Investment Appraisal and Discounting

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Why is discounting used in investment appraisal?

To reduce the future income to a present value equivalent (correct)

To increase the value of future projects

To determine the number of years to expected return

To calculate the annual interest rate

What is the primary benefit of diversification?

Increasing potential income

Decreasing insurance costs

Increasing risk

Reducing uncertainty regarding income (correct)

What is the formula to calculate the present value of a future income?

PV = X / (1 + r)^t (correct)

PV = X * (1 + r)^t

PV = X / (1 - r)^t

PV = X * (1 - r)^t

What is the purpose of the discount rate in investment appraisal?

To reduce the present value of future income Signup and view all the answers

What is the primary reason why risk averse people buy insurance?

To avoid risk and ensure a certain income level Signup and view all the answers

What is the Net Present Value (NPV) of an investment?

The present value of a future flow of income minus the initial cost of investment Signup and view all the answers

What is the expected value of the property if the house is not insured and there is a 5% probability of a P10,000 loss?

P49,500 Signup and view all the answers

What is the benefit of buying the insurance policy in the example?

It eliminates the risk and ensures a certain income level Signup and view all the answers

What is the present value of P1000 received in 5 years, with an annual discount rate of 10%?

P620.92 Signup and view all the answers

What is the significance of the discount factor in investment appraisal?

It reduces the present value of future income Signup and view all the answers

What is the insurance premium in the example?

P500 Signup and view all the answers

What is the maximum amount the insurance company agrees to pay if the house is broken into?

P10,000 Signup and view all the answers

What is the primary function of a risk premium?

To compensate investors for taking risks Signup and view all the answers

What occurs when an investor's risk aversion increases?

The risk premium increases Signup and view all the answers

How is the risk-adjusted discount rate calculated?

By adding the risk premium to the discount rate Signup and view all the answers

Which of the following investors has the highest risk-adjusted discount rate?

Investor C Signup and view all the answers

What is the purpose of modifying the NPV formula to include a risk element?

To introduce a risk element into the discounting process Signup and view all the answers

What is the initial cost of the investment project?

P40 000 Signup and view all the answers

What is the purpose of diversification in investing?

To maximize return while reducing risk Signup and view all the answers

What is the probability of power cuts in 2021?

50% Signup and view all the answers

What is the expected income if you sell only gas stoves and there are power cuts?

P30 000 Signup and view all the answers

What is the total income if you diversify and sell both gas stoves and electric stoves, regardless of whether there are power cuts or not?

P21 000 Signup and view all the answers

What is the advantage of diversifying and selling both gas stoves and electric stoves?

Stabilizes income Signup and view all the answers

What is the income earned from electric stoves if you diversify and sell both gas stoves and electric stoves, and there are power cuts?

P6 000 Signup and view all the answers

What is the expected return on the total investment portfolio Rp in terms of b, Rm, and Rf?

Rp = bRm + (1-b)Rf Signup and view all the answers

What is the relationship between the standard deviation of the return on the risky asset (σm) and the risk-free asset (σf)?

σm > σf Signup and view all the answers

What is the expression for the standard deviation of the portfolio (σp) in terms of b and σm?

σp = bσm Signup and view all the answers

What is the equation that describes the relationship between the portfolio risk σp and expected return Rp?

Rp = Rf + (Rm - Rf) / σp * σm Signup and view all the answers

What is the intercept of the budget line described by the equation Rp = Rf + (Rm - Rf) / σm * σp?

Rf Signup and view all the answers

What is the slope of the budget line described by the equation Rp = Rf + (Rm - Rf) / σm * σp?

(Rm - Rf) / σm Signup and view all the answers