Questions and Answers
What is the NPV if the required return is 13.1 percent for an investment with cash flows of -$42,100, $22,650, $17,950, and $13,100?
1,014.06
What does the Payback Period Rule state?
The calculated payback is less than a pre-specified number of years.
The Payback Period incorporates the time value of money.
False
What is the maximum initial investment for a project expected to have equal annual cash flows of $98,200 over 9 years with a required return of 7.7 percent?
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What is the Payback Period for Project A with an initial cost of -$50,000 and cash flows of $20,000, $15,000, and $20,000 over three years?
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What is the NPV for Living Colour Co.'s project with cash flows of -$35,550, $7,880, $9,450, $13,350, $15,490, and $10,160, given a required return of 7.6 percent?
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Calculate the Profitability Index based on a cost of $325 and a present value of future cash flows of $350.
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The initial investment is included when calculating the present value of the future cash flows in the Profitability Index.
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What is the first step in the Net Present Value (NPV) process?
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What is the NPV of cash flows with an initial cost of -$150 and future cash flows of $175 and $100 at a required return of 15%?
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According to the video, one of the biggest challenges for the Net Present Value method is identifying what?
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What is the net present value for a project with a required return of 12.2 percent, an initial cash outflow of -$51,300, and cash inflows of $13,350, $14,100, and $27,200 in the following years?
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What is the profitability index for a project with cash flows of -$273,000, $145,900, $163,400, and $128,500 at a required return of 8.7 percent?
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The Internal Rate of Return (IRR) represents what?
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Based on an internal rate of return of ______ percent, you should _____ the project with cash flows of -$151,000, $41,700, $78,750, and $57,650 at a required return of 11.5 percent.
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What are non-conventional cash flows?
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What is the payback period for a project that costs $16,500 today and generates cash flows of $3,700 per year for seven years?
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What is the IRR for Filter Corp.'s project with the cash flows of -$14,000, $6,200, $7,500, $4,900, and $4,500?
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Study Notes
Net Present Value (NPV)
- NPV calculates the profitability of an investment by discounting future cash flows to the present value and subtracting the initial investment.
- Example: Investment with cash flows of -$42,100 (Year 0), $22,650 (Year 1), $17,950 (Year 2), and $13,100 (Year 3) yields an NPV of $1,014.06 at a 13.1% return; project accepted.
Payback Period Rule
- Accepts projects if the calculated payback period is less than a predetermined threshold.
- A disadvantage of the Payback Period is that it does not consider the time value of money.
Cash Flow Analysis
- A project lasting nine years with annual cash flows of $98,200 is acceptable at a maximum initial investment of $621,171.53 with a required return of 7.7%.
- To compute the Payback Period for Project A with an initial cost of $50,000, cash inflows are: Year 1: $20,000, Year 2: $15,000, Year 3: $20,000, resulting in a Payback Period of 2.75 years.
Profitability Index
- The Profitability Index is calculated as the present value of future cash flows divided by the initial investment.
- Example: An investment cost of $325 and future cash flows worth $350 yields a Profitability Index of 1.08.
Steps in NPV Calculation
- The first step in the NPV process involves estimating future cash flows.
- The Internal Rate of Return (IRR) is the discount rate that results in an NPV of zero for the project.
Challenges and Applications
- A common challenge in NPV analysis is accurately determining the appropriate discount rate.
- Non-conventional cash flows are defined as a combination of cash inflows and outflows over a period.
Other Financial Metrics
- A project generating cash flows of $3,700 annually for seven years at a cost of $16,500 has a Payback Period of 4.46 years.
- Filter Corp's project with cash flows: Year 0: -$14,000, Year 1: $6,200, Year 2: $7,500, Year 3: $4,900, Year 4: $4,500, has an IRR of 25.48%.
Key Figures
- NPV of Living Colour Co.’s project cash flows (Year 0: -$35,550; Year 1: $7,880; Year 2: $9,450; Year 3: $13,350; Year 4: $15,490; Year 5: $10,160) is $9,251.98 at a 7.6% return.
- A project with cash inflows of $13,350 (Year 1), $14,100 (Year 2), and $27,200 (Year 3), has an NPV of -$8,944.13 with a required return of 12.2%.
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Description
Test your knowledge on investment appraisal methods with these flashcards from Finance Chapter 9. Cover crucial concepts like NPV calculations and the Payback Period Rule. Ideal for students looking to solidify their understanding of financial decision-making.
