Investment Analysis Flashcards

A supplier offers a rebate of $10,000 paid two years from today. Using a 10% discount rate, what is its present value?

Answer: $8,264

PV = $10,000 / (1.10)^2 = $10,000 / 1.21 ≈ $8,264.

Under the net present value (NPV) decision rule, an independent capital equipment purchase should be accepted when:

Answer: Its NPV is greater than zero

A positive NPV means the investment earns more than the required rate of return and adds value.

The internal rate of return (IRR) of a procurement investment is best defined as the discount rate that:

Answer: Makes the project's NPV equal to zero

IRR is the rate at which the present value of inflows exactly equals the present value of outflows.

Two mutually exclusive sourcing projects give conflicting rankings: Project A has the higher NPV, while Project B has the higher IRR. Which should generally be chosen?

Answer: Project A, because NPV measures absolute value added

NPV is preferred for mutually exclusive choices because it measures the dollar increase in firm value directly.

Which rate is most commonly used as the discount rate when evaluating a company's capital investment proposals?

Answer: Weighted average cost of capital (WACC)

WACC represents the blended cost of the firm's debt and equity financing and serves as the hurdle rate.

If the discount rate used to evaluate a long-term supply contract is increased, the present value of its future savings will:

Answer: Decrease

A higher discount rate shrinks the present value of every future cash flow.

A firm spent $40,000 on a feasibility study for new warehouse equipment last year. When analyzing whether to buy the equipment now, how should the $40,000 be treated?

Answer: Excluded, because it is a sunk cost

Sunk costs have already been incurred and cannot be recovered, so they are irrelevant to the decision.