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Chp7_ReviewAnswers

Chp7_ReviewAnswers - Chapter 7 Investment Decision Rules...

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Chapter 7 Investment Decision Rules Answers to Chapter 7 Review Questions 1. The NPV of an investment gives the value created by the investment. This is the increase in shareholder wealth by investing in the project. 2. The payback period is the amount of time it takes for a project to pay back the initial investment. The drawbacks of the payback period are: It does not adjust cash flows for time value of money It ignores all cash flows beyond the payback period The choice of the payback time period is not grounded in economic theory 3. The IRR decision rule is to accept a project when the IRR is greater than the cost of capital. This gives the same decision as NPV most of the time, but does not necessarily work under any of the following conditions: You are deciding between mutually exclusive investments The investment has an initial inflow of cash, followed by cash outflows There are multiple IRRs There is no IRR 4.
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