Investment Appraisal

Question 1

P.372 - Effective interest rate

Answer 1

= ((1 + i ÷ n)^n) - 1

Where:
- r = effective interest rate
- i = nominal interest rate
- n = number of time periods

Question 2

P.376 - Present Value (PV)

Answer 2

= Future value × Discount factor

Discount factor given with present value table

Question 3

P.376 - What is payback period?

Answer 3

The time a project will take to pay back the money spent (based on cash flows)

= Initial investment ÷ Annual cash inflow

Question 4

P.382 - Net Present Value (NPV)

Answer 4

Sum of present values of cash flows for each year once each has been multiplied by their relevant discount factors.

Question 5

P.385 - Internal Rate of Return (IRR)

Answer 5

= L + (Nₗ ÷ (Nₗ - Nₕ)) × (H - L)

Where:
- L = Lower discount rate
- H = Higher discount rate
- Nₗ = NPV at lower rate
- Nₕ = NPV at higher rate

If IRR > cost of capital then project = good

Question 6

P.389 - NPV if it has even cash flows

Answer 6

= Annual cashflow × Annuity factor - Initial investment

Question 7

P.390 - Finding IRR using Annuity table

Answer 7

• Calculate cumulative discount factor (initial investment ÷ annual inflow)
• Find life of project n
• Look along row n until you find closest value to CDF
• The column header is the IRR

Question 8

P.391 - NPV of project with a perpetuity

Answer 8

Perpetuity means cashflow will remain consistent for foreseeable future

= (Annual cashflow ÷ Discount rate) - Initial investment

Question 9

P.392 - IRR of a project with a perpetuity

Answer 9

= (Annual inflow ÷ Initial investment) × 100