AMA Q22 - Chapter 12

Question 1

What is PP

Answer 1

Payback Period

The time it takes an investment’s cash inflows to exceed the initial cost

Question 2

What are the two criteria when deciding whether to accept a project in regards to PP?

Answer 2

1. Is the PP within the company policy?
2. Is the PP the shortest of all options?

Question 3

Advantages of PP

Answer 3

1. Easy to understand
2. Considers liquidity/cash-flow
3. Quick calculation

Question 4

Disadvantages of PP

Answer 4

1. Arbitrary
2. Ignores the value of money
3. Ignores the specific timing of the cash inflows

Question 5

What is DPP?

Answer 5

Discounted Payback Period

Almost the same as Payback Period

Question 6

Three reasons for the time-value of money

Answer 6

1. Risk - having the money is seemed as more risky than someone promising it
2. Consumption - Being able to spend the money is useful
3. Investment - money can be invested

Question 7

How to calculate the discount factor

Answer 7

1/ compound interest to the power of how every long (years)

Question 8

Present value calculation

Answer 8

Future amount x 1/compound interest to the power of how every long (years)

Question 9

NPV calculation

Answer 9

Total of all inflows at discounted rate less initial investment amount

Question 10

Cost of capital?

Answer 10

The interest that could be earned on an amount of money

Question 11

When should a project be rejected in regards to NPV?

Answer 11

if the value is negative, or the highest value

(it means the return is less than just earning interest on the money)

Question 12

Discount rate = cost of capital

Answer 12

Discount rate = cost of capital

Question 13

Disadvantage of discounted cashflow technique, NPV?

Answer 13

It doesn’t factor the risk of the investment

Question 14

Advantage of discounted cashflow technique, NPV?

Answer 14

It accounts for the time value of money

Question 15

Net present costs

Answer 15

the cost of a piece of ongoing expenditure at its discounted value

Question 16

Formula for interpolation

Answer 16

a + (NPVa / (NPVa - NPVb) x (b - a)

Question 17

What does linear interpolation achieve?

Answer 17

It shows the impact of difference discount rates (interest rates) on the Net Present Value of an investment

Question 18

What is a disadvantage of linear interpolation?

Answer 18

It cannot work with changing interest rates

Question 19

Accounting Rate of Return calculation

Answer 19

Average annual profit /

Initial investment (or average investment)

Question 20

Average Investment calculation for ARR

Answer 20

(initial outlay + residual value) / 2

Question 21

Advantages of ARR

Answer 21

• It is easy to understand
• It considers the entire life of the project/investment
• It considers profit rather than cash

Question 22

Disadvantages of ARR

Answer 22

• It does not consider the time value of money
• It is not helpful in regards to cashflow