Question 1

The value additivity principle indicates that, when a firm undertakes an independent project, the value of the firm is increased by the ____ from the project.

Accepted Answer

The value additivity principle suggests that the value of a firm increases by the net present value (NPV) of any independent project it undertakes. NPV is calculated by taking the present value of cash inflows and subtracting the present value of cash outflows.

Question 2

Real options in capital budgeting can be classified in all of the following ways EXCEPT ____.

Accepted Answer

Real options in capital budgeting can be classified into abandonment options, investment options, and shutdown options. Purchasing power option is not a classification of real options in capital budgeting.

Question 3

Which of the following investment decision rules (if any) assumes that the cash flows generated are reinvested over the life of the project at the firm's cost of capital?

Accepted Answer

The assumption that cash flows generated are reinvested at the firm's cost of capital is not specifically associated with the payback period, internal rate of return, or accounting rate of return. These methods have different assumptions and do not explicitly assume reinvestment at the firm's cost of capital.

Question 4

____ options allow a firm to design into a project the capability of shifting the product mix of the project if demand or relative product prices dictate such a shift.

Accepted Answer

Output flexibility options allow firms to adjust their product mix to align with demand and changing product prices. Input flexibility options, on the other hand, refer to the ability to adjust the production process or raw materials used in a product. Expansion and growth options are not specifically related to product mix adjustments.

Question 5

Which of the following would increase the net present value of a project?

Accepted Answer

Decreasing the discount rate would increase the present value of future cash flows, thus increasing the net present value of the project. Increasing the net investment (A) would decrease the net present value, while using straight-line depreciation (B) rather than MACRS would have no effect on the net present value, and decreasing expected accounts payable (C) may increase cash outflows, reducing net present value.

Question 6

The profitability index is the ratio of the ____ to the ____.

Accepted Answer

The profitability index is calculated as the present value of future net cash flows divided by the net investment, which is represented by option C.

Question 7

The ____ of an investment is the period of time for the ____ to equal the initial cash outlay.

Accepted Answer

The payback period is the time it takes for the cumulative cash inflows to equal the initial cash outlay. Therefore, option B is the correct answer. Option A is incorrect because the profitability index measures the present value of the cash inflows relative to the initial investment, but doesn't provide information about how long it takes to recoup the initial investment. Option C is also incorrect because the payback period is based on the cumulative cash inflows, not the present value of the cash inflows. Option D is incorrect because there is a correct answer.

Question 8

When dealing with ____ cash flows, the ____ is computed with the help of a financial calculator or by using capital budgeting spreadsheet programs.

Accepted Answer

When dealing with uneven cash flows, the internal rate of return (IRR) is computed with the help of a financial calculator or by using capital budgeting spreadsheet programs to account for the variability in cash flows over time.

Question 9

With the net present value approach, all net cash flows are discounted at the ____.

Accepted Answer

The net present value approach involves discounting all net cash flows at the required rate of return, discount rate, or cost of capital, as these terms are often used interchangeably in finance to represent the rate used for discounting future cash flows.

Question 10

If the net present value of an investment project is positive, then the ____.

Accepted Answer

A positive net present value indicates that the present value of cash inflows from the project exceeds the initial investment. This means that the project is generating a return that is greater than the firm's cost of capital, making it a viable investment option. Choice A is incorrect as a positive NPV means that the IRR is greater than the required rate of return. Choice B is incorrect as the payback method does not consider the time value of money or the profitability of a project, and only focuses on the time it takes to recover the initial investment.

Question 11

The net present value method assumes that cash flows are reinvested at the ____, whereas the internal rate of return method assumes that cash flows are reinvested at the ____.

Accepted Answer

The net present value (NPV) method assumes cash flows are reinvested at the firm's cost of capital, while the internal rate of return (IRR) method assumes reinvestment at the computed IRR.

Question 12

The "value additivity principle" means that the ____.

Accepted Answer

The value additivity principle means that the value of the firm is the sum of the value of all the projects undertaken. This principle is important in capital budgeting decisions because it helps managers to prioritize projects that will create the most value for the firm. By selecting projects with positive net present values, managers can ensure that they are adding value to the firm's net worth. However, accepting all projects with a positive net present value (option A) may not be feasible due to resource constraints. Option C is incorrect because growth through the addition of new projects is not necessarily guaranteed to create value for the firm.

Question 13

The profitability index would be ____ if the present value of the net cash flows (NCF) over the life of a project were ____.

Accepted Answer

The profitability index would be negative if the present value of the net cash flows over the life of a project were less than zero. This is because the profitability index is calculated by dividing the present value of the net cash flows by the initial investment. If the present value of the net cash flows is less than zero, then the profitability index will be less than one, which indicates that the project is not profitable.

Question 14

The ____ approach takes into account both the magnitude and timing of cash flows over the entire life of a project in measuring its economic desirability.

Accepted Answer

The internal rate of return (IRR) considers the magnitude and timing of cash flows throughout the life of a project, making it a better measure of economic desirability than the payback period, accounting rate of return, or average rate of return.

Question 15

Generally, the ____ is considered to be a more realistic reinvestment rate than the ____.

Accepted Answer

The cost of capital is considered a more realistic reinvestment rate than the internal rate of return because it reflects the rate of return required by investors to invest in a project, taking into account the risk of the investment, whereas the internal rate of return assumes that all future cash flows can be reinvested at the project's own IRR, which may not be realistic.

Question 16

The internal rate of return does NOT take into account the ____.

Accepted Answer

The internal rate of return (IRR) only considers the timing and magnitude of cash flows over the entire life of a project. It does not take into account the explicit risk of the net cash flows. The net investment is already factored into the IRR calculation as it represents the initial cash outflow at time zero.

Question 17

If a capital expenditure project has an expected 20% internal rate of return, and a $10,000 net present value, and one cash flow sign change, then which one of the following statements about the project is true?

Accepted Answer

The presence of a single cash flow sign change ensures the project has only one internal rate of return, ruling out option B. The fact that the NPV is positive at a discount rate lower than the IRR indicates the discount rate used for NPV calculation is less than 20%, not greater, eliminating option A. Option C is incorrect because the IRR calculation assumes reinvestment at the IRR itself, not the firm's required rate of return.

Question 18

There are many reasons why a firm can earn above-normal profits. These reasons include all of the following EXCEPT ____.

Accepted Answer

The ability of new firms to acquire necessary factors of production is not a reason why a firm can earn above-normal profits. In fact, if new firms are able to easily acquire the same factors of production, it could lead to increased competition and lower profits for existing firms.

Question 19

The ____ is interpreted as the ____ for each dollar of initial investment.

Accepted Answer

The profitability index is a ratio that measures the present value of future cash flows generated by an investment in relation to the initial investment. Therefore, option C is the correct choice as it identifies the profitability index as the parameter used to interpret the present value return for each dollar of initial investment. Options A and B are incorrect as these do not accurately describe the interpretation of the profitability of an investment. Option D is incorrect as it suggests that none of the provided choices are correct, which is not the case.

Question 20

The reason for a post-audit is to ____.

Accepted Answer

A post-audit is conducted to review the accuracy of cash flow estimates made during the capital budgeting process. This helps financial managers identify and correct errors in cash flow estimation, which in turn can improve future capital budgeting decisions. Options B and C are not accurate and D is not the primary purpose of a post-audit.

Quiz 12: Capital Budgeting: Decision Criteria and Real Option Considerations

The value additivity principle indicates that, when a firm undertakes an independent project, the value of the firm is increased by the ____ from the project.

Real options in capital budgeting can be classified in all of the following ways EXCEPT ____.

Which of the following investment decision rules (if any) assumes that the cash flows generated are reinvested over the life of the project at the firm's cost of capital?

____ options allow a firm to design into a project the capability of shifting the product mix of the project if demand or relative product prices dictate such a shift.

Which of the following would increase the net present value of a project?

The profitability index is the ratio of the to the .

The of an investment is the period of time for the to equal the initial cash outlay.

When dealing with cash flows, the is computed with the help of a financial calculator or by using capital budgeting spreadsheet programs.

With the net present value approach, all net cash flows are discounted at the ____.

If the net present value of an investment project is positive, then the ____.

The net present value method assumes that cash flows are reinvested at the , whereas the internal rate of return method assumes that cash flows are reinvested at the .

The "value additivity principle" means that the ____.

The profitability index would be if the present value of the net cash flows (NCF) over the life of a project were .

The ____ approach takes into account both the magnitude and timing of cash flows over the entire life of a project in measuring its economic desirability.

Generally, the is considered to be a more realistic reinvestment rate than the .

The internal rate of return does NOT take into account the ____.

If a capital expenditure project has an expected 20% internal rate of return, and a $10,000 net present value, and one cash flow sign change, then which one of the following statements about the project is true?

There are many reasons why a firm can earn above-normal profits. These reasons include all of the following EXCEPT ____.

The is interpreted as the for each dollar of initial investment.

The reason for a post-audit is to ____.