Finance for Non-Finance Managers Investment Decision Making 2 — Questions and Answers
Question 1: Internal Rate of Return (IRR) is best described as:
- The minimum return required by investors
- The discount rate at which a project's NPV equals zero (Correct answer)
- The average annual profit divided by initial investment
- The percentage of revenue reinvested in the business
Correct answer: The discount rate at which a project's NPV equals zero
IRR is the discount rate that makes the net present value of all cash flows from a project equal to zero.
Question 2: If a project's IRR exceeds the company's required rate of return (hurdle rate), the project should:
- Be rejected
- Be accepted (Correct answer)
- Be deferred indefinitely
- Be reviewed by external auditors
Correct answer: Be accepted
If IRR > hurdle rate, the project generates a return above the minimum required, so it should be accepted.
Question 3: Discounting cash flows means:
- Reducing cash flows to account for inflation only
- Converting future cash flows to their equivalent value today (Correct answer)
- Offering payment discounts to customers
- Reducing the budget for a project midway through
Correct answer: Converting future cash flows to their equivalent value today
Discounting converts future cash flows to present value using a discount rate that reflects the cost of capital and risk.
Question 4: What is opportunity cost in investment decision making?
- The cost of lost opportunities due to poor advertising
- The return foregone by choosing one investment over the next best alternative (Correct answer)
- The total cost of a missed budget target
- The expense of hiring external consultants
Correct answer: The return foregone by choosing one investment over the next best alternative
Opportunity cost is the value of the best alternative that must be given up when making an investment decision.
Question 5: Which of the following describes a sunk cost?
- A future cost that depends on the decision made
- A cost already incurred and not recoverable regardless of the decision (Correct answer)
- A variable cost that changes with output
- A cost that can be saved by canceling a project
Correct answer: A cost already incurred and not recoverable regardless of the decision
Sunk costs are past expenditures that cannot be recovered and should NOT influence future investment decisions.
Question 6: The Accounting Rate of Return (ARR) is calculated as:
- Average annual profit divided by average investment (Correct answer)
- Total cash inflows divided by total cash outflows
- Net present value divided by initial investment
- Free cash flow divided by total revenue
Correct answer: Average annual profit divided by average investment
ARR = Average Annual Profit ÷ Average Investment, expressing the return as a percentage of the investment's book value.
Finance for Non-Finance Managers Investment Decision Making 2
Internal Rate of Return (IRR) is best described as: