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FM D Investment appraisal

Written by Mahnoor Sheikh (ACCA)

ACCA · Financial Management · 10 questions

Name: ____________________   Date: ____________

  1. A project has a positive NPV. What does this mean?

    • A It will pay back in one year
    • B It has no risk
    • C It is expected to add to shareholder wealth at the cost of capital
    • D It reduces profit

  2. A real rate of 5 percent and inflation of 3 percent give what money (nominal) rate?

    • A 8.00%
    • B 2.00%
    • C 8.15%
    • D 15.00%

  3. Which discount rate should be used with money (nominal) cash flows?

    • A The inflation rate
    • B The money (nominal) cost of capital
    • C Zero
    • D The real cost of capital

  4. A real project has cash flows of $40,000 a year for 3 years and costs $100,000. The real cost of capital is 5 percent. What is the NPV, to the nearest dollar?

    • A $108,930
    • B $20,000
    • C $8,930
    • D $-8,930

  5. An asset costing $100,000 gets a 25 percent allowance in year 1 and the tax rate is 30 percent. What is the year 1 tax saving?

    • A $30,000
    • B $25,000
    • C $2,500
    • D $7,500

  6. Machine A has an EAC of $6,309 and machine B has an EAC of $5,630. Which should be chosen and why?

    • A B, because it has the lower equivalent annual cost
    • B A, because it lasts longer
    • C A, because it costs more
    • D Neither

  7. Under single-period capital rationing with divisible projects, how are projects ranked?

    • A By NPV alone
    • B By profitability index (NPV per unit of capital)
    • C By payback
    • D By cost

  8. Which of these is a limitation of sensitivity analysis?

    • A It uses probabilities
    • B It considers all variables at once
    • C It is too complicated
    • D It looks at one variable at a time and gives no probabilities

  9. A lease or buy decision should discount the cash flows at:

    • A The after-tax cost of debt
    • B Zero
    • C The cost of equity
    • D The risk-free rate

  10. Which of these is a limitation of payback?

    • A It is hard to calculate
    • B It uses discounting
    • C It looks at profit only
    • D It ignores cash flows after the payback period

Answer key

1. C, 2. C, 3. B, 4. C, 5. D, 6. A, 7. B, 8. D, 9. A, 10. D

  1. A positive NPV means the return is higher than the required return.

  2. 1.05 x 1.03 - 1 = 8.15%.

  3. Real cash flows go with the real rate.

  4. 40,000 x 2.7232 = 108,930. NPV = 8,930.

  5. 25,000 x 30% = 7,500.

  6. The lowest EAC is chosen.

  7. The index gives the most NPV per unit of scarce capital.

  8. It shows how much a variable can change before the decision changes.

  9. The lease is a form of borrowing.

  10. Discounted payback deals with the time value of money.