Question

A project has an NPV of £12,632 when a discount rate of 12% is used and the same project has an NPV of (£6,935) when a discount rate of 24% is used. The approximate internal rate of return of the project is:

Select one:

a. 18.5%

b. 15.16%

c. 20.5%

d. 19.75%
An investment project costs $10,500 and will generate $4,000 in annual cash flows for five years. What is the exact internal rate of return (IRR)?

Select one:

a. 5.56%

b. 13.2%

c. 26.19%

d. 19.27%

Which of the following is a reason that makes NPV a better approach to capital budgeting on a purely theoretical basis?

Select one:

a. It measures the direct impact on investors’ wealth (value created).

b. It measures the benefits relative to the amount invested.

c. Financial decision makers are inclined to higher rates of return.

d. Interest rates are expressed as annual rates of return.

An investment project costs $13,500 and will generate $4,600 in annual cash flows for six years. What is the discounted payback period if the discount rate is 7 percent?

Select one:

a. 3.4 years

b. 4.1 years

c. 3.7 years

d. 4.8 years

What is the profitability index of a project that has an initial cash outflow of $600, an inflow of $250 for the next 4 years and a cost of capital of 10 percent?

Select one:

a. 1.036

b. 1.321

c. 0.667

d. 1.444

An investment project costs $20,000 and will generate $5,000 in annual cash flows for two years followed by $4,000 in annual cash flows for six years. What is the payback period?

Select one:

a. 5.33 years

b. 4.50 years

c. 4.67 years

d. 4.25 years

Answer 1

1. Internal Rate of Return = [(NPV @ 12%) / (NPV @ 12% - NPV @ 24%)] * (24%-12%) + 12%

= [12632 / (12632 - (-6935))] * 12% + 12%

= (0.6456 * 12%) + 12%

= 7.747% + 12%

= 19.747%

= 19.75%

Hence, the answer is d. 19.75%.

2.

IRR = [(NPV @ 15%) / (NPV @ 15% - NPV @ 30%)] * (30%-15%) + 15%

= [2909 / (2909 - (-758))] * 15% + 15%

= (0.7933 * 15%) + 15%

= 11.90% + 15%

= 26.90% (approximately)

Its nearer to 26.19%

Hence, the answer is c. 26.19%.

3. NPV gives importance to direct cash benefits but not in terms of rate of return.

Hence, the answer is a. It measures the direct impact on investors’ wealth (value created).

4.

From the above, it can be observed that cummulative cash inflows exceed initial investment in year 4. So, the discounted pay back period exists in between years 3 and 4. It is calculated as follows:

= [(13500 - 12072) / 3509] * 1 year + 3 years

= 0.4 year + 3 years

= 3.4 years.

Hence, the answer is a. 3.4 years.

5.

Profitability Index = 792.47 / 600

= 1.321

Hence, the answer is b. 1.321.

6. Payback period is different from discounted payback period. Here, discounting of cash inflows doesnot take place.

From the above, it can be observed that cummulative cash inflows exceed initial investment in year 5. So, the pay back period exists in between years 4 and 5. It is calculated as follows:

= [(20000 - 18000) / 4000] * 1 year + 4 years

= 0.50 year + 4 years

= 4.50 years.

Hence, the answer is b. 4.50 years.