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AFM Advanced investment appraisal

ACCA · Strategic Professional · 7 questions

Name: ____________________   Date: ____________

  1. A project costs $1,000 at time 0 and gives inflows of $500, $600 and $700 in years 1 to 3. The reinvestment rate is 8 percent. The terminal value of the inflows at the end of year 3 is:

    • A $1,800
    • B $1,931
    • C $1,500
    • D $2,100

  2. Using the terminal value of $1,931 and an outlay of $1,000, the modified internal rate of return over three years is closest to:

    • A 19.3%
    • B 24.5%
    • C 10.0%
    • D 31.1%

  3. In adjusted present value, the base case NPV is calculated by discounting the project cash flows at:

    • A The cost of debt
    • B The ungeared cost of equity
    • C The WACC
    • D The risk free rate

  4. Under capital rationing, where projects are divisible and not repeatable, the correct approach is to rank projects by:

    • A Profitability index (NPV per unit of capital)
    • B Accounting rate of return
    • C Size of the NPV
    • D Payback period

  5. A real option to delay a project until more information is available is most like a:

    • A Call option
    • B Put option
    • C Forward contract
    • D Swap

  6. An option to abandon a project and sell the assets if it fails resembles a:

    • A Put option
    • B Call option
    • C Futures contract
    • D Interest rate swap

  7. A project's value is most sensitive to an input if:

    • A The input is the largest number
    • B It is a fixed cost
    • C The input is certain
    • D A small change in that input produces a large change in NPV

Answer key

1. B, 2. B, 3. B, 4. A, 5. A, 6. A, 7. D

  1. 500 x 1.08^2 + 600 x 1.08 + 700 = 583.2 + 648 + 700 = 1,931.2.

  2. MIRR = (1,931 / 1,000)^(1/3) - 1 = 24.5%.

  3. APV values the project as if all equity financed and adds the financing side effects such as the tax shield.

  4. Rank by NPV per $ of the limiting resource and accept in order until the capital is used up.

  5. Delay gives the right, but not the obligation, to invest later, and has value when there is uncertainty.

  6. The right to sell at a known value gives downside protection.

  7. Sensitivity analysis identifies the variables where a small error matters the most.