boken kap 6 del 1

Question 1

What is
- NPV
- AAR
- IRR
- PI
- R
?

Answer 1

NPV = Net Present value
AAR = Average accounting return
IRR = Internal rate of return
PI = Profitability index
R = Discount rate

Question 2

Q: What is the basic investment rule of the NPV method?

Answer 2

A: Accept the project if the NPV is greater than zero; reject it if the NPV is less than zero.

Question 3

Q: What does the net present value (NPV) represent in project evaluation?

Answer 3

A: The contribution of any project to a firm’s value.

Question 4

Q: What is the discount rate for a risky project called, and why?

Answer 4

A: The discount rate is often called the opportunity cost because investing in the project takes away the shareholder’s opportunity to invest dividends elsewhere.

Question 5

Q: What are the three key attributes of the NPV method?

Answer 5

1. NPV uses cash flows, not earnings.
2. NPV uses all the cash flows of the project.
3. NPV discounts the cash flows properly, accounting for the time value of money.

Question 6

Q: What is the payback period in investment decisions?

Answer 6

A: The time it takes to receive the original investment payment back from the cash flows.

Question 7

Q: What is the payback period rule?

Answer 7

A: Accept projects that reach payback before the selected date and reject others.

Question 8

Q: What are three problems with the payback period method?

Answer 8

1. It doesn’t consider the timing of cash flows within the payback period.
2. It ignores all cash flows after the payback period.
3. The choice of the payback cutoff date is arbitrary.

Question 9

Q: Why might large companies use the payback period method for small decisions?

Answer 9

• It allows managers to see the consequences of the investment relatively quickly.
• Firms with limited cash may justify its use.
• It’s useful when investing in emerging markets.

Question 10

Q: When is NPV preferred over the payback period method?

Answer 10

A: For evaluating large investments.

Question 11

Q: What is a flaw of the discounted payback period method?

Answer 11

A: It ignores cash flows that occur after the payback date.

Question 12

Q: What is the discounted payback period method?

Answer 12

A: It determines how long it takes for discounted cash flows to equal the initial investment, showing when a project starts generating positive value.