Investment Appraisal Test
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.
Question 1.
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.
Question 2.
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.
Question 3.
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
Question 4.
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
Question 5.
Which of the following defines IRR?
A. The discount rate which when applied to a
set of projected cash flows makes their NPV
= zero
B. The reduction in value of money due to the
effects of inflation.
Wrong The discount rate which when
applied to a set of projected cash
flows makes their NPV = zero is the IRR
Correct
Question 6.
A firm has a choice between 2 projects A and
B, A costs £40,000 and gives a net return
over 5 years of £170,000. B costs £45,000
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 65%
Wrong. B has an ARR of 62%,
whilst A’s ARR is 65%
Question 7.
An investment has the following projected
cash flows. Yr1 £5,000 Yr2 £6,000
Yr3 £6,000, Yr4 5,000. The cost of the
project is £15,000 - what is the payback
period.
Need help, click here
Answer here.
Total cash flows.
Find year in which payback occurs.
Calculate how much is needed to reach
payback in this year
Find monthly cash flow for year in
which payback occurs.
Calculate how many months it
will take to reach payback.
2 years 8 months
Question 8.
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
Question 9.
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
Question 10.
Under which of the situations given below is
Payback an appropriate method of IA to
use?
A. Inflation is high
B. There are several alternative projects that
need analysis
C. The technology being invested in is
changing rapidly.
No. Does not account for inflation. Though
it could be argued that payback is important if future flows
of money are likely to lose a large
proportion of their real value
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. For further
more detailed revision please use the case studies on
the ALoA web site.
www.aloa.co.uk.