Finance for Non-Finance Managers Investment Decision Making 1 — Questions and Answers
Question 1: What is the payback period?
- The time it takes for an investment to generate its first profit
- The time required for cumulative cash inflows to recover the initial investment (Correct answer)
- The interest rate that makes NPV equal to zero
- The annual return on a project expressed as a percentage
Correct answer: The time required for cumulative cash inflows to recover the initial investment
The payback period measures how long it takes for cash inflows from an investment to repay the original outlay.
Question 2: A project costs $100,000 and generates $25,000 per year. What is its payback period?
- 2 years
- 4 years (Correct answer)
- 5 years
- 10 years
Correct answer: 4 years
Payback period = $100,000 ÷ $25,000 per year = 4 years.
Question 3: What is the main weakness of the payback period method?
- It is too complex to calculate
- It ignores the time value of money and cash flows after payback (Correct answer)
- It requires knowledge of the discount rate
- It cannot be applied to capital projects
Correct answer: It ignores the time value of money and cash flows after payback
The payback period ignores the time value of money and disregards any cash flows that occur after the payback point.
Question 4: Net Present Value (NPV) is positive when:
- The project's cost exceeds its benefits
- The present value of cash inflows exceeds the initial investment (Correct answer)
- The payback period is less than one year
- The IRR is lower than the discount rate
Correct answer: The present value of cash inflows exceeds the initial investment
A positive NPV means the project's discounted cash inflows exceed the cost, adding value to the firm.
Question 5: Time value of money is based on the principle that:
- Money grows with inflation automatically
- A dollar received today is worth more than a dollar received in the future (Correct answer)
- Investments always generate positive returns
- Cash flows far in the future are more valuable
Correct answer: A dollar received today is worth more than a dollar received in the future
A dollar today can be invested to earn a return, making it worth more than the same dollar received later.
Question 6: Which investment appraisal method accounts for the time value of money?
- Simple payback period
- Accounting rate of return (ARR)
- Net present value (NPV) (Correct answer)
- Gross profit margin
Correct answer: Net present value (NPV)
NPV discounts future cash flows back to their present value using a required rate of return, accounting for the time value of money.
Finance for Non-Finance Managers Investment Decision Making 1
What is the payback period?