Capital Budgeting

What is Net Present Value (NPV) and how is it calculated?

• Net Present Value (NPV) is calculated by adding the initial investment to the present value of cash inflows

• Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows.

• Net Present Value (NPV) is the total value of all future cash flows

• Net Present Value (NPV) is the difference between the future value of cash inflows and the future value of cash outflows

Explain the concept of Internal Rate of Return (IRR) and how it is used in capital budgeting decisions.

• IRR is the interest rate charged to borrowers and paid to savers by financial institutions.

• IRR is the amount of money that a company invests in a project.

• IRR is the total amount of revenue generated by a project over its entire lifespan.

• IRR is the discount rate that makes the net present value of all cash flows from a particular project equal to zero. .

Define Payback Period?

• Payback Period is the time it takes for an investment to generate enough cash flows to recover the initial investment.

• Payback Period is the time it takes for an investment to generate losses

• Payback Period include consideration of time value of money

• Payback Period include focus on long-term cash flows

What is Profitability Index (PI)?

• Profitability Index measures the ratio of the present value of future cash flows to the initial investment.

• Profitability Index does not consider future cash flows

• Profitability Index measures the absolute value of the investment

• Profitability Index is the same as IRR

Calculate the NPV of a project with an initial investment of $100,000, expected annual cash flows of $30,000 for 5 years, and a discount rate of 10%.

Determine the IRR of a project with an initial investment of $150,000 and expected annual cash flows of $40,000 for 4 years.

Calculate the payback period for a project with an initial investment of $200,000 and expected annual cash flows of $50,000 for 6 years.

Compare two projects with the following NPV values: Project A = $50,000 and Project B = $70,000. Which project would you recommend and why?

• Project A because it has a lower NPV

• Project A because it has a higher NPV

• Project B because it has a higher NPV

• Project B because it has a lower NPV

Explain the concept of discounting and its role in calculating NPV.

• Discounting is the process of increasing the future value of cash flows by applying a premium rate.

• Discounting is the process of determining the present value of future cash flows by applying a discount rate.

• Discounting is not relevant in calculating NPV as it only applies to future investments.

• Discounting involves reducing the present value of future cash flows by applying a discount rate.

Discuss the limitations of using IRR as a capital budgeting technique.

• IRR does not account for the scale of the project or the timing of cash flows.

• IRR always provides a clear and accurate decision-making tool

• IRR is not affected by the timing of cash flows

• IRR takes into account the risk associated with the project