Investement

Question 1

IRR

Answer 1

IRR is the discount rate at which NPV equals zero

Question 2

Rule of IRR

Answer 2

Invest in any project offering a rate of return that is higher than the opportunity cost of capital

Question 3

3 issues with IRR

Answer 3

Mutually exclusive projects
Doesn’t differentiate between lending and borrowing projects
When lots of changes to sign + or -

Question 4

Payback ads

Answer 4

Straightforward method
It’s important - long payback period means capital will be tied up for a long period implying in turn, high investment risk

Question 5

Payback dis

Answer 5

Ignores the timing of cash flows
The risk of investment + cash flows occurring after the payback period

Most importantly it doesn’t consider the shareholders wealth maximisation objective

Question 6

Ads of NPV

Answer 6

Accounts for all expected cash flows of the investment, the timing of these cash flows and the risk of the investment

Most impotent the method takes into consideration the shareholders wealth maximisation objective

Question 7

Dis of NPV

Answer 7

The method can fail to be an effective decision criterion when capital rationing exists

In such cases it need to be complemented by the profitability index in order to rank the investments