Lecture 8 (chapter 7)

Question 1

Vad gäller NPV-rule och andra regler?

Answer 1

NPV-rule är alltid most accurate men inte den som används mest. Finns andra regler som rekommenderar andra regler än NPV-regeln, och då kan de ha negativt NPV.

Question 1

IRR and positive NPV?

Answer 1

Om IRR > r så är NPV positivt (detta stämmer inte alltid enligt IRR-regeln)

Question 2

IRR-regel?

Answer 2

IRR-regeln rekomenderar att investera i projekt så länge som:
IRR > cost of capital
IRR > expected return of securities / projects with an equivalent risk (samma men med andra ord)

All negative cash flows must precedes its positiv cash flows.

Question 3

Pitfalls with IRR-rule:

Answer 3

1. Delayed investments
2. Multiple IRR
3. Nonexisting IRR

Question 4

The payback rule?

Answer 4

Only accept a project if it pays back its initial investment within a pre-specified period

Question 5

Reasons why pay back rule works poorly?

Answer 5

1. It ignores the discount rate
2. Ignores payments after the payback period
3. The payback period is usually determined in an arbitrary way

Question 6

How should we do if we can only commit capital for a shorter specific time?

Answer 6

Only invest if the payback rule and NPV rule agrees. But NPV has to be positive.

Question 7

What does it mean if investments are mutually exclusive? What does the NPV rule say about this?

Answer 7

That our decision to invest in a project affects our decision to invest in another project. For example if we have a limited budget.

NPV rule says that we should choose the investment with highest NPV.

Question 8

What’s the problem with IRR-rule?

Answer 8

The investment with highest IRR that IRR-rule recommends isn’t always the most correct decision if the projects have different:
- scale of investment (smaller gives higher IRR)
- timing of cash flows (same cash flow but in 1 year or 5 years)
- risk (IRR is the same but NPV is lower in the one with higher risk)

Question 9

A firm has limited resources, how should they invest?

Answer 9

Not necessarily invest in the project with highest NPV. Given their limited resources they should invest in what gives them highest NPV.
projekt 1 för 100 ger NPV 110.
projekt 2 för 50 ger NPV 60.
projekt 3 för 50 ger NPV 70.
Välj projekt 2 + 3 för att maximera.

Question 10

Calculate Profitability Index (PI)

Answer 10

PI = NPV / Resources consumed

Question 11

PI?

Answer 11

Profitability Index.
Steg 1. Räkna ut alla PI
Steg 2. Sortera från högst till lägst PI
Steg 3. Börja från högsta och välj alla nedåt fram tills att resursbegränsningarna säger stopp.