Investment Appraisal Very Short Answer Type Questions

Question 1.
What is investment appraisal?
Answer:
Investment appraisal is an integral part of capital budgeting (see capital budget), and is applicable to areas even where the returns may not be easily quantifiable such as personnel, marketing, and training

Question 2.
What is inflation?
Answer:
Inflation is the rate at which the general level of prices for goods and services is rises and subsequently, purchasing power falls.

Question 3.
What are the different types of inflation?
Answer:
The different types of inflation are:

  • Demand pull inflation
  • Cost push inflation
  • Built-in inflation

Question 4.
What is risk analysis?
Answer:
Risk analysis is the process of defining and analyzing the dangers to individuals, businesses and government agencies posed by potential natural and human-caused adverse events.

Question 5.
What is risk? What are types of risk?
Answer:
The quantifiable likelihood of loss or less-than-expected returns. Examples: currency risk, inflation risk, principal risk, country risk, economic risk, mortgage risk, liquidity risk, market risk, opportunity risk, income risk, interest rate risk, prepayment risk, credit risk, unsystematic risk, call risk, business risk, counterparty risk, purchasing-power risk, event risk.

Question 6.
What is systematic risk?
Answer:
Systematic risks are associated with external environment, these are non diversifiable and is associated with securities market as well as economic, sociological, political considerations of the prices of-a.ll securities in the market.

Question 7.
What is unsystematic risk?
Answer:
Unsystematic risk is also Called unique risk and it is unique to firm or industry. It is caused by factors like labour strike, irregular disorganised management policies and consumer preferences.

Question 8.
What is business risk?
Answer:
This relates to the variability of the business, sales, income, profits etc. which in turn depend on the market conditions for the product mix, input supplies, strength of competitors, etc. The Internal Business Risk leads to fair in revenues and in profit of the company, but can be corrected by certain changes in the company’s policies.

Question 9.
What is financial risk?
Answer:
Financial Risk: This relates to the method of financing, adopted by the company, high leverage leading to larger debt servicing problems or short-term liquidity problems due to bad debts, delayed receivables and fall in current assets or rise in current liabilities.

Question 10.
What is insolvency risk?
Answer:
Default or Insolvency Risk:
The borrower or issuer of securities may become insolvent or may default or delay the payments due, such as interest instalments or principal repayments. The borrower’s credit rating might have fallen suddenly and he became default prone and in its extreme form it may take to insolvency or bankruptcies. In such cases, the investor may get no return or negative returns.

Question 11.
Distinguish between risk and uncertainty.
Answer:
Risk and uncertainty go together. Risk suggests that the decision-maker knows that there is some possible consequence of an investment decision, but uncertainty involves a situation, where the outcome is not known to the decision-maker. But basically, whether the outcome is known or not, the investments involve both risk and uncertainty.

Question 12.
How is the risk measured or technique of measuring risk?
Answer:
The risk. associated with the capital budgeting decisions is measured through the following methods:

  • Risk adjusted rate of return
  • Certainty equivalent co-efficient
  • Probabilistic method
  • Sensitivity analysis
  • Co-efficient of variation method or Standard deviation
  • Decision tree analysis.

Question 13.
What is lease or buy?
Answer:
Lease or buy decision involves applying capital budgeting principles to determine if leasing as asset is a better option than buying it. Leasing in a contractual arrangement in which a company (the lessee) obtains an asset from another company (the lessor) against periodic payments of lease rentals.

Question 14.
What is replacement assets value?
Answer:
The monetary value that would be required to replace the production capability of the, present assets in the plant. Includes production or process equipment, as well as utilities, support and related assets. It should not be based on the insured value or depreciated value of the assets. It includes the replacement value of the buildings and the grounds if these assets are maintainted by the maintenance expenditures.

Question 15.
What is replacement decision?
Answer:
Decision regarding replacement of an existing asset with another is based on the net present value and internal rate of return of the incremental cash flows, i.e. the difference between periodic net cash flows if the existing asset is kept and the periodic net cash flows if the asset is replaced.

In capital budgeting and engineering economics, the existing asset is called the defender and the asset which is proposed to replace the defender is called the challenger. Estimation of incremental cash flows for such replacement analysis involves calculation of net cash flows of the defender, net cash flows of the challenger and then finding the difference in cash flows for both the assets.

Question 16.
What do you mean by capital rationing?
Answer:
Capital rationing is the act of placing restrictions on the amount of new investments or projects undertaken by a company. This is accomplished by imposing a higher cost of capital for investment consideration or by setting a ceiling on specific portions of a budget.