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web.groovymark@gmail.com
- December 17, 2024
Question 01
Which of the following is an advantage of the payback period method?
a) It accounts for the time value of money.
b) It provides information on liquidity.
c) It evaluates all cash flows of the project.
d) It is useful for long-term projects.
Answer: b) It provides information on liquidity.
Explanation: The payback period method helps assess how quickly a project will generate enough cash to recover its initial investment.
Question 02
The IRR method assumes that cash flows are reinvested at:
a) The cost of capital.
b) The IRR.
c) The risk-free rate.
d) The required return.
Answer: b) The IRR.
Explanation: The IRR method assumes reinvestment of cash flows at the internal rate of return, which can sometimes be unrealistic.
Question 03
Which of the following statements is true about NPV?
a) NPV disregards the cost of capital.
b) NPV always leads to acceptance of long-term projects.
c) NPV measures the difference between the project’s cash inflows and outflows in present value terms.
d) NPV is calculated without considering project risks.
Answer: c) NPV measures the difference between the project’s cash inflows and outflows in present value terms.
Explanation: NPV calculates the present value of a project’s cash flows, accounting for the time value of money.
Question 04
What is the primary difference between IRR and NPV methods?
a) IRR considers all cash flows, while NPV only considers positive ones.
b) NPV uses the discount rate, while IRR finds the rate at which NPV equals zero.
c) NPV ignores the cost of capital, while IRR incorporates it.
d) IRR is more accurate for projects with unequal cash flows.
Answer: b) NPV uses the discount rate, while IRR finds the rate at which NPV equals zero.
Explanation: NPV uses a given discount rate, whereas IRR calculates the discount rate that makes the project’s NPV zero.
Question 05
The profitability index is defined as:
a) The ratio of present value of cash inflows to initial investment.
b) The return on investment over the project’s life.
c) The payback period of a project.
d) The difference between IRR and WACC.
Answer: a) The ratio of present value of cash inflows to initial investment.
Explanation: The profitability index helps measure the value created per unit of investment, indicating whether the project is worthwhile.
Question 06
Which of the following projects should be rejected based on its IRR?
a) A project with an IRR higher than the cost of capital.
b) A project with an IRR equal to the required rate of return.
c) A project with an IRR lower than the cost of capital.
d) A project with an IRR equal to zero.
Answer: c) A project with an IRR lower than the cost of capital.
Explanation: Projects with an IRR below the cost of capital are not expected to generate sufficient returns and should be rejected.
Question 07
Sensitivity analysis involves:
a) Changing multiple variables simultaneously to determine their impact on the project.
b) Altering one key variable at a time to assess its impact on project NPV.
c) Evaluating all variables as constants throughout the project.
d) Calculating the NPV for various time periods of the project.
Answer: b) Altering one key variable at a time to assess its impact on project NPV.
Explanation: Sensitivity analysis changes one variable at a time to see how sensitive the project’s outcome is to changes in assumptions.
Question 08
In the context of capital budgeting, a contingent project refers to:
a) A project whose acceptance depends on another project.
b) A project that is mutually exclusive with another.
c) A project that requires a minimum payback period.
d) A project with only variable costs.
Answer: a) A project whose acceptance depends on another project.
Explanation: Contingent projects are interdependent, meaning one project may only be pursued if another is accepted.
Question 09
The best decision criterion for mutually exclusive projects is:
a) Profitability index.
b) Net present value.
c) Internal rate of return.
d) Payback period.
Answer: b) Net present value.
Explanation: NPV is the most reliable method for selecting between mutually exclusive projects because it measures the total value added.
Question 10
Which of the following is true for independent projects with conventional cash flows?
a) If NPV is positive, IRR must be lower than the cost of capital.
b) If NPV is positive, the project should be accepted.
c) If IRR is greater than the cost of capital, the project should be rejected.
d) If NPV is negative, the project will always have a positive payback period.
Answer: b) If NPV is positive, the project should be accepted.
Explanation: A positive NPV indicates the project will add value to the firm and should therefore be accepted.
Question 11
In scenario analysis, the worst-case scenario refers to:
a) The most optimistic outcome for the project.
b) The situation with the lowest expected cash inflows and highest costs.
c) The case where the project NPV is zero.
d) The scenario with the fastest payback period.
Answer: b) The situation with the lowest expected cash inflows and highest costs.
Explanation: The worst-case scenario assumes the most unfavorable conditions, helping assess the risk of a project.
Question 12
Which of the following methods focuses on cash flows rather than accounting income?
a) Payback period.
b) Discounted payback period.
c) Net present value.
d) Average accounting return.
Answer: c) Net present value.
Explanation: NPV focuses on cash flows rather than accounting profits, providing a better measure of project profitability.
Question 13
The profitability index method can be misleading when:
a) Comparing independent projects.
b) Evaluating mutually exclusive projects.
c) Projects have conventional cash flows.
d) The required rate of return is higher than the IRR.
Answer: b) Evaluating mutually exclusive projects.
Explanation: Profitability index can rank mutually exclusive projects incorrectly because it does not measure absolute value creation.
Question 14
If a project has multiple IRRs, it indicates:
a) The project has no cash flows.
b) The project’s NPV is always positive.
c) The project has unconventional cash flows.
d) The project’s profitability index is negative.
Answer: c) The project has unconventional cash flows.
Explanation: Multiple IRRs occur when there are changes in the sign of cash flows, making the interpretation of IRR more complex.
Question 15
Which of the following methods provides the most accurate reflection of a project’s profitability?
a) Internal rate of return.
b) Payback period.
c) Net present value.
d) Discounted payback period.
Answer: c) Net present value.
Explanation: NPV is considered the most reliable method for evaluating project profitability because it accounts for the time value of money.
Question 16
The purpose of capital budgeting is to:
a) Determine the company’s cash flow needs.
b) Evaluate investment projects to maximize shareholder wealth.
c) Assess a project’s long-term financing needs.
d) Minimize the company’s debt.
Answer: b) Evaluate investment projects to maximize shareholder wealth.
Explanation: Capital budgeting involves selecting projects that will increase the firm’s overall value.
Question 17
What is the role of depreciation in capital budgeting decisions?
a) It reduces taxable income, thereby providing a tax shield.
b) It represents cash inflows from the project.
c) It is excluded from operating cash flows.
d) It increases the project’s NPV.
Answer: a) It reduces taxable income, thereby providing a tax shield.
Explanation: Depreciation lowers taxable income, reducing tax liabilities and enhancing project cash flows.
Question 18
Which of the following correctly defines a sunk cost?
a) A cost that will be incurred only if the project is accepted.
b) A cost that has already been incurred and cannot be recovered.
c) A future cost that varies depending on the project’s success.
d) A fixed cost associated with project financing.
Answer: b) A cost that has already been incurred and cannot be recovered.
Explanation: Sunk costs are not relevant to capital budgeting decisions because they cannot be recovered.
Question 19
The discounted payback period is the length of time until:
a) A project pays back its initial investment in nominal terms.
b) The present value of cash inflows equals the initial investment.
c) The project reaches its profitability index threshold.
d) The project’s NPV becomes positive.
Answer: b) The present value of cash inflows equals the initial investment.
Explanation: The discounted payback period measures the time required for the present value of cash inflows to cover the initial investment.
Question 20
If a project’s NPV is negative, the project’s profitability index must be:
a) Less than 1.
b) Equal to 1.
c) Greater than 1.
d) Negative.
Answer: a) Less than 1.
Explanation: A profitability index less than 1 indicates that the project’s cash inflows are insufficient to recover the initial investment
