Capital Budgeting

Question 1

What is the Fisher Formula

Answer 1

(1 + Nominal rate of return) = (1 + Real rate of return) × (1 + Inflation rate)

Question 2

What is the purpose of IRR

Answer 2

internal rate of return (IRR), which calculates the discount rate for the project that would cause the project’s NPV to be $0.

Question 3

What are the rules for using IRR

Answer 3

IF IRR is greater than the discount rate appropriate for the project, then the project should be accepted

Question 4

What is a sensitivity Analysis

Answer 4

It’s a What-if Analysis. What would the impact be if one of the key assumptions are challenged

Question 5

Things to consider when dealing with an international investment

Answer 5

Political risk
Exchange rate risks
Cash flow Risks
Discount Risks

Question 6

What is capital rationing

Answer 6

When there are multiple projects with positive NPVs but there are limited capital resources - the project that must be pursued is valued via capital rationing. Where the project with the highest rank on the profitability index is selected

Question 7

Profitability Index

Answer 7

NPV of Project/Initial Investment

Higher the better