Discounted Cash Flow

Question 1

What is meant by simple interest?

Answer 1

Interest accrues only on the initial amount invested

Question 2

What is meant by compound interest?

Answer 2

Interest is reinvested alongside the principal

Question 3

What is meant by EAIR?

Answer 3

Interest is charged on a non-annual basis

Question 4

When is it necessary to know the EAIR?

Answer 4

Interest on bank overdrafts (and credit cards) is often charged on a monthly basis

Question 5

The more frequent the compounding methods in EAIR?

Answer 5

The higher the EAIR is

Question 6

A discount factor for a cash flow arising now?

Answer 6

The discount factor is always one

Question 7

The main assumption for TVM?

Answer 7

Investors prefer to receive $1 today rather than $1 in one year

Question 8

Liquidity preference for TVM?

Answer 8

If money is received today it can either be spent or reinvested to earn more in future

Question 9

Risk for TVM?

Answer 9

Cash received today is safe, future cash receipts may be uncertain.

Question 10

Inflation for TVM?

Answer 10

Cash today can be spent at today’s prices but the value of future cash flows may be eroded by inflation

Question 11

Two methods for DCF?

Answer 11

NPV (absolute measure)
IRR (relative measure)

Question 12

Advantage of DCF (Take into account)

Answer 12

tThe time value of money

All of a project’s cash flows over its entire duration; and
the timing of cash flows

Question 13

Advantage of DCF (Objective basis)

Answer 13

Provide a more objective basis for evaluating and selecting investment projects as they are not affected by financial accounting policies

Question 14

Disadvantage of the DCF methods?

Answer 14

Complexity of estimating appropriate discount rate
Complex calculation

Question 15

What does a project’s NPV show?

Answer 15

The theoretical change in the dollar value of the company due to the project

Question 16

What if positive NPV projects are accepted?

Answer 16

Shareholder wealth is therefore increased

Question 17

What is an annuity?

Answer 17

A stream of identical cash flows arising each year for a finite period of time.

Question 18

What is a perpetuity?

Answer 18

A stream of identical cash flows arising each year to infinity.

Question 19

What does IRR represent?

Answer 19

The average annual percentage return from a project and therefore shows the highest finance cost that can be accepted for the project

Question 20

If IRR > Cost of capital

Answer 20

Accept project

Question 21

If IRR < Cost of capital

Answer 21

Reject project

Question 22

What must be given for an NPV to be zero?

Answer 22

The present value of the cash inflows must equal the initial cash outflow

Question 23

What happens if cash outflows are followed by cash inflows and then more cash outflows?

Answer 23

The situation of “multiple yields” may arise

Question 24

If NPV > 0?

Answer 24

Accept

Question 25

If NPV < 0?

Answer 25

Reject

Question 26

What does NPV show?

Answer 26

Dollar change in value of company/wealth of shareholders

Question 27

What is an absolute measure?

Answer 27

$

Question 28

What is a relative measure?

Answer 28

%

Question 29

If IRR > target %

Answer 29

Accept

Question 30

If IRR < target %

Answer 30

Reject

Question 31

Can IRR have multiple answers?

Answer 31

Yes

Question 32

Is NPV better than IRR

Answer 32

Yes as it’s absolute, takes into account size of project