This test consists of 10 questions designed to test
your understanding of the methods of
investment appraisal.
The links provide you with a choice of answer,
along with explanations and solutions.
You will need a calculator to complete this test.
The payback method of IA will always select the
investment that
a. gives the highest rate of return
b. returns the cost of investment first
c. has the highest total net cash flow.
The payback method prioritises those
investments that return the cost of investment
in the shortest time. Your answer is correct.
The Payback method focuses on time,
not overall return . Try again.
The Payback method focuses on time, not
overall return . Try again.
Annual, or average rate of return method of IA will
always select?
A. The project with the lowest cost
B. The project with the highest total net return
C. The project with the highest average return
Wrong. Think of the name of the method,
then try again
Wrong. Think of the name of the method,
then try again
Correct.
Which of the following methods of IA allows for the
effects of inflation on the real value of net cash
flows?
A. Payback
B. Net Present Value
C. ARR
Wrong. Payback takes no account of the
effects of inflation
Correct. Discounting cash flows allows for
predicted effects of inflation
Wrong. ARR takes no account of the
effects of inflation
Which of the following is an advantage of using the
Payback method?
A. Selects the overall most profitable project
B. Allows easy comparison between alternative
investments
C. Focuses on the short term, and cash flows
Wrong. Payback ignores total profitability
Try again
Payback only focuses on cash flows, and
no other method of comparison.
Try again
Correct
Which of the following is an advantage of ARR?
A. It allows easy comparison between projects of
different cost
B. It allows for the reduction in value of money due to
the effects of inflation.
Wrong
Correct
A firm has a choice between 2 projects A and B, A
costs £400,000 and gives a net return over 5 years of
£170,000. B costs £450,000 and over 5 years gives a
net return of £185,000. Using the ARR method
which would be chosen?
A.
B.
Correct. This project has an ARR of 8.5%
Wrong. B has an ARR of 8.2%,
whilst A’s ARR is 8.5%
An investment has the following projected cash flows.
Yr1 £5,000 Yr 2 £6,000 Yr 3 £6,000, Yr 4
£5,000. The cost of the project is £15,000 - what is
the payback period.
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Answer here.
Total cash flows for the end of each year.
Find year in which payback occurs.
Calculate how much is needed at the end of previous
year to reach payback in this year
Find monthly cash flow for year in
which payback occurs (cash flow for year divided by12).
Calculate how many months it will take to reach payback
Amount outstanding at beginning of year
divided by monthly cash flow for year.
2 years 8 months
Given a discount rate of 5%, what will be the adjusted
value of the following flows of cash. Yr1 £5,000
Yr2 £6,000 Yr3 £6,500
Yr4 £5,000. ?
Discount Table
Help
Answer
Discount Table for 5%
Yr1 0.952
Yr2 0.907
Yr3 0.864
Yr4 0.823
Yr5 0.784
To find NPV, multiply each years cash flow,
by the discount factor for that year,
and then total your discounted cash flows.
The correct answer is £19,110
ARR can be criticised as a method of investment
appraisal because?
A. It ignores the total profitability of projects
B. It makes comparison between projects difficult
C. It ignores that fact that the real value of cash flows
falls with time.
ARR takes into account all cash flows
It calculates return as a proportion of initial investment.
This makes comparison relatively easy
Correct. ARR does not allow for the effects of
inflation
Under which of the situations given below is
Payback an appropriate method of IA to use?
A. Cash flow is not important
B. There are several alternative projects that need
analysis
C. The technology being invested in is changing
rapidly.
No.
No. Payback makes analysis difficult.
No account of total profitability is made
Correct, well done. This is one of the 2 most
important advantages of payback, the
other is that it focuses on cash flows.
You have now completed the test.