Project Investment Analysis Quiz
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Project Investment Analysis Quiz

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@HarmoniousCamellia3609

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Questions and Answers

What is the correct Annual Cash Flow corresponding to the random number 53?

  • 15,000
  • 20,000
  • 5,000
  • 3,000 (correct)

    • What is the Project Life corresponding to the random number 97?

  • 10 years
  • 7 years
  • 9 years (correct)
  • 5 years

    • Which value of Annual Cash Flow has the highest probability based on the ranges provided?

  • 20,000
  • 15,000
  • 30,000 (correct)
  • 25,000

    • What cumulative probability is associated with an Annual Cash Flow of 25,000?

    <p>0.70</p> Signup and view all the answers

    What does the abbreviation PVAF represent in the context of simulation results?

    <p>Present Value Annuity Factor</p> Signup and view all the answers

    How many years is the Project Life for an Annual Cash Flow of 40,000?

    <p>6 years</p> Signup and view all the answers

    What is the cumulative probability of receiving an Annual Cash Flow of 10,000?

    <p>0.02</p> Signup and view all the answers

    Which random number corresponds to an Annual Cash Flow of 15,000?

    <p>02</p> Signup and view all the answers

    What does the risk adjusted discount rate (RADR) include?

    <p>Risk-free rate and risk premium</p> Signup and view all the answers

    What happens to the discount rate if the risk of an investment project is higher than a similar project?

    <p>It is adjusted upward</p> Signup and view all the answers

    If the risk-free rate is 6% and the risk premium is 4%, what is the RADR?

    <p>10%</p> Signup and view all the answers

    What is the primary purpose of using a risk adjusted discount rate?

    <p>To require higher returns from risky projects</p> Signup and view all the answers

    In what scenario would you expect a higher risk premium?

    <p>For high risk investment projects</p> Signup and view all the answers

    When calculating NPV using RADR, which of the following is NOT included in the formula?

    <p>Market volatility</p> Signup and view all the answers

    What is an example of a risk-free rate of return?

    <p>Return from government securities</p> Signup and view all the answers

    What is the Net Present Value (NPV) calculated from the cash flows mentioned?

    <p>99.79 Lakhs</p> Signup and view all the answers

    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?

    <p>10%</p> Signup and view all the answers

    Which of the following is an advantage of using the Risk-Adjusted Discount Rate?

    <p>Incorporates a risk premium</p> Signup and view all the answers

    What limitation is associated with the Risk-Adjusted Discount Rate?

    <p>Challenges in determining risk-adjusted discount rate</p> Signup and view all the answers

    What is the annual depreciation expense if using a straight-line method over 4 years with an initial outlay of `80,000?

    <p>`20,000</p> Signup and view all the answers

    What does the Certainty Equivalent (CE) approach focus on in capital budgeting?

    <p>Expressing risky cash flows in terms of certain cash flows</p> Signup and view all the answers

    What is the taxable profit in year 1 when inflation is taken into account?

    <p>`24,000</p> Signup and view all the answers

    Which step is involved in the Certainty Equivalent approach?

    <p>Removing risks by using equivalent certain cash flows</p> Signup and view all the answers

    How does inflation impact the annual net cash inflow in year 4 compared to the non-inflation scenario?

    <p>It increases the cash inflow.</p> Signup and view all the answers

    What does the present value of cash flows represent in the context provided?

    <p>The value today of future cash flows discounted at a certain rate</p> Signup and view all the answers

    Why might a decision maker prefer the Certainty Equivalent approach?

    <p>It allows for incorporation of personal risk tolerance</p> Signup and view all the answers

    What is the total profit after tax for year 3 with inflation accounted for?

    <p>`16,620</p> Signup and view all the answers

    What is the total present value of cash flows calculated in the example?

    <p>199.79 Lakhs</p> Signup and view all the answers

    What is the tax amount in year 2 when the inflation rate is 10%?

    <p>`14,200</p> Signup and view all the answers

    Which of the following best describes the impact of inflation on revenues over the project life?

    <p>Revenues increase each year.</p> Signup and view all the answers

    If the annual costs other than depreciation are increased by 10% due to inflation, what is the cost in year 1?

    <p>`22,000</p> Signup and view all the answers

    What is the net cash inflow for year 4 when considering inflation?

    <p>`39,282</p> Signup and view all the answers

    What is the formula to calculate the net cash outflow when replacing equipment?

    <p>Cost of new equipment – [Tax payable/savings from sale + Market value of old equipment]</p> Signup and view all the answers

    How is the change in cash flow per year calculated if the replacement decision is implemented?

    <p>Change in sales ± Change in operating costs - Change in depreciation</p> Signup and view all the answers

    What is considered in the decision rule for accepting or rejecting a project?

    <p>Accept when present value of benefits &gt; present value of costs</p> Signup and view all the answers

    What is the estimated salvage value of the new system?

    <p>1,000</p> Signup and view all the answers

    What is the impact of depreciation on cash flow changes annually with the new system?

    <p>Depreciation is added back when computing cash flow changes</p> Signup and view all the answers

    What is the calculated tax payable from the sale of the old equipment?

    <p>2,250</p> Signup and view all the answers

    What percentage is the cost of capital for the company?

    <p>10%</p> Signup and view all the answers

    What is the original cost of the old system installed 5 years ago?

    <p>`25,000</p> Signup and view all the answers

    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) are 20,000.
    • 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 of 10,000 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 of 5,000.
    • 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.

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