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The lower risk of a project can be recognised by increasing which of the following?
A The cost of the initial investment of the project
B The estimates of future cash inflows from the project
C The internal rate of return of the project
D the required rate of return of the project
Answer is B. I am unable to understand the question and answer as well.
Data of relevance to the evaluation of a particular project are given below.
Cost of capital in real terms 10% per annum
Expected general inflation rate 8% per annum
Expected increase in the project’s annual cash inflow 6% per annum
Expected increase in the project’s annual cash outflow 4% per annum
Which of the following sets of adjustments will lead to the correct NPV being calculated?
Cash inflow
Cash outflow
Discount percentage(A)
Unadjusted
Unadjusted
10.0%(B)
6% p.a. increase
4% p.a. increase
18.8%(C)
6% p.a. increase
4% p.a. increase
10.0%Answer is B. Why A is not correct?
B is answer if nominal terms. A should be correct using real terms.
Help.The first question is a very poor question from Kaplan.
Normally, the way we could deal with more risk would be to discount at a higher rate and for lower risk discount at a lower rate. So D is not correct.
C is obviously not correct because we cannot change the IRR of a project.
A and B are what makes the question very poor. Changing the initial cost is rather ridiculous given that it is going to be fixed, but increasing it makes it more likely that we decide the project is not worthwhile, whereas lower risk means we are keener to accept it.
Increasing the future cash inflows is more feasible because they are always only estimates. Estimating higher inflows makes it more likely that we will decide the project it worthwhile which does fit in with it being lower risk.
However it is still a rather silly question.
As far as the second question is concerned, what you have typed is correct.
However since the question refers to cash inflows and cash outflows, that has to mean the actual cash inflows and outflows. If I were to tell you that I would give you $1,000 you would assume that would be the actual cash amount, not an amount that I would increase by inflation.
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