Course Packet Gap Coverage P2

Question 1

Net Present Value (NPV) is the difference between the market value of a project and its cost.

Answer 1

FALSE

Question 2

Explain how to calculate NPV for a given project.

Answer 2

NPV is calculated by discounting the future cash flows of a project to their present value using a specific discount rate and subtracting the initial investment.

Question 3

A positive NPV indicates that a project’s return exceeds the anticipated costs, making it unprofitable.

Answer 3

FALSE

Question 4

Increasing the discount rate generally increases the NPV of a project.

Answer 4

FALSE

Question 5

How does NPV compare to other project evaluation techniques like IRR or Payback Period?

Answer 5

NPV provides a dollar value estimation of a project’s profitability, considering the time value of money, unlike the Payback Period. It also provides a more consistent measure of profitability compared to IRR, especially for non-standard cash flows.

Question 6

The accuracy of NPV highly depends on external market factors such as interest rates and inflation.

Answer 6

FALSE

Question 7

Describe the concept of incremental cash flows in the context of NPV.

Answer 7

Incremental cash flows are the net additional cash flows expected from a project, representing the difference in the firm’s cash flows with and without the project.

Question 8

Changes in discount rates have a more significant impact on the NPV of short-term cash flows than long-term ones.

Answer 8

FALSE

Question 9

What role does risk play in determining the appropriate discount rate for NPV?

Answer 9

Risk influences the choice of discount rate in NPV calculations, with higher risk projects requiring a higher discount rate to account for the uncertainty in cash flows.

Question 10

NPV is not suitable for comparing two or more investment opportunities when the projects have different durations.

Answer 10

TRUE

Question 11

The Internal Rate of Return (IRR) is always an accurate measure for decision-making in mutually exclusive projects.

Answer 11

FALSE

Question 12

IRR is calculated by setting the NPV equal to zero and solving for the discount rate.

Answer 12

TRUE

Question 13

What is the decision rule based on IRR for accepting or rejecting a project?

Answer 13

A. Accept if IRR > cost of capital; Reject if IRR < cost of capital

Question 14

In what ways is IRR different from NPV?

Answer 14

IRR is a rate of return measure, while NPV gives the actual dollar value of the project. IRR does not consider the scale of investment, whereas NPV does.

Question 15

How does IRR help in comparing different projects?

Answer 15

IRR helps to understand the efficiency of the investment by providing a percentage return, making it easier to compare projects of different sizes.

Question 16

What are the limitations of using IRR for project evaluation?

Answer 16

D. All of the above

Question 17

How do multiple IRRs occur and how are they interpreted?

Answer 17

Multiple IRRs occur in projects with unconventional cash flows and are interpreted as the project having different rates of return depending on the investment period.

Question 18

Explain the concept of the reinvestment rate assumption in IRR.

Answer 18

The reinvestment rate assumption in IRR is that future cash flows from the project are reinvested at the IRR itself, which might not be realistic.

Question 19

How can IRR be used for ranking projects in terms of profitability?

Answer 19

IRR can rank projects by their percentage return, allowing investors to see which projects yield the highest return on a percentage basis.

Question 20

Describe the scenario where IRR and NPV might give conflicting signals.

Answer 20

D. All of the above

Question 21

What is the payback period in capital budgeting?

Answer 21

The payback period is the time it takes for the initial investment of a project to be recovered from the cash inflows generated by the project.

Question 22

How is the payback period calculated?

Answer 22

The payback period is calculated by adding up the project’s cash inflows until the initial investment amount is fully recovered.

Question 23

What are the advantages of using the payback period as a project evaluation tool?

Answer 23

Advantages include simplicity, ease of understanding, and focus on liquidity and risk.