Understanding Flashcards

1
Q

IRR of project gives useful information regarding…

A

….sensitivity of projects NPV to errors in estimate of its cost of capital
! difference between cost of capital and IRR is maximal estimation error that can exist without altering original decision!

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2
Q

The Payback rule and the NPV rule - which is more reliable?

A

NPV!
bc payback rule ignores projects cost of capital and time value of money and cash flows after the payback period

BUT payback rule really simple, especially in small investings

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3
Q

Applying the IRR Rule to mutually exclisuve projects is…

A

… not a good idea
because timing of CF, riskiness, scale of investment differs

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4
Q

Because the IRR is not itself a measure of value…

A

… it is easy to manipulate by restructuring the projects cash flows

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5
Q

Ultimate goal of capital budgeting?

A

determine the effect of the decision on the firms CFs, and evaluate the NPV of these CFs to assess the consequences of the decision of the firms value

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