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Questions and Answers
What can lead to a higher Profitability Index?
What can lead to a higher Profitability Index?
Which formula accurately represents NPV?
Which formula accurately represents NPV?
What defines the Internal Rate of Return (IRR)?
What defines the Internal Rate of Return (IRR)?
Which discount rate is appropriate for calculating NPV?
Which discount rate is appropriate for calculating NPV?
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When comparing two projects based on NPV, which should be chosen?
When comparing two projects based on NPV, which should be chosen?
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What does the Internal Rate of Return (IRR) assume about cash flows from projects?
What does the Internal Rate of Return (IRR) assume about cash flows from projects?
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In what way does Net Present Value (NPV) differ from IRR regarding cash flow reinvestment?
In what way does Net Present Value (NPV) differ from IRR regarding cash flow reinvestment?
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Which statement is true regarding the accuracy of NPV and IRR?
Which statement is true regarding the accuracy of NPV and IRR?
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What is a significant economic reason for leasing instead of purchasing an asset?
What is a significant economic reason for leasing instead of purchasing an asset?
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Which of the following is NOT a principal purpose of purchasing durable goods?
Which of the following is NOT a principal purpose of purchasing durable goods?
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Study Notes
Discount Rate for NPV Calculation
- Use the discount rate equal to the investment return on nonmarketable or marketable securities with similar risk characteristics.
- Avoid low-risk or high-risk securities unless justified for specific project risks.
Understanding NPV
- NPV formula: Present Value of Future Cash Inflows minus Cash Outflow in Current Period.
- An alternative way to comprehend NPV is through future cash flow summation divided by the discount rate, subtracting current cash outflow.
Profitability Index Influencers
- Higher NPV leads to a higher Profitability Index.
- Cost impact: Higher costs can negatively affect the Index while lower NPVs detract from it.
Project Selection Based on NPV
- When comparing projects, choose based on the highest NPV relative to its cost.
- Project A: NPV of $45 million, cost of $33 million.
- Project B: NPV of $54.5 million, cost of $22 million; thus, Project B is preferable.
Internal Rate of Return (IRR)
- IRR is defined as the rate that equalizes the present value of cash inflows and cash outflows.
- It is different from NPV, which represents the absolute value created by the investment.
NPV vs. IRR
- Key difference: NPV assumes reinvestment at the required return rate; IRR assumes reinvestment at IRR rate.
- NPV generally offers clearer results and isn't subject to multiple solutions as IRR may be.
Durable Goods Purchase Reasons
- Common reasons: leveraging technological improvements, dealing with wear and tear, and adapting to changing circumstances.
- Attempting to minimize risk is not a valid reason for purchasing durable goods.
Automobile Change Factors
- Key decision factors include the state of the current vehicle, financial situation, and promotions on new cars.
Human Assets Characteristics
- Human assets are nonmarketable and reflect potential future earnings.
- They are generally rented out to employers for a specified time period.
Purpose of Durable Goods Acquisition
- Main purpose: derive direct benefits from usage rather than appreciating value or tax deductions.
Economic Justifications for Leasing
- Lessor may manage risks of obsolescence and unforeseen expenses.
- Yearly maintenance costs are crucial economic factors in leasing decisions.
Fuel and Operational Cost Calculations
- Fuel consumption calculated from annual mileage; projected at approximately 645 gallons annually.
- Total yearly cost of car ownership estimated at $4,513 against an existing cost of $9,798; resulting in annual savings of $5,285.
Investment Return Calculation for Education
- Adina aims to obtain an MBA to increase her salary by $60,000; associated costs total $104,000 over two years.
- Tax impact accounted, earning potential post-graduation factored into return calculations.
- Investment evaluation must consider her projected retirement age and expected ROI from educational expenditure.
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Description
This quiz covers essential concepts of NPV calculation, including how to determine the appropriate discount rate and the implications of profitability index. Additionally, it explores project selection strategies based on NPV and compares internal rate of return (IRR). Test your understanding of these critical financial evaluation tools.
