Decision Criteria

Question 1

What are the three most popular items of decision criteria?

Answer 1

NPV - Net present value
IRR - Internal rate of return
PB - Payback period
(discount factor = 1/(1-r))

Question 2

Definition NPV

Answer 2

is defined as the PV of all future CF produced by an investment, less the initial cost of the investment
is the value created by the project after paying back and remunerating the capital invested.

Question 3

Calculation of NPV

Answer 3

NPV = Sum(0-n) CFt/(1+r)^t

example: NPV =CF0 + CF1/(1+r)^1 + CF2/(1+r)^2 etc…

Question 4

How to interpret a NPV>0 and <0?

Answer 4

NPV >0 –> Invest
NPV<0–> do not invets
always go for the highest NPV

Question 5

What is the Net present value profile (NPVP) and what is it good for?

Answer 5

The NPVP relates a project’ NPV with discount rate.
Indicates NPV’s sensibility to changes in r
Useful as an indication in case there is no certainty about the cost of capital.

Question 6

Definition IRR

Answer 6

The maximum rate at which the investor would fund the project without loss of money

Question 7

Interpretation IRR <>cost of capital

Answer 7

IRR>cost of capital: invest

IRR < cost of capital:not invest

Question 8

Name three advantages of the IRR

Answer 8

• allows to assess the profitability of the project in terms of a rate
• allows to identify risk margin associated with the project
• allows to calculate the intrinsic profitability of the project without estimation of the cost of capital.

Question 9

Name four disadvantages of the IRR

Answer 9

• does not take into account the size of the project
• does not allow changes in the Cost of capital
• IRR assumes reinvestment, NPV not
• IRR is not always applicable because of its delayed investments, existence of multiple IRRs or sometimes not existent IRR

Question 10

Payback Period (PB) Definition

Answer 10

Calculates the amount of time it takes to pay back the initial investment

Question 11

PB interpretation

Answer 11

accept a PB if its pays back its initial investment within a preestablished period

Question 12

Name four problems of PB:

Answer 12

• completely ignores CFs after recovery time
• Ignores exact timing of CFs
• PB breaks down when investment is spread over time
• Relies on an ad hoc criteria (preestablished timeframe)

Question 13

Name three advantages of PB

Answer 13

• Useful in case of rapid obsolescence of the investment or whether there are limits to the granting of exploration.
• can be used as an indicator of risk and liquidity
• If the required payback period is short (one or two years) then most projects that satisfy the PB rule will have a positive NPV. So firms might save effort by first applying the payback rule, and only if it fails take the time to compute NPV.

Question 14

Name three accounting measures

Answer 14

ROI - Return of investment
ROE - Return of equity
EVA - Economic value added

Question 15

How to calculate ROI/ROE?

Answer 15

ROI = (Net income +A&D+Interests)/(Equity and Debts)
ROE = (Net income +A&D)/(Equity)

Question 16

What other macronomic indicators exist? Name as many as you can:

Answer 16

-Gross value added (GVA)
-Job creation
-Impact on the balance of Payments
-Creation of regional Balances
-Stimulation of other industries
-Staff Training
-Accelerating Development
-Uptake of new technologies
-technological independance
-Improvement of competitiveness in international markets by increasing
productivity