Chapter 2

Question 1

What is opportunity cost?

Answer 1

The sacrifice of the return available on the best forgone project

Question 2

Process of investment appraisal

Answer 2

1. Objective or fundamental question
2. Decision inputs (cash flows & time value of money)
3. Decision analysis (discounted cash flows)
4. Answer

Question 3

The time value of money and its affect on rate

Answer 3

Compensation is required to induce people to make a consumption sacrifice. Compensation is needed for:
- Impatience to consume
- Inflation
- Risk

Question 4

Required return consist of…

Answer 4

Required return = RFR + risk premium

Where RFR = risk-free return and consists of pure time value and inflation

Question 5

Problems with internal rate of return

Answer 5

• Multiple solutions - with uneven/positive and negative cashflows IRR does not work (gives us multiple values)
• Ranking

Question 6

MIRR - difference from IRR

Answer 6

MIRR is the rate of return which if used to compound the initial investment amount produces the same terminal value as the project cash inflows.