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web.groovymark@gmail.com
- December 17, 2024
Question 41
What does the term “capital rationing” refer to in project selection?
a) Allocating unlimited capital to all potential projects
b) Choosing projects based on the shortest payback period
c) Limiting the number of projects a firm undertakes due to budget constraints
d) Increasing project selection based on profitability index (PI)
Answer: c) Limiting the number of projects a firm undertakes due to budget constraints
Explanation: Capital rationing refers to the process of selecting projects under budget constraints, meaning not all viable projects can be undertaken.
Question 42
Which of the following capital budgeting methods focuses only on cash inflows and ignores cash outflows?
a) Profitability index (PI)
b) Payback period
c) Net present value (NPV)
d) Internal rate of return (IRR)
Answer: b) Payback period
Explanation: The payback period method only considers how quickly cash inflows recover the initial investment, ignoring cash outflows after the payback period.
Question 43
What is the formula for calculating profitability index (PI)?
a) Cash inflows / Initial investment
b) NPV / Initial investment
c) Future cash flows / Present value
d) Payback period / IRR
Answer: b) NPV / Initial investment
Explanation: The profitability index (PI) is calculated as the ratio of NPV to the initial investment, helping to evaluate the efficiency of a project.
Question 44
In capital budgeting, which method is considered the most theoretically sound?
a) Payback period
b) Internal rate of return (IRR)
c) Net present value (NPV)
d) Accounting rate of return (ARR)
Answer: c) Net present value (NPV)
Explanation: NPV is considered the most theoretically sound method because it accounts for the time value of money and provides a clear measure of profitability.
Question 45
Which of the following best defines the internal rate of return (IRR)?
a) The discount rate that makes the project’s cash inflows equal to zero
b) The interest rate used to discount future cash flows
c) The discount rate that makes the project’s NPV equal to zero
d) The percentage of future profits to be reinvested in the project
Answer: c) The discount rate that makes the project’s NPV equal to zero
Explanation: IRR is the rate at which the NPV of the project’s cash inflows equals the NPV of its outflows, indicating the break-even rate of return.
Question 46
What does the discounted payback period take into account that the regular payback period does not?
a) Future cash outflows
b) The time value of money
c) Initial investment
d) Future revenues
Answer: b) The time value of money
Explanation: The discounted payback period accounts for the time value of money by discounting future cash inflows, providing a more accurate reflection of project viability.
Question 47
Which method of project evaluation considers both profitability and the time required to recover the investment?
a) Payback period
b) Internal rate of return (IRR)
c) Profitability index (PI)
d) Net present value (NPV)
Answer: d) Net present value (NPV)
Explanation: NPV considers both profitability by discounting future cash flows and the time required to recover the investment, offering a comprehensive project evaluation.
Question 48
What does capital budgeting primarily focus on?
a) Managing daily operational cash flows
b) Allocating funds to long-term investments
c) Estimating the company’s future market share
d) Reducing the firm’s cost of capital
Answer: b) Allocating funds to long-term investments
Explanation: Capital budgeting is primarily concerned with evaluating and allocating resources to long-term investments such as new projects, acquisitions, or equipment.
Question 49
In capital budgeting, what is the main purpose of scenario analysis?
a) To evaluate multiple projects simultaneously
b) To calculate the payback period of different projects
c) To assess the impact of different assumptions on project outcomes
d) To measure the profitability index (PI) of various projects
Answer: c) To assess the impact of different assumptions on project outcomes
Explanation: Scenario analysis evaluates how different assumptions (e.g., best-case, worst-case) impact the project’s outcomes, helping to understand potential risks.
Question 50
A project with a profitability index (PI) less than 1.0 should be:
a) Accepted.
b) Rejected.
c) Considered for funding based on the IRR.
d) Evaluated using payback period criteria.
Answer: b) Rejected.
Explanation: A PI less than 1.0 means that the project’s NPV is negative, indicating that the project is not expected to generate sufficient returns to cover its costs.
