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Present Worth Analysis

Description: This quiz will test your understanding of Present Worth Analysis, a method used in capital budgeting to evaluate the profitability of long-term investments.
Number of Questions: 15
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Tags: engineering economics present worth analysis capital budgeting
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What is the present worth of a series of cash flows?

  1. The sum of all future cash flows discounted back to the present using an appropriate interest rate.

  2. The difference between the initial investment and the sum of all future cash flows.

  3. The value of the investment at the end of its life.

  4. The annual rate of return on the investment.

Show answer
Correct Option: A
Explanation:

The present worth of a series of cash flows is calculated by discounting each cash flow back to the present using an appropriate interest rate and then summing the discounted cash flows.

What is the formula for calculating the present worth of a single cash flow?

  1. PV = CF / (1 + r)^n

  2. PV = CF * (1 + r)^n

  3. PV = CF / r

  4. PV = CF * r

Show answer
Correct Option: A
Explanation:

The formula for calculating the present worth of a single cash flow is PV = CF / (1 + r)^n, where PV is the present worth, CF is the cash flow, r is the interest rate, and n is the number of years.

What is the formula for calculating the present worth of a series of cash flows?

  1. PW = CF1 / (1 + r) + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n

  2. PW = CF1 + CF2 + ... + CFn

  3. PW = CF1 * (1 + r) + CF2 * (1 + r)^2 + ... + CFn * (1 + r)^n

  4. PW = CF1 / r + CF2 / r^2 + ... + CFn / r^n

Show answer
Correct Option: A
Explanation:

The formula for calculating the present worth of a series of cash flows is PW = CF1 / (1 + r) + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n, where PW is the present worth, CF1, CF2, ..., CFn are the cash flows, r is the interest rate, and n is the number of years.

What is the relationship between the present worth and the future worth of a series of cash flows?

  1. The present worth is always greater than the future worth.

  2. The present worth is always less than the future worth.

  3. The present worth is equal to the future worth.

  4. The relationship between the present worth and the future worth depends on the interest rate.

Show answer
Correct Option: D
Explanation:

The relationship between the present worth and the future worth of a series of cash flows depends on the interest rate. If the interest rate is greater than the rate of return on the investment, the present worth will be less than the future worth. If the interest rate is less than the rate of return on the investment, the present worth will be greater than the future worth.

What is the payback period of an investment?

  1. The amount of time it takes for the investment to generate enough cash flow to cover the initial investment.

  2. The amount of time it takes for the investment to reach its break-even point.

  3. The amount of time it takes for the investment to generate a positive net present value.

  4. The amount of time it takes for the investment to reach its maximum value.

Show answer
Correct Option: A
Explanation:

The payback period of an investment is the amount of time it takes for the investment to generate enough cash flow to cover the initial investment.

What is the difference between the payback period and the discounted payback period?

  1. The payback period is based on undiscounted cash flows, while the discounted payback period is based on discounted cash flows.

  2. The payback period is based on future cash flows, while the discounted payback period is based on past cash flows.

  3. The payback period is based on the initial investment, while the discounted payback period is based on the net present value.

  4. The payback period is based on the annual rate of return, while the discounted payback period is based on the internal rate of return.

Show answer
Correct Option: A
Explanation:

The payback period is based on undiscounted cash flows, while the discounted payback period is based on discounted cash flows. This means that the discounted payback period takes into account the time value of money, while the payback period does not.

What is the net present value of an investment?

  1. The difference between the present worth of the investment and the initial investment.

  2. The difference between the future worth of the investment and the initial investment.

  3. The difference between the payback period and the discounted payback period.

  4. The difference between the annual rate of return and the internal rate of return.

Show answer
Correct Option: A
Explanation:

The net present value of an investment is the difference between the present worth of the investment and the initial investment. A positive net present value indicates that the investment is profitable, while a negative net present value indicates that the investment is not profitable.

What is the internal rate of return of an investment?

  1. The discount rate that makes the net present value of the investment equal to zero.

  2. The discount rate that makes the future worth of the investment equal to the initial investment.

  3. The discount rate that makes the payback period equal to the discounted payback period.

  4. The discount rate that makes the annual rate of return equal to the internal rate of return.

Show answer
Correct Option: A
Explanation:

The internal rate of return of an investment is the discount rate that makes the net present value of the investment equal to zero. The internal rate of return is a measure of the profitability of an investment.

What is the relationship between the net present value and the internal rate of return of an investment?

  1. If the net present value is positive, the internal rate of return is also positive.

  2. If the net present value is negative, the internal rate of return is also negative.

  3. If the net present value is zero, the internal rate of return is also zero.

  4. All of the above.

Show answer
Correct Option: D
Explanation:

If the net present value is positive, the internal rate of return is also positive. If the net present value is negative, the internal rate of return is also negative. If the net present value is zero, the internal rate of return is also zero.

What are the advantages of using present worth analysis to evaluate investments?

  1. It takes into account the time value of money.

  2. It is easy to understand and apply.

  3. It can be used to compare different investments.

  4. All of the above.

Show answer
Correct Option: D
Explanation:

Present worth analysis takes into account the time value of money, it is easy to understand and apply, and it can be used to compare different investments.

What are the disadvantages of using present worth analysis to evaluate investments?

  1. It can be difficult to estimate future cash flows.

  2. It is not always clear what discount rate to use.

  3. It does not take into account the risk of the investment.

  4. All of the above.

Show answer
Correct Option: D
Explanation:

It can be difficult to estimate future cash flows, it is not always clear what discount rate to use, and it does not take into account the risk of the investment.

What are some of the common mistakes that people make when using present worth analysis to evaluate investments?

  1. Using an incorrect discount rate.

  2. Not taking into account the risk of the investment.

  3. Ignoring the time value of money.

  4. All of the above.

Show answer
Correct Option: D
Explanation:

Using an incorrect discount rate, not taking into account the risk of the investment, and ignoring the time value of money are all common mistakes that people make when using present worth analysis to evaluate investments.

What are some of the best practices for using present worth analysis to evaluate investments?

  1. Use a realistic discount rate.

  2. Take into account the risk of the investment.

  3. Consider using a sensitivity analysis to test the impact of different assumptions.

  4. All of the above.

Show answer
Correct Option: D
Explanation:

Using a realistic discount rate, taking into account the risk of the investment, and considering using a sensitivity analysis to test the impact of different assumptions are all best practices for using present worth analysis to evaluate investments.

What are some of the alternative methods that can be used to evaluate investments?

  1. Payback period.

  2. Discounted payback period.

  3. Net present value.

  4. Internal rate of return.

Show answer
Correct Option:
Explanation:

Payback period, discounted payback period, net present value, and internal rate of return are all alternative methods that can be used to evaluate investments.

Which method is best for evaluating investments?

  1. There is no one best method.

  2. The best method depends on the specific investment.

  3. The best method is the one that is most familiar to the decision-maker.

  4. The best method is the one that is easiest to use.

Show answer
Correct Option: B
Explanation:

The best method for evaluating investments depends on the specific investment. There is no one best method that is always the best choice.

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