Capital Budgeting (36)

Question 1

What happens to the IRR and the NPV when cash flows are doubled?

Answer 1

IRR is constant; NPV doubles

Question 2

What are the axes for a NPV Profile graph? What do the intercepts represent?

Answer 2

NPV on vertical axes; discount rate on x-axis. Vertical intercept is the sum of undsicounted cash flows; horizontal axis is the rate at which NPV=0 (the IRR).

Question 3

When considering incremental cash flows are interest costs included? Explain.

Answer 3

No. interest costs are included when determining the appropriate interest rate to discount the cash flows.

Question 4

Define Average Acounting Rate of Return (AAR)

Answer 4

AAR = (Avg Net Income)/(Avg Book Value)

Question 5

Define Profitability Index (PI)

Answer 5

PI= (PV of future cash flows)/(Initial investment )=1+(NPV)/(Initial Investment )