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web.groovymark@gmail.com
- December 14, 2024
Question 41
The equivalent annual cost (EAC) method is most useful when:
a) Comparing projects with equal lives.
b) Projects have different lifespans.
c) Evaluating mutually exclusive projects.
d) Calculating the time value of money.
Answer: b) Projects have different lifespans.
Explanation: The EAC method helps to standardize the cost of projects with varying lifespans by converting total project costs into an annual figure.
Question 42
A project’s modified internal rate of return (MIRR) differs from its IRR because:
a) It assumes reinvestment at the firm’s cost of capital.
b) It disregards the time value of money.
c) It assumes all cash flows are equal.
d) It always results in a lower NPV.
Answer: a) It assumes reinvestment at the firm’s cost of capital.
Explanation: MIRR modifies the reinvestment assumption of the IRR by assuming that cash inflows are reinvested at the firm’s cost of capital, rather than the IRR.
Question 43
Which of the following is not included in a project’s incremental cash flows?
a) Sunk costs.
b) Opportunity costs.
c) Cash inflows from the project.
d) Depreciation tax shield.
Answer: a) Sunk costs.
Explanation: Sunk costs are excluded from the analysis of incremental cash flows since they have already been incurred and cannot be recovered.
Question 44
The capital asset pricing model (CAPM) is used to:
a) Measure a project’s risk-adjusted NPV.
b) Estimate the expected return of an asset based on its beta.
c) Determine the appropriate discount rate for a project.
d) Calculate the time value of money.
Answer: b) Estimate the expected return of an asset based on its beta.
Explanation: CAPM uses beta to estimate the expected return on an asset, accounting for its risk relative to the market.
Question 45
In the context of capital budgeting, a real option refers to:
a) The ability to alter a project’s course based on new information.
b) A financial option that is used to hedge project risk.
c) An option that is exercised after a project is completed.
d) The sale of the project’s future cash flows.
Answer: a) The ability to alter a project’s course based on new information.
Explanation: Real options give managers flexibility to adapt a project in response to changes in market conditions or other factors.
Question 46
The profitability index (PI) is considered a relative measure because it:
a) Expresses project value as a percentage of initial investment.
b) Is expressed in terms of dollars rather than percentages.
c) Only measures cash inflows.
d) Can only be used for mutually exclusive projects.
Answer: a) Expresses project value as a percentage of initial investment.
Explanation: PI measures the value created per dollar invested by expressing the project’s benefits relative to its initial cost.
Question 47
The degree of operating leverage (DOL) is defined as the:
a) Percentage change in operating cash flows divided by the percentage change in sales.
b) Ratio of total fixed costs to variable costs.
c) Total debt divided by total equity.
d) Change in a project’s NPV as fixed costs increase.
Answer: a) Percentage change in operating cash flows divided by the percentage change in sales.
Explanation: DOL measures how sensitive a firm’s operating income is to changes in sales, indicating how fixed costs impact profitability.
Question 48
Which of the following actions is most likely to reduce the risk of a project?
a) Increasing fixed costs.
b) Decreasing variable costs.
c) Shortening the project’s duration.
d) Using more equity financing.
Answer: d) Using more equity financing.
Explanation: Using more equity reduces the firm’s financial leverage, lowering the risk of the project.
Question 49
What is the primary advantage of using simulation analysis?
a) It simplifies the capital budgeting process.
b) It accounts for uncertainty in multiple variables simultaneously.
c) It eliminates project risk.
d) It generates a single possible outcome.
nswer: b) It accounts for uncertainty in multiple variables simultaneously.
Explanation: Simulation analysis models multiple scenarios and variable outcomes, helping to assess the full range of potential project risks.
Question 50
If a project’s NPV is greater than zero, this means that:
a) The project is expected to generate more cash flows than the cost of capital.
b) The project should be rejected.
c) The project will lose money over time.
d) The project’s payback period is less than one year.
Answer: a) The project is expected to generate more cash flows than the cost of capital.
Explanation: A positive NPV indicates that the project will generate more value than it costs, making it a good investment.
