boken kap 6 del 3

Question 1

Q4: When is there only one IRR for a project?

Answer 1

When the cash flow has only one change in sign.

Question 2

Q6: What is the scale problem with IRR for mutually exclusive projects?

Answer 2

IRR ignores the scale of investments, focusing only on return rates. It may favor a higher percentage return rather than the highest absolute return.

Question 3

Q5: What are the general rules for decision-making based on cash flow patterns and IRR?

Answer 3

1. First cash flow negative, remaining positive:
   o Accept if IRR > R; Reject if IRR < R.
   o Accept if NPV < 0; Reject if NPV > 0.
2. First cash flow positive, remaining negative:
   o Accept if IRR < R; Reject if IRR > R.
   o Accept if NPV > 0; Reject if NPV < 0.
3. Some cash flows are positive and some negative after the first:
   o No valid IRR.
   o Accept if NPV > 0; Reject if NPV < 0.

Question 4

Q7: How can the scale problem be addressed?

Answer 4

1. Compare NPVs of the projects. or
2. Calculate incremental NPV of the larger project over the smaller project. or
3. Compare the incremental IRR to the discount rate.

Question 5

Q9: How do you calculate incremental cash flows between two projects?

Answer 5

Subtract the smaller project’s cash flow from the larger project’s cash flow, resulting in an initial outflow at date 0.

Question 6

Q10: What is the timing problem with IRR?

Answer 6

IRR focuses on the rate where NPV is zero, ignoring the impact of cash flow timing on NPV.

Question 7

Q1: What are the three methods to select a better option between projects with IRR when you have the timing problem?

Answer 7

1. Compare the NPVs of the projects.
2. Compare the incremental IRR to the discount rate.
3. Calculate the NPV of the incremental cash flows.

Question 8

Q2: Why is IRR still widely used despite its deficiencies?

Answer 8

IRR is simple to use and provides a single, clear number to represent project viability. Companies using IRR are often aware of its limitations.

Question 9

Q4: When should a project be accepted or rejected based on the Profitability Index?

Answer 9

• Accept if PI > 1
• Reject if PI < 1

Question 10

Q5: What is a limitation of the Profitability Index for mutually exclusive projects?

Answer 10

The Profitability Index has the same scale problem as IRR. Incremental analysis should be used for such projects.

Question 11

Q6: How should projects be ranked under capital rationing?

Answer 11

Rank projects based on their PI and choose the combination of projects with the highest combined NPV within the budget. Use up all of the money.

Question 11

Q7: What is the limitation of PI under capital rationing?

Answer 11

The PI method cannot handle capital rationing over multiple periods.