Discount Rate vs Interest Rate Quiz

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What does the net present value (NPV) calculation take into account?

The future value of the cash inflows and the initial investment

The discount rate equal to the firm's cost of capital

Both the future value of the cash inflows and the discount rate (correct)

None of the above

What is the key decision rule for accepting or rejecting a project based on NPV?

Accept the project if the NPV is less than zero dollars

Accept the project if the NPV is positive, regardless of the value

Accept the project if the NPV is greater than or equal to zero dollars (correct)

Accept the project if the NPV is equal to zero dollars

What is the key difference between NPV and IRR in terms of reinvestment assumptions?

NPV and IRR both assume reinvestment at the cost of capital

NPV and IRR both assume reinvestment at the project's IRR

NPV assumes reinvestment at the cost of capital, while IRR assumes reinvestment at the project's IRR (correct)

NPV assumes reinvestment at the project's IRR, while IRR assumes reinvestment at the cost of capital

Why do companies prefer larger cash inflows in the early years rather than later years?

Early year cash inflows are more predictable than later year cash inflows Signup and view all the answers

What is the key relationship between NPV and IRR?

IRR is the discount rate where the present value of the cash inflows exactly equals the initial investment Signup and view all the answers

How do companies typically view long-term payback periods for investment projects?

Companies shy away from long-term payback periods due to the relative uncertainties of the cash inflows after Year 1 Signup and view all the answers

What is the primary difference between the discount rate and the interest rate?

The discount rate represents the real change in value to a person or group based on their productive use of money and inflation effects. Signup and view all the answers

What is the payback period?

The time it takes for a firm to recover its initial investment through cash inflows. Signup and view all the answers

If $1,000 is invested at 10% interest for one year, what is the future value according to the time value of money concept?

$1,100 Signup and view all the answers

If an investment of $10,000 earns 8% interest compounded annually, what will be its value after 5 years?

$14,860 Signup and view all the answers

If the cost of capital is 15%, which investment is better: Investment A that generates $100,000 two years from now or Investment B that generates $110,000 three years from now?

Investment B is better. Signup and view all the answers

If an investment of $20,000 earns interest at a rate of 6% compounded annually, how long will it take for the investment to double in value?

11.9 years Signup and view all the answers

What is the primary purpose of an economic evaluation?

Both (a) and (b) Signup and view all the answers

What is the relationship between interest rate and the time value of money?

Interest rate reflects the gain from investing money over a specific time period Signup and view all the answers

If an investment has an 11% interest rate, what can be inferred?

All of the above are correct Signup and view all the answers

How is the interest rate determined in a financial transaction?

It is determined by mutual agreement between the borrower and the lender, based on market forces Signup and view all the answers

What is the primary difference between interest rate and discount rate?

Interest rate is the amount charged for borrowing money, while discount rate is the rate at which future money is reduced to its present value Signup and view all the answers

If the market interest rate for a loan is 8%, what does this imply about the time value of money?

Money now is worth more than the same amount of money in the future Signup and view all the answers