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Questions and Answers
What is the correct Annual Cash Flow corresponding to the random number 53?
What is the correct Annual Cash Flow corresponding to the random number 53?
What is the Project Life corresponding to the random number 97?
What is the Project Life corresponding to the random number 97?
Which value of Annual Cash Flow has the highest probability based on the ranges provided?
Which value of Annual Cash Flow has the highest probability based on the ranges provided?
What cumulative probability is associated with an Annual Cash Flow of 25,000?
What cumulative probability is associated with an Annual Cash Flow of 25,000?
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What does the abbreviation PVAF represent in the context of simulation results?
What does the abbreviation PVAF represent in the context of simulation results?
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How many years is the Project Life for an Annual Cash Flow of 40,000?
How many years is the Project Life for an Annual Cash Flow of 40,000?
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What is the cumulative probability of receiving an Annual Cash Flow of 10,000?
What is the cumulative probability of receiving an Annual Cash Flow of 10,000?
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Which random number corresponds to an Annual Cash Flow of 15,000?
Which random number corresponds to an Annual Cash Flow of 15,000?
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What does the risk adjusted discount rate (RADR) include?
What does the risk adjusted discount rate (RADR) include?
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What happens to the discount rate if the risk of an investment project is higher than a similar project?
What happens to the discount rate if the risk of an investment project is higher than a similar project?
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If the risk-free rate is 6% and the risk premium is 4%, what is the RADR?
If the risk-free rate is 6% and the risk premium is 4%, what is the RADR?
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What is the primary purpose of using a risk adjusted discount rate?
What is the primary purpose of using a risk adjusted discount rate?
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In what scenario would you expect a higher risk premium?
In what scenario would you expect a higher risk premium?
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When calculating NPV using RADR, which of the following is NOT included in the formula?
When calculating NPV using RADR, which of the following is NOT included in the formula?
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What is an example of a risk-free rate of return?
What is an example of a risk-free rate of return?
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What is the Net Present Value (NPV) calculated from the cash flows mentioned?
What is the Net Present Value (NPV) calculated from the cash flows mentioned?
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If an enterprise has an initial investment of 200 lakhs, a risk-free rate of 5%, and a risk premium of 3%, what is the RADR?
If an enterprise has an initial investment of 200 lakhs, a risk-free rate of 5%, and a risk premium of 3%, what is the RADR?
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Which of the following is an advantage of using the Risk-Adjusted Discount Rate?
Which of the following is an advantage of using the Risk-Adjusted Discount Rate?
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What limitation is associated with the Risk-Adjusted Discount Rate?
What limitation is associated with the Risk-Adjusted Discount Rate?
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What is the annual depreciation expense if using a straight-line method over 4 years with an initial outlay of `80,000?
What is the annual depreciation expense if using a straight-line method over 4 years with an initial outlay of `80,000?
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What does the Certainty Equivalent (CE) approach focus on in capital budgeting?
What does the Certainty Equivalent (CE) approach focus on in capital budgeting?
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What is the taxable profit in year 1 when inflation is taken into account?
What is the taxable profit in year 1 when inflation is taken into account?
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Which step is involved in the Certainty Equivalent approach?
Which step is involved in the Certainty Equivalent approach?
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How does inflation impact the annual net cash inflow in year 4 compared to the non-inflation scenario?
How does inflation impact the annual net cash inflow in year 4 compared to the non-inflation scenario?
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What does the present value of cash flows represent in the context provided?
What does the present value of cash flows represent in the context provided?
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Why might a decision maker prefer the Certainty Equivalent approach?
Why might a decision maker prefer the Certainty Equivalent approach?
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What is the total profit after tax for year 3 with inflation accounted for?
What is the total profit after tax for year 3 with inflation accounted for?
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What is the total present value of cash flows calculated in the example?
What is the total present value of cash flows calculated in the example?
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What is the tax amount in year 2 when the inflation rate is 10%?
What is the tax amount in year 2 when the inflation rate is 10%?
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Which of the following best describes the impact of inflation on revenues over the project life?
Which of the following best describes the impact of inflation on revenues over the project life?
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If the annual costs other than depreciation are increased by 10% due to inflation, what is the cost in year 1?
If the annual costs other than depreciation are increased by 10% due to inflation, what is the cost in year 1?
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What is the net cash inflow for year 4 when considering inflation?
What is the net cash inflow for year 4 when considering inflation?
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What is the formula to calculate the net cash outflow when replacing equipment?
What is the formula to calculate the net cash outflow when replacing equipment?
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How is the change in cash flow per year calculated if the replacement decision is implemented?
How is the change in cash flow per year calculated if the replacement decision is implemented?
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What is considered in the decision rule for accepting or rejecting a project?
What is considered in the decision rule for accepting or rejecting a project?
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What is the estimated salvage value of the new system?
What is the estimated salvage value of the new system?
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What is the impact of depreciation on cash flow changes annually with the new system?
What is the impact of depreciation on cash flow changes annually with the new system?
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What is the calculated tax payable from the sale of the old equipment?
What is the calculated tax payable from the sale of the old equipment?
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What percentage is the cost of capital for the company?
What percentage is the cost of capital for the company?
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What is the original cost of the old system installed 5 years ago?
What is the original cost of the old system installed 5 years ago?
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Study Notes
Initial Investment Details
- Project initial outlay is `80,000 with an expected life of 4 years.
- No salvage value at the end of the project life.
- Annual revenues are
60,000 while annual costs (excluding depreciation) are20,000. - Tax rate applied is 50%.
Cash Flow Analysis Without Inflation
- Annual depreciation on a straight-line basis amounts to `20,000.
- Taxable profit consistently stands at `20,000 each year.
- Tax liability of
10,000 results in a profit after tax of10,000 annually. - Net cash inflow each year totals `30,000.
Cash Flow Analysis With 10% Inflation
- When factoring in 10% inflation, projected annual revenues increase steadily:
- Year 1: `66,000
- Year 2: `72,600
- Year 3: `79,860
- Year 4: `87,846
- Annual costs adjust accordingly:
- Year 1: `22,000
- Year 2: `24,200
- Year 3: `26,620
- Year 4: `29,282
- Taxable profit, tax, and profit after tax rise in tandem with inflation.
Random Number Simulation
- Random numbers can be extracted from a pre-defined table for simulations, correlating annual cash flow and project life.
- Example values: `3,000 annual cash flow and 9 years project life illustrate simulation results.
Risk Adjusted Discount Rate (RADR)
- RADR compensates investors for delaying consumption and incorporates inflation and additional risks.
- The equation for NPV includes parameters such as net cash flow (NCF), risk-adjusted discount rate (k), initial investment (I), and time period (t).
- RADR is calculated by summing the risk-free rate and risk premium.
Risk-Free Rate and Risk Premium
- The risk-free rate represents returns from riskless investments, typically found in government securities (e.g., 6%).
- Risk premium is the additional return required by investors to take on extra risk, higher for riskier projects.
Certainty Equivalent (CE) Approach
- CE estimates equivalent certain cash flows in risky project contexts.
- Involves removing risk by substituting risky cash flows with guaranteed returns.
- Steps include calculating net cash outflow, estimating changes in cash flow, and evaluating present value of benefits against costs.
Example: Certainty Equivalent Calculation
- Company Roby’s cube evaluates replacing an old system with a new one costing
50,000 and expected annual savings of5,000. - Initial calculations involve understanding the tax implications and determining net cash outflows from the old system.
- A thorough analysis of the economic viability is made, considering costs, savings, tax rates, and depreciation.
Summary of Advantages and Limitations of RADR
- Advantages: Easy comprehension and inclusion of risk premium in calculations.
- Limitations: Finding risk premium can be challenging, and standard deviation of projects may not be calculated through this method.
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Description
Test your knowledge on project investment analysis through this quiz. You will evaluate key components such as initial outlay, annual revenues, costs, and tax implications. Understand the financial metrics necessary for making sound investment decisions.
