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web.groovymark@gmail.com
- December 17, 2024
Question 41
What is the main drawback of the payback period method?
a) It does not consider all project cash flows.
b) It is difficult to calculate.
c) It requires a complex understanding of financial metrics.
d) It focuses too much on long-term profitability.
Answer: a) It does not consider all project cash flows.
Explanation: The payback period only considers cash flows up to the point where the initial investment is recovered, ignoring any subsequent cash flows.
Question 42
What does “capital rationing” refer to in capital budgeting?
a) Limiting the amount of projects a firm will pursue.
b) Allocating available capital only to projects with the highest NPV.
c) Accepting every project with a positive NPV.
d) Borrowing money to fund all investment opportunities.
Answer: b) Allocating available capital only to projects with the highest NPV.
Explanation: In capital rationing, the firm allocates its limited capital to the most profitable projects, usually determined by NPV.
Question 43
What is the main advantage of using the IRR method?
a) It is easier to interpret for managers.
b) It does not require estimating future cash flows.
c) It does not depend on the cost of capital.
d) It is always more accurate than NPV.
Answer: a) It is easier to interpret for managers.
Explanation: The IRR method is easy to interpret because it provides a percentage return, which is a familiar concept for most managers.
Question 44
Which of the following statements is true about the payback period method?
a) It accounts for the time value of money.
b) It provides a clear measure of a project’s profitability.
c) It is useful for evaluating the liquidity of a project.
d) It is superior to NPV for project evaluation.
Answer: c) It is useful for evaluating the liquidity of a project.
Explanation: The payback period method is useful for assessing how quickly a project will generate enough cash to cover the initial investment, indicating its liquidity.
Question 45
What is the purpose of calculating the profitability index (PI) for a project?
a) To compare the project’s IRR to the required rate of return.
b) To determine how much value a project creates per unit of investment.
c) To estimate how long it will take to recover the initial investment.
d) To assess the project’s overall cash flow.
Answer: b) To determine how much value a project creates per unit of investment.
Explanation: The profitability index calculates how much value a project generates relative to its cost, making it useful for ranking investment opportunities.
Question 46
Which of the following describes the term “capital budgeting”?
a) Managing a firm’s day-to-day cash flows.
b) Deciding how much cash to hold for operations.
c) Allocating capital to long-term investment projects.
d) Determining how to reduce short-term expenses.
Answer: c) Allocating capital to long-term investment projects.
Explanation: Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with a firm’s strategic goals.
Question 47
In project evaluation, which method calculates the percentage return on an investment?
a) Net present value (NPV)
b) Profitability index (PI)
c) Internal rate of return (IRR)
d) Payback period
Answer: c) Internal rate of return (IRR)
Explanation: IRR calculates the percentage return on an investment by determining the discount rate that makes the project’s NPV equal to zero.
Question 48
What does the payback period method fail to consider?
a) The time required to recover the initial investment.
b) The project’s liquidity.
c) Future cash flows beyond the payback period.
d) The amount of the initial investment.
Answer: c) Future cash flows beyond the payback period.
Explanation: The payback period method does not consider cash flows that occur after the initial investment is recovered, which may lead to incorrect conclusions about the project’s value.
Question 49
How does the profitability index (PI) differ from net present value (NPV)?
a) PI ignores the time value of money, while NPV considers it.
b) PI focuses on the project’s overall value, while NPV focuses on its profitability.
c) PI measures the return per unit of investment, while NPV measures total value.
d) PI is based on accounting figures, while NPV is based on cash flows.
Answer: c) PI measures the return per unit of investment, while NPV measures total value.
Explanation: The profitability index expresses the value generated per dollar invested, while NPV provides an absolute measure of the total value added by the project.
Question 50
In capital budgeting, what is the meaning of “mutually exclusive projects”?
a) Projects that must be undertaken together.
b) Projects that share the same financial resources.
c) Only one project can be chosen, even if multiple projects have positive NPVs.
d) Projects that have identical cash inflows and outflows.
Answer: c) Only one project can be chosen, even if multiple projects have positive NPVs.
Explanation: For mutually exclusive projects, the firm can only select one project, even if several projects have positive NPVs, because they compete for the same resources.
