Capital Budgeting Techniques: A Comprehensive Guide for Juris Doctor Students

Question 1

Which capital budgeting technique uses a discount rate to determine the present value of a project's cash flows?

Accepted Answer

NPV

Answer

IRR

Answer

PI

Answer

Payback Period

Question 2

Which of the following is NOT considered a capital budgeting technique used to evaluate investment opportunities?

Accepted Answer

Return on Investment

Answer

Net Present Value

Answer

Internal Rate of Return

Answer

Payback Period

Question 3

During the evaluation of a capital budgeting project, which factor should be excluded from consideration?

Accepted Answer

Environmental impact

Answer

Anticipated cash flows

Answer

Potential risks

Question 4

What is the primary objective of capital budgeting?

Accepted Answer

Maximize shareholder wealth by allocating funds to projects with positive NPV or IRR

Answer

Minimize risk and uncertainty in investment decisions

Answer

Comply with all applicable regulatory requirements

Answer

Increase company profitability in the short term

Question 5

Which capital budgeting technique assumes equal cash flows over the project's lifespan?

Accepted Answer

Annuity

Answer

NPV

Answer

Payback

Answer

IRR

Question 6

What is the appropriate discount rate to use in capital budgeting calculations?

Accepted Answer

Company's weighted average cost of capital (WACC)

Answer

Current market interest rate

Answer

Projected inflation rate

Answer

Industry growth rate

Question 7

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

Accepted Answer

Discounted payback period considers the time value of money, while the payback period does not.

Answer

Payback period is calculated before taxes, while discounted payback period is calculated after taxes.

Answer

Discounted payback period is more conservative than the payback period.

Answer

There is no difference between the two techniques.

Question 8

What is the minimum acceptable rate of return (MARR) for a capital budgeting project?

Accepted Answer

Company's WACC

Answer

Current market interest rate

Answer

Expected inflation rate

Answer

Return on existing company assets

Question 9

Which of the following is NOT a relevant factor to consider when evaluating a capital budgeting project?

Accepted Answer

Management's personal preferences

Answer

Project size

Answer

Project risk

Answer

Company's strategic objectives

Question 10

Which capital budgeting technique is most appropriate for evaluating projects with a long pay-out period?

Accepted Answer

Net Present Value (NPV)

Answer

Internal Rate of Return (IRR)

Answer

Payback Period

Answer

Accounting Rate of Return (ARR)

Question 11

In capital budgeting, when is the payback period calculation most suitable?

Accepted Answer

For projects with a modest initial investment

Answer

For projects with significant uncertainty

Answer

For projects with an extended payback period

Answer

For projects with a high return rate

Question 12

How do a company's risk tolerance and investment horizon impact the selection of capital budgeting techniques?

Accepted Answer

Risk-averse companies with short investment horizons often prefer techniques prioritizing short payback periods and higher internal rates of return.

Accepted Answer

Risk-tolerant companies with long investment horizons tend to favor techniques emphasizing long-term cash flow patterns.

Answer

All capital budgeting techniques give equal consideration to risk tolerance and investment horizon.

Answer

A company's risk tolerance has no bearing on the selection of a capital budgeting technique.

Question 13

Which of the following is NOT a qualitative factor considered in capital budgeting?

Accepted Answer

Net present value

Answer

Environmental impact

Answer

Strategic fit

Answer

Technological advancements

Question 14

The payback period method measures the:

Accepted Answer

Time to recover the initial investment

Answer

Average annual return on investment

Answer

Present value of future cash flows

Answer

Internal rate of return

Question 15

Net present value (NPV) is calculated by:

Accepted Answer

Discounting future cash flows back to the present at the project's cost of capital

Answer

Adding up all future cash flows

Answer

Subtracting the initial investment from total future cash flows

Answer

Dividing future cash flows by the cost of capital

Question 16

The weighted average cost of capital (WACC) is:

Accepted Answer

The average cost of all capital sources

Answer

The cost of equity capital

Answer

The cost of debt capital

Answer

The rate of return required by investors

Question 17

Which of the following is NOT a step in the capital budgeting process?

Accepted Answer

Implement projects

Answer

Identify potential projects

Answer

Evaluate projects

Answer

Select projects

Question 18

Capital rationing occurs when a company:

Accepted Answer

Has limited funds to invest

Answer

Has more profitable projects than it can finance

Answer

Is unable to obtain financing for its projects

Answer

Has a cost of capital that is too high

Question 19

Discuss the ethical implications of using capital budgeting techniques. How can biases or personal preferences influence the decision-making process?

Accepted Answer

Ethical factors, such as environmental sustainability, should be integrated into capital budgeting evaluations.

Answer

Capital budgeting techniques are objective and free from biases.

Answer

Personal preferences should always be prioritized over objective analysis in capital budgeting decisions.

Answer

Biases can be fully eliminated by using only quantitative data in capital budgeting.

Question 20

Which capital budgeting technique incorporates the expected cash flows over a project's entire lifespan, considering the time value of money?

Accepted Answer

Net Present Value (NPV)

Answer

Payback Period

Answer

Accounting Rate of Return (ARR)

Question 21

What is the fundamental distinction between the payback period and the discounted payback period?

Accepted Answer

The discounted payback period incorporates the time value of money, unlike the payback period.

Answer

The payback period invariably exceeds the discounted payback period.

Answer

The payback period is exclusive to small-scale projects, while the discounted payback period is applicable to large-scale projects.

Question 22

Identify a major limitation of the Accounting Rate of Return (ARR).

Accepted Answer

It disregards the time value of money.

Answer

It is solely applicable to projects with steady cash flows.

Answer

It is unaffected by a project's risk profile.

Question 23

What is the purpose of the hurdle rate in capital budgeting?

Accepted Answer

It establishes the minimum acceptable rate of return for a project to be deemed viable.

Answer

It facilitates the computation of a project's payback period.

Answer

It is exclusively used in conjunction with the NPV method.

Question 24

Which factors should be considered when selecting an appropriate capital budgeting technique?

Accepted Answer

Nature of the project, data availability, and risk tolerance of the decision-maker.

Answer

The same capital budgeting technique should always be employed.

Answer

Project size is the primary determinant.

Question 25

Define the Modified Internal Rate of Return (MIRR).

Accepted Answer

A variation of the IRR that incorporates the reinvestment rate of a project's cash flows.

Answer

It is exclusively utilized for projects with negative NPV.

Answer

It consistently exceeds the IRR.

Question 26

Identify a qualitative factor that can influence capital budgeting decisions.

Accepted Answer

Strategic alignment

Answer

Payback period

Answer

Discount rate

Answer

Cash flow projections

Question 27

What is the purpose of sensitivity analysis in capital budgeting?

Accepted Answer

To assess how variations in input variables impact a project's financial outcomes.

Answer

It negates the need for scenario analysis.

Answer

It is only applicable to projects with low risk.

Question 28

What is a key benefit of using scenario analysis in capital budgeting?

Accepted Answer

It facilitates the consideration of multiple potential outcomes.

Answer

It eliminates the need for sensitivity analysis.

Answer

It is exclusively useful for short-term projects.

Question 29

When should a capital budgeting decision be reconsidered?

Accepted Answer

When substantial changes occur in the project's assumptions or external environment.

Answer

Only upon project completion.

Answer

Only when the project faces financial difficulties.

Question 30

What is the purpose of calculating the internal rate of return (IRR) of a project?

Accepted Answer

To determine the rate at which the project's cash flows cover its initial investment.

Answer

To calculate the project's net present value.

Answer

To estimate the payback period of the project.

Question 31

Which of the following is an advantage of the net present value (NPV) method?

Accepted Answer

It considers the time value of money and provides a clear measure of the project's absolute profitability.

Answer

It is always positive for profitable projects.

Answer

It is easy to calculate.

Question 32

What is the difference between the payback period and the average accounting return?

Accepted Answer

The average accounting return considers the project's entire life, while the payback period only considers the time it takes to recover the initial investment.

Answer

The payback period is always shorter than the average accounting return.

Answer

The average accounting return is only relevant for projects with positive cash flows.

Question 33

What is the role of scenario analysis in capital budgeting?

Accepted Answer

To evaluate the impact of different possible outcomes on the project's financial performance.

Answer

To calculate the project's breakeven point.

Answer

To identify the most pessimistic assumptions for the project.

Question 34

Which of the following is a limitation of capital budgeting models?

Accepted Answer

They can be complex and time-consuming to develop.

Answer

They can eliminate the need for human judgment in project evaluation.

Answer

They are always accurate.

Question 35

What is the difference between a capital asset and a current asset?

Accepted Answer

A capital asset is a long-term asset that is used in the company's operations, while a current asset is a short-term asset that is expected to be converted into cash within one year.

Answer

A capital asset is always larger than a current asset.

Question 36

Which of the following is a qualitative factor to consider when evaluating capital budgeting projects?

Accepted Answer

Management's experience

Answer

Internal rate of return

Answer

Payback period

Answer

Net present value

Question 37

Explain the concept of the time value of money:

Accepted Answer

Money available today has a higher value than the same amount in the future due to its potential earning capacity

Answer

Money loses value over time due to inflation

Answer

The value of money remains constant over time

Question 38

Which assumption is crucial for the net present value method?

Accepted Answer

All cash flows are discounted back to the present at a uniform rate

Answer

Project cash flows are uniformly distributed

Answer

The salvage value of the project is irrelevant

Question 39

Define the internal rate of return (IRR) of a project:

Accepted Answer

The discount rate that equates the net present value of the project to zero

Answer

The payback period of the project

Answer

The actual rate of return the project is anticipated to generate

Question 40

What is the payback period of a project?

Accepted Answer

The length of time required for the project to generate enough cash flow to cover its initial investment

Answer

The return rate expected from the project

Question 41

Which factor below is considered qualitative when evaluating capital budgeting projects?

Accepted Answer

Strategic alignment

Answer

Net present value

Answer

Payback period

Answer

Internal rate of return

Question 42

What is the primary objective of sensitivity analysis in capital budgeting?

Accepted Answer

Evaluating the impact of changes in key assumptions on the project's financial viability

Answer

Identifying the most likely scenario for a project's cash flows

Answer

Eliminating risk from the project

Question 43

Describe the overall purpose of the capital budgeting process:

Accepted Answer

It is a structured approach to evaluate and select long-term investment opportunities

Answer

A technique for determining the cost of capital

Answer

A method for predicting future cash flows

Question 44

Which capital budgeting technique uses a discount rate to calculate the present value of future cash flows, thereby considering the time value of money?

Accepted Answer

Net Present Value (NPV)

Answer

Profitability Index (PI)

Answer

Internal Rate of Return (IRR)

Answer

Payback Period

Question 45

If a project has a negative Net Present Value (NPV), what does this indicate?

Accepted Answer

The project is expected to generate less value than the initial investment and should be rejected.

Answer

The project is marginally profitable and should be accepted.

Answer

The project is highly profitable and should be accepted.

Question 46

The Internal Rate of Return (IRR) is the discount rate that makes the present value of future cash inflows equal to the initial investment. Which capital budgeting technique determines this rate?

Accepted Answer

Internal Rate of Return (IRR)

Answer

Net Present Value (NPV)

Answer

Payback Period

Answer

Profitability Index (PI)

Question 47

What is a major drawback of the Payback Period method in capital budgeting?

Accepted Answer

It ignores the time value of money, potentially leading to inaccurate project evaluations.

Answer

It is not applicable to all types of projects.

Answer

It gives equal weight to all cash flows.

Answer

It is too complex to calculate.

Question 48

When evaluating projects with uneven cash flows, which capital budgeting technique is generally considered most appropriate?

Accepted Answer

Net Present Value (NPV)

Answer

Profitability Index (PI)

Answer

Payback Period

Answer

Internal Rate of Return (IRR)

Question 49

What is the relationship between the Net Present Value (NPV) and the Internal Rate of Return (IRR) for a project?

Accepted Answer

If the NPV is positive, the IRR will be greater than the discount rate used to calculate the NPV.

Answer

The NPV and IRR are always equal.

Answer

If the NPV is negative, the IRR will be less than the discount rate used to calculate the NPV.

Question 50

The Adjusted Present Value (APV) technique is specifically designed for evaluating projects with what characteristic?

Accepted Answer

Different risk profiles, including those with financing side effects.

Answer

Determining the IRR of a project.

Answer

Measuring the profitability of a project.

Answer

Calculating the payback period of a project.

Question 51

When choosing between two mutually exclusive projects, which capital budgeting technique is most reliable for making the decision?

Accepted Answer

Net Present Value (NPV)

Answer

Profitability Index (PI)

Answer

Payback Period

Answer

Internal Rate of Return (IRR)

Question 52

What is the ultimate goal of capital budgeting?

Accepted Answer

To allocate capital to projects that are expected to maximize the value for the company's shareholders.

Answer

To ensure that all projects are profitable.

Answer

To minimize the risk of investment.