D362 Corporate Finance - Set 4 - Part 2

Correct Answer: Internal rate of return (IRR).

The IRR is the rate at which the NPV of the investment becomes zero, representing the break-even rate of return for the project.

Correct Answer: It accounts for the time value of money.

NPV considers the time value of money by discounting future cash flows, making it a reliable method for evaluating project profitability.

Correct Answer: It does not consider cash flows after the payback period.

The discounted payback period focuses on the time needed to recover the investment, ignoring cash flows that occur after the payback period.

Correct Answer: Accepting one project means rejecting the other.

Mutually exclusive projects require a choice between alternatives, where accepting one prevents the acceptance of the other.

Correct Answer: To test the impact of varying key variables on project outcomes.

Sensitivity analysis helps to understand how changes in key assumptions (e.g., costs or revenues) affect the overall project performance.

Correct Answer: The project is expected to add value to the firm.

A positive NPV means the projects discounted cash inflows exceed its costs, adding value to the firm.

Correct Answer: Internal rate of return (IRR)

IRR calculates the expected percentage return on a project, representing the discount rate that results in an NPV of zero.

Correct Answer: When the NPV is negative.

A negative NPV indicates that the project's costs exceed its expected inflows, making it unprofitable and thus should be rejected.

Correct Answer: Scenario analysis

Scenario analysis evaluates different possible outcomes, providing a better understanding of the risks and uncertainties surrounding a projects cash flows.

Correct Answer: To eliminate the issue of multiple IRRs in non-conventional cash flows.

MIRR resolves the issue of multiple IRRs by assuming that cash inflows are reinvested at the firms cost of capital, making it a more reliable indicator.

Correct Answer: Net present value (NPV)

NPV directly factors in the cost of capital by discounting future cash flows using the required rate of return or cost of capital.

Correct Answer: Research and development expenses from the past year

A sunk cost refers to an expense that has already been incurred and cannot be recovered, such as past research and development costs.

Correct Answer: Sensitivity analysis

Sensitivity analysis measures how changes in key variables (e.g., sales, costs) impact the project's cash flows, helping to assess the projects risk.

Correct Answer: It is easy to calculate and understand.

The payback period method is simple and straightforward, making it useful for quickly evaluating projects, though it has limitations.

Correct Answer: The project is expected to add value to the firm.

A PI greater than 1 means the present value of future cash flows exceeds the initial investment, suggesting that the project adds value.

Correct Answer: It assumes cash inflows are reinvested at the IRR, which may not be realistic.

IRR assumes that all cash inflows are reinvested at the IRR, which may not always reflect real-world investment conditions.

Correct Answer: Net present value (NPV)

NPV is preferred in cases with multiple IRRs because it provides a clear decision criterion without the issue of multiple rates of return.

Correct Answer: The projects future cash inflows

The payback period is determined by how quickly the projects future cash inflows can recover the initial investment.

Correct Answer: It ignores the time value of money.

ARR is criticized because it is based on accounting profits rather than cash flows and does not account for the time value of money.

Correct Answer: Accepted.

A project with positive cash flows and a payback period shorter than its life is generally considered viable and should be accepted.