Capital Budgeting: Evaluating Long-Term Investments for Success

Question 1

Which of the following is NOT a widely recognized method used in capital budgeting?

Accepted Answer

Profitability Index (PI)

Answer

Net Present Value (NPV)

Answer

Internal Rate of Return (IRR)

Answer

Payback Period

Question 2

The calculation of NPV involves:

Accepted Answer

Discounting future cash flows back to the present using a discount rate

Answer

Adding up all future cash flows

Answer

Subtracting initial investment from future cash flows

Answer

Calculating the average of all future cash flows

Question 3

The IRR is defined as:

Accepted Answer

The discount rate at which the NPV of a project equals zero

Answer

The rate of return that the project is expected to generate

Answer

The payback period of the project

Answer

The initial investment required for the project

Question 4

The payback period refers to:

Accepted Answer

The number of years it takes for the project to generate enough cash flow to cover the initial investment

Answer

The total amount of cash flow that the project is expected to generate

Answer

The discount rate used in the NPV calculation

Answer

The rate of return that the project is expected to generate

Question 5

The capital budgeting process should be integrated with the overall strategic planning of the organization.

Accepted Answer

True

Answer

False

Question 6

Which of the following is a limitation of the payback period method in capital budgeting?

Accepted Answer

Disregard for the time value of money

Answer

Simplicity and ease of calculation

Answer

Focus on the recovery of initial investment

Question 7

Identify the method **NOT** used in capital budgeting.

Accepted Answer

Return on Investment

Answer

Payback Period

Answer

Net Present Value

Answer

Internal Rate of Return

Question 8

Explain the fundamental difference between Net Present Value (NPV) and Internal Rate of Return (IRR).

Accepted Answer

NPV considers the time value of money, while IRR equates the present value of inflows to the present value of outflows.

Answer

IRR is a more accurate measure than NPV.

Answer

NPV is more straightforward to calculate than IRR.

Question 9

Describe the purpose of sensitivity analysis in capital budgeting.

Accepted Answer

To gauge the impact of varying assumptions on project outcomes.

Answer

To identify the most lucrative project.

Answer

To ascertain the ideal investment period.

Question 10

Identify the primary limitation of the payback period as a capital budgeting method.

Accepted Answer

It disregards the time value of money.

Answer

It is solely suitable for short-term projects.

Answer

It fails to account for project risk.

Answer

It is overly complex to calculate.

Question 11

A project yields an NPV of £50,000 and an IRR of 12%. Based on this, what is an accurate statement?

Accepted Answer

The project is feasible if the cost of capital is below 12%.

Answer

The project is not viable at any cost of capital.

Answer

The project should be pursued regardless of the cost of capital.

Question 12

State a significant advantage of employing capital budgeting techniques.

Accepted Answer

It aids in making well-informed investment decisions.

Answer

It eliminates all potential risks associated with investment projects.

Answer

It is a legal requirement for all organizations.

Answer

It guarantees a positive return on investment.

Question 13

Explain the significance of the discount rate in capital budgeting.

Accepted Answer

It converts future cash flows to their present value.

Answer

It determines the appropriate cost of capital.

Answer

It calculates the payback period.

Question 14

A project has an NPV of £0. What does this imply?

Accepted Answer

The project is neutral at the current cost of capital.

Answer

The project should be rejected under any cost of capital scenario.

Answer

The project should be accepted under any cost of capital scenario.

Question 15

How do varying discount rates affect the Net Present Value (NPV) of a project, influencing investment decisions?

Accepted Answer

Higher discount rates lower NPVs, making projects seem less appealing.

Answer

Discount rate changes do not impact NPV.

Answer

Lower discount rates guarantee positive NPVs, ensuring project approval.

Answer

Setting the discount rate as high as possible maximizes NPV.

Question 16

Which of the following is NOT a method used in capital budgeting?

Accepted Answer

Gross Profit Margin

Answer

Net Present Value

Answer

Internal Rate of Return

Answer

Payback Period

Question 17

A project has an IRR of 12% and a payback period of 3 years. Which method would you recommend using to evaluate the project and justify your choice?

Accepted Answer

IRR

Answer

Payback Period

Answer

Both methods equally

Question 18

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

Accepted Answer

Ignores the time value of money

Answer

Accounts for risk

Answer

Can be used to compare projects of different sizes

Answer

Easy to calculate

Question 19

Which of the following is a qualitative factor that should be considered when evaluating a capital budgeting project?

Accepted Answer

Environmental impact

Answer

Cash flow projections

Answer

Investment horizon

Answer

Project risk

Question 20

Which of the following is a limitation of using the Net Present Value (NPV) method for capital budgeting?

Accepted Answer

Ignores the time value of money

Answer

Provides a single, overall measure of a project's profitability

Answer

Accounts for the opportunity cost of capital

Answer

Considers all cash flows over the project's life

Question 21

The payback period for an investment is the:

Accepted Answer

Time it takes for the investment to generate enough cash flows to cover its initial cost

Answer

Total amount of cash flows generated by the investment

Answer

Rate of return on the investment

Question 22

Which of the following is a disadvantage of using the payback period method in capital budgeting?

Accepted Answer

Ignores the time value of money

Answer

Provides a good indication of liquidity

Answer

Simple and easy to calculate

Answer

Can be used as a screening tool

Question 23

The cost of capital is used in capital budgeting to determine the:

Accepted Answer

Appropriate discount rate for cash flows

Answer

Riskiness of a project

Answer

Expected return on an investment

Question 24

A project with a positive NPV and IRR of 15% should be:

Accepted Answer

Accepted

Answer

Rejected

Answer

Neither accepted nor rejected

Answer

More information is needed to make a decision

Question 25

Which of the following is an example of a qualitative factor that may be considered in capital budgeting decisions?

Accepted Answer

Environmental impact

Answer

Initial investment cost

Answer

Expected cash flows

Question 26

Sensitivity analysis in capital budgeting involves:

Accepted Answer

Examining how changes in input variables affect the project's financial outcomes

Answer

Identifying the most likely outcome for a project

Answer

Estimating the cost of capital

Question 27

A project has an Internal Rate of Return (IRR) of 10% and a cost of capital of 8%. The project should be:

Accepted Answer

Accepted

Answer

More information is needed to make a decision

Answer

Neither accepted nor rejected

Answer

Rejected

Question 28

Which method used in capital budgeting considers the time value of money and all cash flows over the project's life?

Accepted Answer

Net Present Value

Answer

Return on Investment

Answer

Break-Even Analysis

Answer

Payback Period

Question 29

When calculating a project's internal rate of return (IRR), which factor is not relevant?

Accepted Answer

Risk

Answer

Initial investment

Answer

Cash flows

Question 30

A capital budgeting project has the following cash flows: Year 0: -£100,000; Year 1: £25,000; Year 2: £50,000. Calculate the payback period for this project.

Accepted Answer

2 years

Answer

1 year

Answer

3 years

Answer

4 years

Question 31

Which advantage does the net present value (NPV) method offer for capital budgeting?

Accepted Answer

Considers the time value of money

Answer

Applicable only to small-scale projects

Answer

Is unaffected by risk

Answer

Easy to calculate

Question 32

A project has an NPV of £10,000 and an IRR of 12%. Which capital budgeting method is more appropriate for evaluating this project?

Accepted Answer

NPV

Answer

IRR

Answer

Return on Investment

Answer

Payback Period

Question 33

Identify the major limitation of the payback period method for capital budgeting?

Accepted Answer

Ignores the time value of money

Answer

Can be used to compare projects of different sizes

Answer

Unaffected by risk

Answer

Easy to calculate

Question 34

A project has an IRR of 15% and a cost of capital of 10%. Determine if the project should be accepted or rejected.

Accepted Answer

Accepted

Answer

Not viable

Answer

Requires further analysis

Answer

Rejected

Question 35

What is a key benefit of incorporating sensitivity analysis into capital budgeting?

Accepted Answer

Identification of potential risks and uncertainties

Answer

Elimination of forecasting

Answer

Guarantee of project success

Question 36

Calculate the discounted payback period of a project with the following cash flows: Year 0: -£100,000; Year 1: £50,000; Year 2: £25,000, using a discount rate of 10%.

Accepted Answer

1.79 years

Answer

3 years

Answer

1 year

Answer

2 years

Question 37

Which factor, considered in capital budgeting, cannot be quantified?

Accepted Answer

Strategic alignment

Answer

Internal Rate of Return

Answer

Net Present Value