Deck 10: Capital Budgeting Decisions

Question 1

Which of the following is not a step in the capital budgeting process?

A) Evaluating alternatives
B) Identifying investment alternatives
C) Implementing the chosen investment decisions
D) Monitoring and evaluating the implemented decisions
E) All of the above are steps in the Capital budgeting process

Answer 1

All of the above are steps in the Capital budgeting process

Question 2

Which of the following is not an example of a capital expenditure?

A) Plant
B) Equipment
C) Accounts receivable
D) Research and development

Answer 2

Accounts receivable

Question 3

Which of the following is an example of a capital expenditure?

A) Prepaid Insurance
B) Accounts Receivable
C) Investment in Equities
D) Research and Development

Answer 3

Research and Development

Question 4

What is the process through which a company makes capital expenditure decisions?

A) Capital budgeting
B) Cash flow budgeting
C) Revenue forecasting
D) Net Income forecasting

Question 5

This is referred to as the return on an investment that compensates the investor for explicit and implicit costs, where implicit costs include the opportunity cost of the investor's capital.

A) Capital profit
B) Normal profit
C) Economic profit
D) Competitive advantage

Question 6

This is referred to as the return on an investment in excess of the normal profit.

A) Capital profit
B) Normal profit
C) Economic profit
D) Competitive advantage

Question 7

What type of analysis is based on the idea that a company focuses on the strategic decisions about which industries or products the company invest?

A) Top-down analysis
B) Horizontal analysis
C) Bottom-up analysis

Question 8

What type of analysis is based on the idea that a company is simply a set or portfolio of capital investment decisions?

A) Top-down analysis
B) Horizontal analysis
C) Bottom-up analysis

Question 9

An analysis that considers the value of all opportunities that the investment provides including the opportunity to expand, abandon, or wait is best described as:

A) capital budgeting.
B) the payback period.
C) real-option valuation.
D) the discounted cash flow.

Question 10

Which of the following is not an advantage of payback period?

A) Easy to calculate
B) A useful initial screening technique
C) Considers the time value of money through the hurdle rate.
D) Measures the liquidity of a project (i.e. how fast cash inflows occur)

Question 11

Which of the following companies is least likely to use cost leadership to give it a comparative or competitive advantage?

A) Costco
B) Starbucks
C) Wal-Mart
D) McDonald's

Question 12

Which of the following companies is least likely to use product differentiation to give it a comparative or competitive advantage?

A) Exxon
B) Virgin America
C) Harley Davidson
D) Hard Rock Hotel and Casino

Question 13

The estimated value added of a project, which we calculate as the sum of the present value of all future after-tax incremental cash flows generated by an initial cash outlay, less the present value of the investment outlays, is best described as the:

A) capital profit
B) normal profit
C) economic profit
D) net present value

Question 14

The CEO of your company asks your opinion of a prospective project. It has a zero net present value, what is your recommendation?

A) Decline to take on the project.
B) The project should be accepted.
C) Not enough information to decide.

Question 15

Which method is consistent with owners' wealth maximization in the case of deciding among mutually exclusive projects?

A) Payback period
B) Net present value
C) Internal rate of return
D) Discounted payback period

Question 16

Which of the following projects should be declined?

A) Project A, which has a net present value of $45,000
B) Project B, which has a net present value of $0
C) Project C, which has a net present value of -$15,000
D) Both Project B and Project C should be declined

Question 17

Consider the following project:
Initial outlay = $15 million
Year 1 expected cash flow = $5 million
Year 2 expected cash flow = $6 million
Year 3 expected cash flow = $7 million
Project cost of capital = 8%
The net present value of this project is closest to:

A) -$3.00 million
B) $0.33 million
C) $3.00 million
D) $3.30 million

Question 18

Consider following project:
The net present value of this project is closest to:

A)-$20.00 million
B)-$6.46 million
C) $6.46 million
D) $20.00 million

Question 19

Which of the following does not take the time value of money into account?

A) Payback period
B) Net present value
C) Internal rate of return
D) Modified internal rate of return

Question 20

Which of the following considers all project cash flows?

A) Payback period
B) Internal rate of return
C) Discounted payback period

Question 21

When evaluating two mutually exclusive projects with a crossover rate of 6% and IRR _A < IRR _B , we prefer Project A when the discount rate is:

A) equal to 6%.
B) less than 6%.
C) greater than 6%.

Question 22

Consider the following project:
The net present value of this project is closest to:

A) -$3.00 million
B) $0.79 million
C) $3.00 million
D) $19.21 million
E) $20.00 million

Question 23

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the net present value of this project is closest to:

A) $226.39
B) $244.51
C) $264.07
D) $2,000.00

Question 24

We should reject a project if the:

A) net present value less than $0.
B) profitability index greater than 1.
C) internal rate of return is greater than the project's cost of capital.
D) modified internal rate of return is greater than project's cost of capital.

Question 25

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the net present value of this project is closest to:

A) -$48.15
B) -$44.58
C) -$41.28
D) $200

Question 26

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the internal rate of return on this project is closest to:

A) 5.15%
B) 8.00%
C) 9.30%
D) 20.00%

Question 27

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the internal rate of return on this project is closest to:

A) -22.54%
B) 6.33%
C) 8.00%
D) 20.00%

Question 28

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the profitability index of this project is closest to:

A) 1.000
B) 1.024
C) 1.111
D) 1.200

Question 29

Consider the following project end of year cash flows:
If the project's cost of capital is 8 percent, the profitability index of this project is closest to:

A) 0.882
B) 0.955
C) 1.111
D) 1.200

Question 30

Which of the following statements is incorrect?

A) Unlike net present value, internal rate of return does not use discounted cash flows.
B) Internal rate of return is also called the economic rate of return of a given project.
C) Internal rate of return is the discount rate that makes the present value of all project cash flows equal to zero.
D) A company should accept a project whenever the internal rate of return is greater than the appropriate risk-adjusted discount rate.

Question 31

Consider the following project:
The net present value of this project is closest to:

A) 3.3%
B) 8.0%
C) 9.2%
D) 20.0%

Question 32

Consider the following project:
The internal rate of return of this project is closest to:

A) 3.3%
B) 8.0%
C) 18.9%
D) 22.4%

Question 33

Consider the following project:
If cash flows are reinvested at the project's cost of capital, the modified internal rate of return for this project is closest to:

A) 3.3%
B) 8.0%
C) 8.8%
D) 9.2%
E) 20.0%

Question 34

Consider the following project:
If cash flows are reinvested at the project's cost of capital, the modified internal rate of return for this project is closest to:

A) 8.0%
B) 18.9%
C) 22.4%
D) 60.0%

Question 35

Consider the following project:
If the cash flows are received uniformly throughout the year, the payback period is closest to:

A) 2 years
B) 2 years and 5 months
C) 3 years
D) 3 years and 5 months

Question 36

Consider the following project:
If the cash flows are received uniformly throughout the year, the payback period is closest to:

A) 2 years
B) 2 years and 4 months
C) 2 years and 8 months
D) 2 years and 10 months
E) 3 years

Question 37

Consider the following project:
If the cash flows are received uniformly throughout the year, the discounted payback period for this project is closest to:

A) 2 years
B) 2 years and 4 months
C) 2 years and 8 months
D) 2 years and 10 months
E) 3 years

Question 38

Consider the following project:
If the cash flows are received uniformly throughout the year, the discounted payback period for this project is closest to:

A) 2 years
B) 2 years and 5 months
C) 2 years and 6 months
D) 2 years and 7 months
E) 3 years

Question 39

Which of the following statements is incorrect?

A) The market is efficient, even in case of capital rationing.
B) If a company faces capital rationing, they may have to turn down positive net present value projects.
C) Under capital rationing, the decision on projects is based on the combination of projects that gives the highest net present value while satisfying the capital budget constraint.
D) Cost of Capital is no longer the appropriate opportunity cost under capital rationing. Cash flows generated by a project can be reinvested at a rate higher than assumed by the cost of capital because the company is leaving some positive net present value projects on the table due to lack of financing.

Question 40

Which of the following is not a disadvantage of using internal rate of return?

A) Considers all the project's cash flows.
B) Should not use when the capital budget is limited.
C) Cannot be used when the signs of cash flows change more than once.
D) Should not be used when deciding among mutually exclusive projects.

Question 41

Consider the following project:
Which of the following statements is incorrect?

A) The internal rate of return is between 6 percent and 7 percent.
B) The project pays back in terms of the payback period approach.
C) The project has a positive net present value if the project's cost of capital is 6 percent.
D) The profitability index is greater than 1.0 when the project's cost of capital is 5 percent.

Question 42

Consider the following project:
Initial outlay = $15 million
Year 1 expected cash flow = $5 million
Year 2 expected cash flow = $5 million
Year 3 expected cash flow = $10 million
Project cost of capital = 10%
The profitability index for this project is closest to:

A) 0.33
B) 1.08
C) 1.19
D) 1.33

Question 43

Consider the following project information:
Initial outlay = $40 million
Year 1 expected cash flow = $8 million
Year 2 expected cash flow = $10 million
Year 3 expected cash flow = $30 million
Project cost of capital = 10%
The profitability index for this project is closest to:

A) 0.55
B) 0.95
C) 1.20
D) 1.33

Question 44

We should accept a project if:

A) profitability index < 1
B) net present value < 0
C) internal rate of return > project's cost of capital
D) modified internal rate of return > project's cost of capital

Question 45

Consider two projects, Project J and Project K, with the following end of year cash flows:
If these projects are mutually exclusive and have a cost of capital of 5 percent, the appropriate decision is to:

A) accept Project J and reject Project K.
B) reject Project J and accept Project K.
C) accept both projects.
D) reject both projects.

Question 46

Consider two projects, Project J and Project K, with the following end of year cash flows:
If these projects are mutually exclusive and have a cost of capital of 7 percent, the appropriate decision is to:

A) accept Project J and reject Project K.
B) reject Project J and accept Project K.
C) accept both projects.
D) reject both projects.

Question 47

Consider two projects, Project J and Project K, with the following end of year cash flows:
If these projects are independent and have a cost of capital of 5 percent, the appropriate decision is to:

A) accept Project J and reject Project K.
B) reject Project J and accept Project K.
C) accept both projects.
D) reject both projects.

Question 48

Consider two projects, Project P and Project Q, with the following end of year cash flows:
Which of the following statements is correct?

A) The crossover discount rate is less than the internal rate of return of both projects.
B) If the cost of capital is 5 percent, the profitability index of both projects will be less than 1.0.
C) If these two projects are independent and the cost of capital is 6 percent, we should reject both projects.
D) If these two projects are mutually exclusive and the cost of capital is 5 percent, we should accept only Project P.

Question 49

Allotting investment capital among available investment projects is best described as:

A) allocating.
B) portioning.
C) capital rationing.
D) capital budgeting.

Question 50

When selecting among projects when there is capital rationing, we should select projects based on the:

A) sum of net present values.
B) highest net present values.
C) highest internal rates of return.
D) profitability index values greater than 1.0.

Question 51

Consider these five projects:
If there is a budget of $50,000, which projects, if any, should be accepted?

A) All projects
B) Project One only
C) Only Projects One, Two, Four and Five
D) Only Projects One, Two, Three and Five

Question 52

Consider these five projects:
If there is a budget of $5,000, which projects, if any, should be accepted?

A) All projects
B) Project E only
C) Only Projects A, B, C and D
D) Only Projects A, B, C and E

Question 53

Consider these five projects:
If there is a budget of $4,000, which projects, if any, should be accepted?

A) All projects
B) Project E only
C) Only Projects A, B and D
D) Only Projects A, B and E

Question 54

The essence of creating value is generating normal profits through capital investments.

Question 55

The purchase of property is a capital budgeting decision.

Question 56

A comparative advantage is any strategy or company action that reduces the competition that the company experiences.

Question 57

Patents, copyrights, and trademarks are examples of competitive advantages.

Question 58

Top-down analysis focuses on the strategic decisions about the industries or products in which the company should invest.

Question 59

Discounted cash flow used to evaluate stocks and bonds cannot be used for capital investment decisions.

Question 60

Discounted cash flow valuation involves estimating future cash flows and comparing their discounted values with investment outlays required today.

Question 61

Projects that produce a net present value of 0 should be accepted.

Question 62

When the internal rate of return is higher than the hurdle rate, a company should invest in the capital project.

Question 63

If the net present value of a project is positive, the profitability index will be greater than 1.0.

Question 64

If the internal rate of return on a project is greater than the project's cost of capital and the cash flows have only one sign change, the net present value of the project will be greater than $0.

Question 65

The difference between internal rate of return and modified internal rate of return is that internal rate of return has a more realistic assumption regarding reinvestment of cash flows from the project.

Question 66

The mortgage broker says that your mortgage refinance has a payback period of one year and 3 months. This means that you will have the mortgage paid off in one year and three months.

Question 67

Project B is the better option at a discount rate of 9%.

Question 68

The profitability index (PI) formula is: PI = PV (cash outflows) / PV (cash inflows).

Question 69

The profitability index for an initial outlay of $15million and subsequent end-of-year cash inflows of $5, $5 and $10 million, respectively, if the discount rate is 15 percent is 1.12.

Question 70

The net present value and internal rate of return have different assumptions regarding cash flows. net present value assumes that all cash flows are reinvested at one consistent discount rate, while the internal rate of return assumes that all cash flows are reinvested at the internal rate of return (similar yielding investments).

Question 71

The discount rate used in calculating a project's net present value is the project's cost of capital.

Question 72

The same accept / reject decision is reached when looking at independent projects using net present value, internal rate of return, and the profitability index methods.

Question 73

The net present value and internal rate of return methods yield the same ranking when evaluating projects.

Question 74

When evaluating two mutually exclusive projects with a crossover rate of 7 percent and IRR _A < IRR _B we prefer Project A when the discount rate is greater than 7 percent.

Question 75

If a project has a positive net present value using a discount rate of 6%, the project's internal rate of return is greater than 6%.

Question 76

With contingent projects, one must be turned down even if the net present values of both are positive.

Question 77

The pure play approach involves estimating betas and the risk associated with an investment and the optimal financing by estimating the weighted average cost of capital of companies in an industry associated with the project.

Question 78

List 3 of the 5 forces that Michael Porter identifies as critical factors that determine the profitability and attractiveness of investing in an industry.

Question 79

Calculate the net present value of a project with the following:
Initial outlay: $10 million
Year 1 expected cash flow $8 million
Year 2 expected cash flow $5 million
Year 3 expected cash flow $5 million
Project cost of capital = 10%

Question 80

Calculate the net present value of a project with the following:
Initial outlay: $15 million
Year 1 expected cash flow $5 million
Year 2 expected cash flow $5 million
Year 3 expected cash flow $8 million
Project cost of capital = 10%