NNV and IRR

Question 1

What is NPV and what is the acceptance criteria?

Answer 1

• NPV is the total present value of future project cash flow, minus the initial investment
• You only accept the NPV if it is above zero
• You choose the investment with the highest NPV

Question 2

What is the Payback Period Method?

What is the ranking criteria?

Answer 2

• It calculates how long it takes the project to “pay back” its initial investment
• Choose the shortest pay-back period

Question 3

What is the discounted payback period?

Answer 3

• The same as the Payback Period, but it takes the time value of money into account
• Year +(initial investment – almost paid back investment in year) /next number

Question 4

What is the AAR?

Answer 4

• Another investment decision approach

- Calculates as: Average net income / Average Book Value of Investment

Question 5

What is IRR?

Answer 5

• IRR is a investment decision method that sets the Net Present Value to zero
• Accept it if IRR exceeds the required return
  Select the highest IRR

Question 6

What is PI?

Answer 6

• PI is another way of deciding investments
• Its calculated as: Total PV of future cash flows / The initial investment
• Accept if PI is bigger than 1
• Select the PI that’s highest

Question 7

What method should be the primary decision rule?

Answer 7

NPV and IRR

Question 8

When is the IRR rule unreliable?

Answer 8

• IRR is unreliable with non-conventional cash flows or mutually exclusive projects

Question 9

How is PVIFA calculated?

Answer 9

= 1-(1+r)^-n / r