiple IRRs in Project C indicate that the project has both positive and negative cash flows, complicating the decision-making process.</p> Signup and view all the answers

<p>In mutually exclusive projects, only one project can be accepted; you can accept either A or B, or reject both, but not both A and B.</p> Signup and view all the answers

<p>NPV indicates the projected profitability of a project; it should be positive for acceptance and is often considered alongside IRR for comprehensive evaluation.</p> Signup and view all the answers

<p>A project with mixed cash flows often has multiple changes in cash flow direction, leading to more than one IRR, which makes it difficult to determine a reliable rate of return.</p> Signup and view all the answers

<p>Having a negative first cash flow usually indicates that the project requires an investment upfront, influencing the acceptance criteria based on IRR higher than the required return (R).</p> Signup and view all the answers