18 Questions
What is the primary purpose of an economic evaluation?
To determine the financial desirability of a project or investment
What is the difference between interest rate and discount rate?
Interest rate is the rate of gain received from an investment, while discount rate is the rate at which future amounts are reduced to their present value
What does an 11% interest rate indicate?
For every dollar of money used, an additional $0.11 must be returned as payment for the use of that money
Who determines the interest rate?
The market through mutual agreement between the borrower and the lender
What is the main purpose of the discount rate?
To determine the present value of future cash flows
How is the interest rate different from the discount rate?
Interest rate is the price of borrowing money, while discount rate is the rate used to determine the present value of future cash flows
What is the main difference between discount rate and interest rate?
The discount rate represents real change in value based on productive use of money and inflation, while the interest rate does not.
What does the payback period represent in a firm's investment?
The exact length of time needed to recover the initial investment from cash inflows.
In the context of the time value of money, why is a dollar received in the future worth less than a dollar received today?
Because money can earn interest through investment over time.
What concept arises due to the relationship between interest and time in finance?
Time value of money
How does the time value of money affect investments over different periods?
It shows that a dollar today can earn interest for tomorrow, increasing its future value.
Given an option between two investments, how does the cost of capital affect decision-making?
It influences the selection based on which investment generates higher returns at a lower cost.
What is the primary difference between NPV and IRR in terms of reinvestment assumptions?
NPV assumes reinvestment at the cost of capital, while IRR assumes reinvestment at the project's IRR.
If the NPV of a project is negative, what should a company do?
Reject the project, as a negative NPV indicates an unprofitable investment.
What is the relationship between NPV and IRR when NPV = 0?
The IRR is equal to the discount rate where NPV = 0.
Why do companies prefer larger cash inflows in the early years of a project?
Early cash inflows have a lower cost of capital and are more predictable.
Which statement best describes the relationship between NPV and payback period?
Companies shy away from long-term payback periods due to the relative uncertainties of later cash inflows.
Which of the following statements about NPV and IRR is true?
NPV is a more conservative approach than IRR.
Test your knowledge on the difference between discount rate and payback period in finance. Understand how these concepts affect the value of money in different ways over time.
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