EXTRA (Risk Mgmt & Cap. Budget)

Question 1

What is the Accounting Rate of Return?

What is the formula?

Answer 1

ARR = (Expected Increase in Annual Income) / (Avg or Initial Investment)

ARR does not account of the time value of money.
Also ARR does not also places emphasis on annual income unlike IRR which emphasizes cash flow.

Question 2

How is salvage value treated in the discounted payback method?

Answer 2

Salvage value is ignored.

Question 3

Define Internal Rate of Return (IRR)

Answer 3

IRR is the rate of discount at which PV of future cash flows equals exactly the investment.

The hurdle rate = the firm’s minimum acceptable rate of return for taking a project.