Question

1. question

What does the accounting rate of return measure?

1. The total profits expected from the project, expressed as a percentage of the average annual investment in the project.
2. The average annual expected profit expressed as a percentage of the average funds invested in it.
3. The total profits expected from the project, expressed as a percentage of the initial outlay.
4. The average annual expected profit expressed as a percentage of the initial outlay.

2. question

Which of the following is an advantage of using the payback period?

1. It ignores the actual timing of cash flows.
2. It is useful measure of the speed with which a project will pay back its initial costs
3. It takes no account of the time value of money.
4. It ignores cash inflows after the payback point has been reached

3. question

Alternative projects, X and Y, have been evaluated and the following results found:

	Project X	Project Y
Payback period	3.1 years	3.5 years
Accounting rate of return	17%	21%
Net Present Value	$385,000	$481,000

Which of the following is the most valid reason for choosing to undertake project Y?

1. Project Y will yield the highest accounting rate of return.
2. Project Y has a longer payback period than project X
3. Project Y will yield the highest NPV.
4. Project Y will give rise to greater cash flows than project X.

Answer 1

Question 1) Answer: B. The average annual expected profit expressed as a percentage of the average funds invested in it.
Accounting rate of return = Average net profit/Average investment.
Option A & C, expectes total profit, but the ARR will use average net profit, hence option A & C are wrong
Option D, express percentage of initial outlay, but actual ARR will use average investment hence this option also wrong.

Question 2) Answer: B. It is useful measure of the speed with which a project will pay back its initial costs.
Followings are the disadvantages of payback period:
- It ignores the actual timing of cash flows.
- It takes no account of the time value of money.
- It ignores cash inflows after the payback point has been reached.
Only option B is the advantage of payback period.

Question 3) Answer: C. Project Y will yield the highest NPV.
Longer payback period we will not select, so option B is not suitable.
Option A ignores the actual cashflow from the project, hence it may mislead.