Invesment Decisions

Question 1

Capital budgeting techniques 4

Answer 1

1. Payback period PBP
2. Internal rate return IRR
3. Net present value NPV
4. Profitability index PI

Question 2

Independent project

Answer 2

Acceptance or reject do not depend on others project

Question 3

PBP payback period

Answer 3

Period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow

Question 4

Internal rate of return

Answer 4

IRR is the discount rate that equates the present value of the furture net cash flows from an investment project with the project’s initial outflow

Question 5

NPV net present value

Answer 5

Present value of an investment project’s

Question 6

Dependent

Answer 6

Acceptance depends on the accoetance of other projects

Question 7

Mutually exclusive

Answer 7

A project whose acceptance precludes the accoetance of other projects

Question 8

Capital rationning

Answer 8

Occurs when a constrain or budget is placed on the total size of capital expenditures during a particular period

Question 9

Capital allowance and taxation 4

Answer 9

1. Tax relief on capital expenditure is given theough capital alowance
2. 25% reducing balance capital allowances given on plant and machinery in UK
3. 100%, 50% and 40% first year allowances have been offered for specific investments
4. Balancing allowance and balancing charge

Question 10

Inflation 3

Answer 10

1. Can have a serious effect on capital investment decisions
2. The real value of future cash flows can be seriously reduced
3. The uncertainty associated with teh value of future cash flows is increased

Question 11

Risk ans uncertainty 4

Answer 11

1. Risk refers to a set of unique circumstances which can be assigned probabilities
2. Uncertainty implies probabilities cannot be assigned to different sets of circumstances
3. Risk increase with viability of returns
4. Uncertainty increases with project life

Question 12

Sensitivity analysis 5

Answer 12

1. A method of evaluating project risk.
2. It examines the responsiveness of project NPV to changes in project variables.
3. Only one variable is changed at a time.
4. One method involves changing variables by a set amount then recalculating NPV.
5. Another method involves finding the change in a variable which gives a zero NPV.

Question 13

Risk-adjusted rate classes 5

Answer 13

1. Applies concept of risk premium, which has time preference and risk preference elements.
2. Hurdle rate increases for riskier projects.
3. Hard to choose risk premium for given project.
4. One solution is to put projects in risk classes and allocate risk premiums.
5. Still difficult to assess project risk and to assign some projects to different classes

Question 14

Problems with risk-adjusted rates:

Answer 14

1. Projects are likely to be allocated to risk classes on the basis of total risk.
2. Allocation to risk classes is likely to take account of company risk only.
3. Risk premiums are likely to be derived on an ad hoc basis.