NPV, IRR, ARR Theory Questions

Question 1

Explain the benefits of using the general valuation method of discounted cash flow as a tool for investment appraisal

Answer 1

• the notion of time value of money is captured by cash flow in investment appraisal
• there are other alternative investment appraisal methods: payback period, ARR, and IRR

Question 2

Explain the concept of real inflation rates

Answer 2

• write in fisher equation for nominal value of interest rates
  (1+ money rate of return) = (1+ real rate of return) x (1+ rate of inflation)
• nominal interest rates contain both the rate of inflation and the real rate of return
• real interest rates are important to allow for a more succinct view of return