13.3 Evaluating investment proposals

• Capital investment appraisal is the process of evaluating the viability and profitability of long-term investments
• The internal rate of return (IRR) is the discount rate that makes the NPV of a project equal to zero
• The payback period measures the time it takes to recover the initial investment
• Evaluating investment proposals helps maximize potential profitability and long-term cash flows
• A positive NPV indicates that a project is financially viable.


  True
• The formula for NPV is NPV = \sum_{t = 1}^{n} \frac{Cash\ Inflows_{t}}{(1 + Discount\ Rate)^{t}} - Initial\ Investment
• The payback period is simple to calculate but ignores the time value of money
• Evaluating investment proposals is crucial for efficient resource allocation.


  True
• NPV and IRR can always be directly compared to rank projects.

  False
• What does ARR measure in capital investment appraisal?

  Average annual profit
• The NPV formula includes discounting future cash inflows using the discount rate.
• Why is NPV important in capital investment appraisal?

  Considers time value of money
• Which technique considers the discount rate that makes NPV equal to zero?

  IRR
• What are cash inflows in the context of NPV calculation?

  Money coming into the project
• In the example provided, the NPV is calculated to be $1,978.11.


  True
• Why is evaluating investment proposals essential for businesses?

  Resource allocation and accountability
• What does strategic alignment ensure in investment proposals?

  Supports business objectives
• What does Net Present Value (NPV) calculate in capital investment appraisal?

  Difference between present values
• Match the investment appraisal technique with its advantage:

  Payback Period ↔️ Simple to calculate

  Accounting Rate of Return (ARR) ↔️ Considers profitability

  Net Present Value (NPV) ↔️ Accounts for time value of money

  Internal Rate of Return (IRR) ↔️ Considers time value of money
• Steps to calculate NPV

  1️⃣ Estimate cash flows

  2️⃣ Choose discount rate

  3️⃣ Calculate present value

  4️⃣ Sum present values

  5️⃣ Subtract initial investment
• What discount rate makes the NPV of a project equal to zero?

  Internal Rate of Return (IRR)
• NPV is generally considered more reliable than IRR.


  True
• NPV provides a clearer indication of a project's financial viability than IRR.


  True
• IRR considers the time value of money.


  True
• Match the feature with the corresponding technique:

  Definition ↔️ Difference between present value of cash inflows and initial investment (NPV)

  Decision Criteria ↔️ Positive NPV indicates a viable investment

  Multiple Solutions ↔️ May have multiple solutions (IRR)
• NPV provides absolute monetary values for investment decisions.


  True
• Evaluating investment proposals helps maximize returns and manage risks.


  True
• The present value formula discounts future cash flows using the discount rate.

  True
• IRR is the discount rate that makes the NPV of a project equal to zero
• What is the primary strength of NPV compared to Payback Period and ARR?

  Accounting for time value of money
• Match the technique with its primary advantage:

  IRR ↔️ Considers time value of money

  NPV ↔️ Provides absolute monetary value
• What is the key difference between NPV and IRR in their decision criteria?

  Positive NPV vs. IRR > cost of capital
• Match the feature with the correct technique:

  Discount rate when NPV is zero ↔️ IRR

  Absolute monetary value ↔️ NPV
• Payback Period and Discounted Payback Period are more comprehensive than NPV and IRR for evaluating project profitability.

  False
• The payback period considers cash flows after the recovery period.

  False
• The discounted payback period accounts for the time value of money
• If the discount rate is 8%, the discounted payback period for the project is approximately 4.5 years.
• The main disadvantage of the payback period is that it ignores the time value of money
• The discounted payback period considers the time value of money.


  True
• What does NPV stand for?

  Net Present Value