Question

Which of the following decision model does not take into account of the time value of money?

		Discounted Payback Period
		Net Present Value
		Profitability Index
		Payback period

Which of the following decision model takes into account of all the cash flows of a project.

		Payback period
		Discounted payback period
		Profitability index
		None

The discount rate that is used for calculating the present values of a project's cash flows is the rate of return on other investments, which have lower risk than that of the project.

True

False

Diversification helps the investor to significantly reduce the standard deviation of their investment as they create a portfolio by allocating their investment to different securities.

True

False

Variance of an investment's returns shows the exact percentage of the investment's risk.

True

False

Answer 1

Q) Which of the following decision model does not take into account of the time value of money?

Answer) Discounted Payback period, Net Present Value and Profitability index considers the cash flows which are discounted to the present value based on the cost of capital; Hence, these methods consider time value of money.

Payback Period is the one which considers the cumulative cash flows (normal) , which are undiscounted and hence, this method does not take the time value of money in to consideration.

Q) Which of the following decision model takes into account of all the cash flows of a project.

Answer) Both Payback Period as well as Discounted Payback period concentrates of the period till when the net cash inflows are sufficient to cover the initial investment (initial outlfow); These two methods doesnt consider the cash flows post the payback period.

Profitability index is computed using the Net Present Value of the Total Cash Flows from the Project during its entire life; Hence, PI considers all the cash flows of any given project.

Q) The discount rate that is used for calculating the present values of a project's cash flows is the rate of return on other investments, which have lower risk than that of the project.

Answer) FALSE;

The discounting rate can also be termed as the Cost of Capital which is used to discount the cash flows expected from the Project. This is not the rate of return from other investments; This rate is the cost at which the company is able to infuse / fund the capital - both equity as well as debt; Hence, WACC (Weighted Average Cost of Capital) is generally used for calculating Present Value.

Q) Diversification helps the investor to significantly reduce the standard deviation of their investment as they create a portfolio by allocating their investment to different securities.

Answer) TRUE; Portfolio diversification is cruicial and is instrumental in spreading the risk levels of individial securities across the portfolio; This shall indeed mitigate the overall volatility of the portfolio.

Q) Variance of an investment's returns shows the exact percentage of the investment's risk.

TRUE; Variance is the factor which measure the volatility between the stocks, as it measures how much a stock tends to deviate from its mean value. The higher the variance, the more wildly the stock fluctuates. Hence, the higher the variance, the riskier the stock;