Rate of Return Analysis Questions and Answers

Answer: A

Correct answer: unreliable, scale not having been considered

Ranking mutually exclusive alternatives by internal rate of return is the classic error. A small project with a high percentage return can be beaten outright by a larger one with a lower percentage, since the extra capital in the larger project may still be earning above the required rate. The recommendation needs redoing incrementally.

Answer: B

Correct answer: report the present worth at the required rate instead

Two roots mean neither is the project’s rate of return, and averaging them produces a number with no interpretation at all. The present worth at the minimum attractive rate is unambiguous and answers the question actually being asked, which is whether the project is worth doing.

Answer: C

Correct answer: both the assertion and the reason are true and the reason explains the assertion

Both are true and the reason gives the mechanism. For a conventional cash flow the present worth decreases monotonically with the discount rate and crosses zero once. A positive present worth at the required rate therefore places that rate to the left of the crossing, which is to say below the internal rate - the two criteria are two readings of the same curve.

Answer: D

The rate does measure the return on committed capital, but a splendid rate on a trivial outlay adds little value, and the figure also rests on reinvestment at that same high rate. Scale and the reinvestment assumption both qualify it.

Answer: A

Correct answer: gives a longer period and accounts for interest

Discounting reduces each receipt before it is counted, so more of them are needed to reach the first cost and the period is always longer at any positive rate - six years against four in the example above. The improvement is real but partial: the method now respects the time value of money while still ignoring everything beyond the payback point.

Answer: B

Only the increments between the alternatives address the question actually being decided, which is whether each extra tranche of capital earns its keep. Individual rates, paybacks and first costs all ignore scale or timing.