COST-BENEFIT ANALYSIS NPV 1

Question 1

is the most important criterion for the financial and the economic evaluation

Answer 1

project’s net present value (NPV)

Question 2

If incremental NPV is positive.

Answer 2

then this project at scale 2 is preferable to scale 1

Question 3

This procedure (scale increase) is repeated until a scale is reached where the NPV of the

Answer 3

incremental benefits and costs associated with a change in scale are negative.

Question 4

If the initial scale of the project had a negative NPV, but all the subsequent incremental net present values for changes of scale were positive,

Answer 4

It still would be possible for the overall project to have a negative NPV.

Question 5

assuming that each successive increment of investment has a unique IRR. If this condition is met, then the optimum scale for the facility will be the one at which the IRR

Answer 5

for the incremental benefits and costs equal to the discount rate used to calculate the net present value of the project

Question 6

the scale at which the IRR is always maximized

Answer 6

The scale where the IRR=MIRR

Question 7

maximum net present value

Answer 7

where IRR is equal to the discount rate called MIRR

Question 8

becomes particularly difficult for large indivisible projects such as infrastructure investments in roads, water systems, and electric generation facilities.

Answer 8

The decision about an appropriate time to start

Question 9

If these projects are built too soon, a

Answer 9

a large amount of idle capacity will exist

Question 10

a large amount of idle capacity will exist

Answer 10

In such cases, the foregone return (that would have been realized if these funds had been invested elsewhere) might be larger in value than the benefits gained in the first few years of the project’s life

Question 11

Whenever the project is undertaken too early or too late

Answer 11

The NPV of such projects may still be positive but it will not be at its maximum

Question 12

The determination of the correct timing of investment projects will be a function of

Answer 12

how future benefits and costs are anticipated to move in relation to their present values.

Question 13

In Case A, the project should be postponed

Answer 13

If the present value of the benefits that are lost by postponing the start of the project from time period t to t+1 is less than the opportunity cost of capital multiplied by the present value of capital costs as of period t.

because the funds would earn more in the capital market than if they were used to start the
project.

Question 14

then the project should proceed.

Answer 14

if the foregone benefits are greater than the opportunity cost of the investment.

Question 15

Case A: Potential Benefits are a Rising Function of Calendar Time

Answer 15

rKt > Bt+1 ⇒ Postpone

rKt < Bt+1 ⇒ Start

Question 16

Case B: Both Investment Costs and Benefits are a Function of Calendar Time

Answer 16

rKt > Bt+1 + (Kt+1 – Kt) ⇒ Postpone

rKt < Bt+1 + (Kt+1 – Kt) ⇒ Start

Question 17

The term, (K1-K0), represents the

Answer 17

savings of the increase in capital costs by commencing the project in t0 instead of t1

Question 18

could be abandoned at some point in time with the result that a

Answer 18

the one-time benefit is generated, equal to its scrap value,

Question 19

five special cases regarding scrap value and change in scrap value of a project

Answer 19

SV > 0 and ∆SV < 0
SV > 0 but ∆SV > 0
SV < 0 but ∆SV = 0
SV < 0 but ∆SV > 0
SV < 0 and ∆SV < 0

Question 20

SV > 0 and ∆SV < 0

SV > 0 but ∆SV > 0

Answer 20

machinery;

Land

Question 21

SV < 0 but ∆SV = 0

SV < 0 but ∆SV > 0

SV < 0 and ∆SV < 0

Answer 21

a nuclear plant;

severance pay for workers

Clean-up costs

Question 22

Case C: Potential Benefits Rise and Decline According to Calendar Time

Answer 22

Stop if rSVtn – Btn+1 – ∆SVtn+1 > 0

Start if rKt < Bt

Question 23

it is necessary to consider the length of life of the two

or more projects.

Answer 23

If the mutually exclusive projects are expected to have

continuous high returns over time

Question 24

The reason for wanting to ensure that mutually exclusive projects are compared over the same span of time is to

Answer 24

give them the same opportunity to accumulate
value over time,
Economic rent that give fixed factor of production

Question 25

The reason for wanting to ensure that mutually exclusive projects are compared over the same span of time is to

Answer 25

give them the same opportunity to accumulate
value over time,
Economic rent that earned by fixed factor of production

Question 26

An increase in the scale of a project will

Answer 26

require additional expenditures and will

likely generate additional expected benefits

Question 27

when the project is viable?

Answer 27

present value of (B1 - C1) is positive

Question 28

The NPV is the maximum because the

Answer 28

incremental NPV for any addition to the scale of the project would be negative

Question 29

Therefore, in order to pick the optimum scale for a project, first, we must make sure that the NPV of the overall project is X and then the NPV of the last addition to the investment to increase
project’s scale must also be

Answer 29

positive

non-negative

Question 30

the MIRR from incremental investments will initially rise as the scale is increased,

Answer 30

but will soon begin to fall with further expansions.

Question 31

This path of the MIRR will also cause

Answer 31

the IRR to rise for the initial ranges of scale and then to fall.

Question 32

At some point, the IRR and the MIRR must be

Answer 32

equal and then change their relationship to each other

Question 33

at the scale that MIRR is less than IRR: in this range,

Answer 33

expansions of scale will cause the overall IRR to FALL

Question 34

The scale where the IRR=MIRR is

Answer 34

always the scale at which the IRR is maximized

Question 35

Optimum scale

Answer 35

when the relevant discount rate is precisely equal to the maximum IRR (NPV) is maximum

Question 36

if a project is delayed too long, then

Answer 36

shortages of goods or services will persist and the output foregone will be greater than the alternative yield of the funds involved.

Question 37

The situations where timing of investment projects becomes an important issue

Answer 37

a) The benefits of the project are a continuously rising function of calendar time, but investment costs are independent of calendar time.
b) The benefits and investment costs of the project are rising with calendar time.
c) The benefits are rising and then declining with calendar time while the investment costs are a function of calendar time.
d) The benefits and investment do not change systematically with calendar time

Question 38

The benefits of the project are a continuously rising function of calendar time, but investment costs are independent of calendar time.

Answer 38

benefits net of operating costs are continuously rising through time and costs do not depend on calendar time.
Ex: the benefits of a road improvement

Question 39

The benefits of the project are a continuously rising function of calendar time, but investment costs are independent of calendar time. If project POSTPONE then

Answer 39

lost benefits but the same capital in alternative uses yields rK, where K denotes the initial capital expenditure and r denotes the opportunity cost of capital for one period.

Question 40

NET gain or benefits

Answer 40

net gain of AIDC

net benefit of CDE