Lecture 9

Question 1

What is Accounting Rate Of Return (ARR)?

Answer 1

The average annual profits expected from a project as a percentage of the capital invested.

Question 2

What are two the equations for Accounting Rate Of Return (ARR)?

Answer 2

ARR =
Average annual profit
———————————————–
Initial Investment
OR

ARR =

     Average annual profit -----------------------------------------------    
             Average Investment

Question 3

What is payback period?

Answer 3

The Payback period is the length of time that it takes for a project to recover its initial cost out of the cash receipts that it generates.

It is measured in years.

Question 4

When you get a postive npv what do you do?

Answer 4

If NPV is positive, accept the project.

Question 5

When you get a negative npv what do you do?

Answer 5

If NPV is negative, reject the project.

Question 6

If you have several mutually exlcusive npv what do you do?

Answer 6

If several projects are mutually exclusive, accept project with highest positive NPV.

Question 7

discount rate equation?

Answer 7

1/ (1+r) ^n

r= discount rate
n= the number of years

Question 8

What is residula value? should it be included into Net presnet Value

Answer 8

Residual Value is any cash at the end of the project e.g., from sale of equipment, inventories sold to a third party, should be included in the projected cash flows and discounted from the end of the project.

Question 9

What are the advantages of NPV?

Answer 9

Advantages:

NPV looks at all costs and benefits of investment opportunities and allows for timing of these.

NPV informs directly as to whether shareholder wealth increases or decrease.
 
\+ve NPV- increase in shareholder wealth 

-ve NPV- decrease in shareholder wealth

Question 10

What are NPV disadvantages?

Answer 10

NPV disadvantages are:

The cash flow figures are estimates and may turn out to be incorrect.

Non-financial managers may have difficulty understanding the concept.

Determination of the correct discount rate can be difficult

Question 11

What is Internal Rate of return (IRR)?

Answer 11

The IRR is a variation of the NPV method.

the annual percentage return achieved by a project at which the sum of discounted cash inflows over the life of the project is equal to the sum of discounted cash outflows’
or ‘ the rate at which NPV = zero’

Question 12

Margin of