Capital Budgeting: Master Investment Appraisal Techniques

Question 1

In capital budgeting, which factor is irrelevant to project evaluation?

Accepted Answer

Decision-makers' personal preferences

Answer

Projected project costs and revenues

Answer

Risks and uncertainties of the project

Answer

Project's alignment with strategic objectives

Question 2

Which capital budgeting methods consider the impact of time on the value of money?

Accepted Answer

Net present value

Accepted Answer

Internal rate of return

Answer

Payback period

Answer

Accounting rate of return

Question 3

Which of the following is a primary consideration when evaluating capital budgeting projects?

Accepted Answer

Cash flows and their timing

Answer

Market share

Answer

Project scope

Answer

Rate of return only

Question 4

The Net Present Value (NPV) technique:

Accepted Answer

Discounts future cash flows back to the present using a specific rate, considering their timing.

Answer

Considers only the initial investment and payback period.

Answer

Assumes equal cash flows over the project's life.

Question 5

Internal Rate of Return (IRR) is the discount rate that equates:

Accepted Answer

Net present value to zero.

Answer

Average annual cash flow to the weighted average cost of capital.

Answer

Project life to the payback period.

Answer

Initial investment to terminal value.

Question 6

Payback period is a capital budgeting technique that measures:

Accepted Answer

The number of years required to recover the initial investment, but does not consider time value of money

Answer

The project's profitability over its entire life.

Answer

The present value of future cash flows.

Question 7

A project has an NPV of -$10,000 and an IRR of 10%. What does this indicate?

Accepted Answer

The project is not financially viable due to the negative NPV.

Answer

The project is highly profitable.

Answer

The project has a payback period of 10 years.

Answer

The project is marginally acceptable.

Question 8

Sensitivity analysis in capital budgeting:

Accepted Answer

Evaluates the project's viability under different scenarios and assumptions.

Answer

Guarantees the success of a project.

Answer

Is only used in the early stages of project evaluation.

Question 9

Which of the following is a limitation of the Payback Period method?

Accepted Answer

It does not consider the time value of money, and may lead to incorrect project selection.

Answer

It is widely used by businesses despite its limitations.

Answer

It can be used to compare projects of different sizes.

Answer

It is only useful for short-term projects.

Question 10

To evaluate a risky investment project, which discount rate is most appropriate?

Accepted Answer

Weighted Average Cost of Capital (WACC)

Answer

Risk-Free Rate

Answer

Prime Rate

Answer

Return on Equity

Question 11

Define the payback period.

Accepted Answer

The duration required for an investment to generate sufficient positive cash flow to recoup its initial cost.

Answer

The average time it takes for an investment to generate a profit.

Question 12

What is the primary objective of capital budgeting?

Accepted Answer

Allocating financial resources to long-term projects that maximize shareholder value.

Answer

Ensuring that all investment projects are profitable.

Answer

Minimizing the risk of investment projects.

Question 13

What is the purpose of sensitivity analysis in capital budgeting?

Accepted Answer

To evaluate the impact of changes in key variables on the investment decision.

Answer

To eliminate all risks associated with an investment project.

Answer

To determine the optimal investment strategy.

Question 14

What is a mutually exclusive investment?

Accepted Answer

An investment that precludes the acceptance of another.

Answer

An investment that generates positive cash flow.

Answer

An investment with a short payback period.

Question 15

Which of the following is NOT a commonly used capital budgeting technique?

Accepted Answer

Payback Ratio

Answer

Discounted Payback Period

Answer

Net Present Value

Answer

Internal Rate of Return

Question 16

The Net Present Value (NPV) of a project is calculated by:

Accepted Answer

Discounting the future cash flows back to the present using an appropriate discount rate

Answer

Adding up the future cash flows

Answer

Subtracting the initial investment from the future cash flows

Question 17

Which of the following is an advantage of using the Internal Rate of Return (IRR) method?

Accepted Answer

It considers the time value of money, making it more accurate than the payback period

Answer

It is always higher than the NPV

Answer

It is easy to calculate

Question 18

The payback period of a project is the amount of time it takes to:

Accepted Answer

Recover the initial investment

Answer

Reach the IRR

Answer

Generate a positive NPV

Answer

Pay off the loan used to finance the project

Question 19

A project with a positive NPV and an IRR greater than the cost of capital is:

Accepted Answer

Acceptable

Answer

Marginal

Answer

Indifferent

Answer

Unacceptable

Question 20

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

Accepted Answer

They rely on estimates and assumptions, which can lead to inaccurate results

Answer

They are only useful for large projects

Answer

They are too complex to use

Answer

They always produce the same result

Question 21

The cost of capital is the:

Accepted Answer

Minimum expected rate of return required by investors for a given level of risk

Answer

Average rate of return on all investments

Answer

Rate of return on the safest investment

Answer

Maximum rate of return that can be earned on an investment

Question 22

Which of the following is NOT a component of a cash flow statement?

Accepted Answer

Accrued expenses

Answer

Financing activities

Answer

Operating activities

Answer

Investing activities

Question 23

The primary purpose of capital budgeting is to:

Accepted Answer

Make informed investment decisions

Answer

Raise funds for investments

Answer

Reduce risk

Answer

Manage cash flow

Question 24

Which of the following is NOT a limitation of the IRR method?

Accepted Answer

Can handle projects with negative cash flows

Answer

Can lead to incorrect decisions if cash flows are uneven

Answer

Cannot evaluate mutually exclusive projects

Answer

Assumes reinvestment of cash flows at the IRR

Question 25

The primary advantage of using the payback period as an investment evaluation method is its:

Accepted Answer

Simplicity and ease of calculation

Answer

Flexibility in handling projects with uneven cash flows

Answer

Ability to consider the time value of money

Answer

Accuracy in evaluating long-term projects

Question 26

When adjusting cash flows for the time value of money, which of the following is used?

Accepted Answer

Discount rate

Answer

Exchange rate

Answer

Inflation rate

Answer

Risk premium

Question 27

An IRR of 12% for a project indicates that:

Accepted Answer

The project will generate a 12% return on investment if financed at the cost of capital

Answer

The project will generate a 12% profit margin

Answer

The payback period of the project is 12 years

Question 28

Which of the following is a potential challenge associated with using capital budgeting techniques?

Accepted Answer

Inaccurate cash flow projections

Answer

Bias in favor of complex projects

Answer

High cost of implementation

Answer

Lack of flexibility in decision-making

Question 29

Which of the following is NOT a commonly used capital budgeting technique?

Accepted Answer

Cost-Benefit Analysis

Answer

Payback Period

Answer

Internal Rate of Return

Answer

Net Present Value

Question 30

A project with a positive Net Present Value (NPV) is considered:

Accepted Answer

Financially viable and potentially profitable.

Answer

Unprofitable and not worth pursuing.

Answer

Cannot be determined without additional information.

Answer

Equally profitable as a project with a zero NPV.

Question 31

The payback period is defined as the:

Accepted Answer

Duration required for a project to generate sufficient cash flows to cover its initial investment.

Answer

Total amount of cash flows a project generates over its lifetime.

Answer

Difference between the present value of cash inflows and outflows.

Question 32

Which of the following is a key advantage of using the Net Present Value method for capital budgeting?

Accepted Answer

It incorporates the time value of money, providing a more accurate representation of project value.

Answer

It is simple to calculate and requires minimal data.

Answer

It is the only method that can be used to compare projects with different lifespans.

Answer

It provides a quick estimate of project profitability.

Question 33

A project with an Internal Rate of Return (IRR) greater than the cost of capital and a positive Net Present Value (NPV) would be considered:

Accepted Answer

Acceptable and financially sound.

Answer

Marginally acceptable and requires further evaluation.

Answer

Unacceptable and not worth investing in.

Answer

Cannot be determined without more information.

Question 34

Which of the following is a limitation of the payback period method?

Accepted Answer

It does not consider the time value of money, which can lead to inaccurate project evaluations.

Answer

It provides a reliable estimate of project profitability.

Answer

It cannot be used to compare projects with different lifespans.

Answer

It is difficult to calculate and requires complex models.

Question 35

A project with a positive Net Present Value (NPV) and an Internal Rate of Return (IRR) less than the cost of capital would be considered:

Accepted Answer

Unacceptable and not financially viable.

Answer

Acceptable and worth considering.

Answer

Cannot be determined without more information.

Answer

Marginally acceptable and requires further analysis.

Question 36

Which of the following is a qualitative factor that can influence capital budgeting decisions?

Accepted Answer

Company's long-term strategic objectives.

Answer

Payback Period

Answer

Internal Rate of Return

Answer

Net Present Value

Question 37

Which of the following is NOT a type of investment appraisal technique used in capital budgeting?

Accepted Answer

Breakeven analysis

Answer

Internal rate of return (IRR)

Answer

Payback period

Answer

Net present value (NPV)

Question 38

A project has an NPV of $10,000 and an IRR of 12%. Based on these criteria, which of the following statements is true?

Accepted Answer

The project should be accepted

Answer

More information is needed to make a decision

Answer

The project should be rejected

Question 39

Which of the following factors is NOT considered when calculating the payback period of a project?

Accepted Answer

Opportunity cost of capital

Answer

Annual cash inflows

Answer

Initial investment amount

Answer

Project life

Question 40

A project with a shorter payback period is generally considered to be:

Accepted Answer

Less risky

Answer

Equally risky

Answer

More risky

Question 41

The internal rate of return (IRR) of a project is defined as:

Accepted Answer

The discount rate that makes the net present value (NPV) of the project equal to zero

Answer

The rate of return required to cover the cost of capital

Answer

The annual rate of return on an investment

Question 42

A project with an IRR greater than the cost of capital should be:

Accepted Answer

Accepted

Answer

Deferred until a later date

Answer

Considered further

Answer

Rejected

Question 43

Sensitivity analysis is a technique used in capital budgeting to:

Accepted Answer

Assess the impact of changes in key variables on project outcomes

Answer

Estimate the cost of capital

Answer

Calculate the payback period

Question 44

Capital budgeting decisions typically:

Accepted Answer

Have long-term implications

Answer

Have insignificant financial impact

Answer

Have short-term implications

Answer

Involve no risk or uncertainty

Question 45

The internal rate of return (IRR) is the discount rate that:

Accepted Answer

Makes the net present value (NPV) of a project equal to zero

Answer

Minimizes the initial investment

Answer

Maximizes the payback period

Answer

Equals the required rate of return

Question 46

Which capital budgeting method ignores the time value of money?

Accepted Answer

Payback period

Answer

Net present value

Answer

Profitability index

Answer

Internal rate of return

Question 47

What is the primary advantage of using discounted cash flow (DCF) methods like NPV and IRR over non-DCF methods like payback period?

Accepted Answer

They consider the time value of money.

Answer

They are simpler to calculate.

Answer

They are based on accounting profits.

Answer

They are less subjective.

Question 48

Which of the following is a sunk cost that should NOT be considered in capital budgeting decisions?

Accepted Answer

Market research expenses incurred last year to evaluate the demand for a new product

Answer

Salvage value of old equipment

Answer

Cost of new equipment

Question 49

A company is analyzing a project with an initial investment of $100,000 and expected cash inflows of $40,000 per year for 3 years. What is the payback period for this project?

Accepted Answer

2.5 years

Answer

2 years

Answer

4 years

Answer

3 years

Question 50

When choosing between two mutually exclusive projects with unequal lives, which method is recommended?

Accepted Answer

Equivalent annual annuity (EAA)

Answer

Payback period

Answer

Internal rate of return

Question 51

Which of the following is a potential limitation of using NPV for capital budgeting?

Accepted Answer

It requires estimating a discount rate, which can be subjective.

Answer

It ignores the time value of money.

Answer

It is a complex method that is difficult to understand.