boken kap 6 del 2 Flashcards
Q: What is the formula for the Average Accounting Return (AAR)?
(Average net income)/(average amount invested)
Q: What are the steps to calculate the Average Accounting Return (AAR)?
Determine average net income: Net cash flow – depreciation – taxes.
Determine average investment:
(Values of the investment over the years)/(amount of years)
Calculate AAR and see if the accounting rate is higher than the targeted accounting rate, then we do the investment.
Q: What are the main issues with the AAR method?
- It relies on accounting figures, which depend on subjective choices by accountants.
- It does not account for the timing of cash flows.
- It offers no guidance on setting the target rate of return.
Q: What is the internal rate of return (IRR)?
A: IRR is the discount rate that makes the net present value (NPV) of a project equal to zero.
Q: What is the general investment rule for the IRR method?
- Accept the project if the IRR is greater than the discount rate.
- Reject the project if the IRR is less than the discount rate.
Q: What is an independent project?
A: A project whose acceptance or rejection does not depend on the acceptance or rejection of other projects.
Q: What is a mutually exclusive project?
A: A project where only one can be accepted, or both can be rejected, but both cannot be accepted.
Q: What is the key distinction between investing-type and financing-type projects?
- Investing-type project: Pay money upfront and receive money later (the norm).
- Financing-type project: Receive money upfront and pay money later. (be careful with financing types because then IRR rule is reversed.)
What is the Most important alternative to NPV?
IRR
Q: Why must you be careful with financing-type projects in the IRR method?
A: For financing-type projects, the IRR rule is reversed; a higher IRR may indicate a less favorable project.
What is the only thing IRR depend on?
cash flows of the project.
Q1: What are the two general problems affecting both independent and mutually exclusive projects when using IRR?
- Investing or Financing: If IRR equals the discount rate, compare the project to borrowing/lending rates to decide.
- Multiple Rates of Return: IRR cannot be used if cash flows have more than one sign change, leading to multiple IRRs. (flip-flops)
Q2: How many IRRs can a project have?
The number of IRRs equals the number of sign changes in cash flow.
Q3: What should you do if a project has more than one IRR?
Use NPV to make decisions or proceed if the discount rate is between the two IRRs.
