Question 1

Unlike other corporations undertaking the capital budgeting process, MNC's need to consider which of the following?

Accepted Answer

MNC's (Multinational Corporations) need to consider the possibility of seizure of assets because they operate in multiple countries with varying political and economic conditions. This can affect the safety and availability of their assets, which should be considered in the capital budgeting process. The development of new products, construction techniques, and selection of management are factors that are important for all corporations, not just MNC's.

Question 2

Examples of external economic data required for project analysis include all of the following except:

Accepted Answer

Labor-management relations are considered an internal factor as they primarily involve the operation and management of the project rather than external economic conditions. The other options listed are all external economic factors that can have a significant impact on a project's analysis and success.

Question 3

Examples of non-financial data required for project analysis include which of the following?

Accepted Answer

Non-financial data includes qualitative factors like the quantity and quality of the labor force, which are crucial for project analysis but not directly related to financial metrics.

Question 4

As a rule, independent projects are accepted if the internal rate of return is greater than or equal to:

Accepted Answer

Independent projects will only be accepted if their return is greater than the cost of capital. The marginal cost of capital is the cost of acquiring additional funds for new investment opportunities. If a project's return is less than the cost of capital, then accepting the project would actually decrease the value of the firm. Therefore, choice C is the correct answer.

Question 5

Examples of internal financial data required for project analysis include all of the following except:

Accepted Answer

Business cycle stages are considered external data because they relate to the broader economic environment in which a project operates, not the internal financial specifics of the project itself.

Question 6

Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm's cost of capital is 8%. Based on this information, the NPV of the project is _________ million and the firm should _________ the project.

Accepted Answer

The NPV (Net Present Value) is calculated by discounting the future cash inflows at the firm's cost of capital and then subtracting the initial investment. Using the given data: NPV = -156 + 40/(1+0.08)^1 + 40/(1+0.08)^2 + 40/(1+0.08)^3 + 40/(1+0.08)^4 + 40/(1+0.08)^5 = $3.7 million (approximately). Since the NPV is positive, the firm should accept the project.

Question 7

The internal rate of return concept is best explained by which of the following?

Accepted Answer

The internal rate of return is the discount rate at which the net present value of future cash flows equals zero. Therefore, option A, rate where NPV is equal to zero, is the best choice to explain this concept. Option B refers to the payback period, while option C refers to the cost of capital, and option D refers to the accounting concept of average book value.

Question 8

A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. If the firm's required return or cost of capital is 10%, the NPV of the project is:

Accepted Answer

We can calculate the present value of the cash flows using the formula:

PV = CF / (1 + r)^n

Where: 
CF = cash flow 
r = required return or cost of capital 
n = number of periods

Using the formula:

PV (year 1-5) = $15,000 / (1 + 0.10)^1 = $13,636 
PV (year 2-5) = $15,000 / (1 + 0.10)^2 = $12,396 
PV (year 3-5) = $15,000 / (1 + 0.10)^3 = $11,269 
PV (year 4-5) = $15,000 / (1 + 0.10)^4 = $10,244 
PV (year 5) = $15,000 / (1 + 0.10)^5 = $9,314

PV (total) = $50,000 + $13,636 + $12,396 + $11,269 + $10,244 + $9,314 = $106,859

Therefore, the NPV of the project is:

NPV = PV - Initial investment 
NPV = $106,859 - $50,000 
NPV = $56,859

The closest answer to $56,859 is B ($6,862), which means that the project has a positive NPV and should be accepted.

Question 9

All of the following statements are correct except:

Accepted Answer

Capital budgeting analysis is a tool used by all departments within a company, not just those in finance.

Question 10

When a project's net present value (NPV) exceeds zero, then:

Accepted Answer

A net present value (NPV) of zero indicates that the project is expected to generate exactly enough cash flows to cover the initial investment and required rate of return. Therefore, if the NPV exceeds zero, the project is expected to generate more cash flows than required to meet these criteria and should be accepted. The payback period method and internal rate of return (IRR) are methods used to evaluate the attractiveness of a project, but they do not override the importance of a positive NPV. The payback period may be longer than one year and is not a definitive criterion for project acceptability, while the IRR may be impacted by financing considerations and is not always the best measure of profitability.

Question 11

Unlike other corporations undertaking the capital budgeting process, ___________ need to consider possible added political and economic risks such as the possibility of seizure of assets, unstable currencies, foreign exchange controls and foreign tax regulations.

Accepted Answer

MNCs (Multinational Corporations) operate in multiple countries and therefore, their capital budgeting process needs to consider political and economic risks that may vary across different countries. These risks include the possibility of seizure of assets, unstable currencies, foreign exchange controls, and foreign tax regulations. MOGs (Major Oil Companies), SWOTs (Strengths, Weaknesses, Opportunities, and Threats), and LTDs (Limited Companies) do not necessarily operate in multiple countries and may not face the same level of political and economic risks as MNCs.

Question 12

Internal rate of return (IRR) and net present value (NPV) methods:

Accepted Answer

IRR and NPV methods generally arrive at the same accept/reject decisions, as they both take into account the time value of money and are based on discounted cash flow analysis. In contrast, the payback period is a less sophisticated method that only looks at the length of time it takes to recover the initial investment, without considering the timing or amount of cash flows beyond that point. While IRR and NPV can differ in the case of non-conventional cash flows with multiple sign changes, they can still be used to make meaningful investment decisions in most cases.

Question 13

Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm's cost of capital is 10%. Based on this information, the NPV of the project is _________ million and the firm should _________ the project.

Accepted Answer

The answer of Shanghai Shipping is considering investing in a...

Question 14

An examples of internal financial data required for project analysis include which of the following?

Accepted Answer

Internal financial data includes financial information specific to the organization, such as transportation costs. Management stock options, number of employees, and length of time the firm has been in business are not financial data, and are not specifically related to project analysis.

Question 15

The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value of all cash flows from a particular project equal to zero. It is therefore the rate at which the project earns a return and is a useful tool for evaluating the profitability of an investment. The payback period (A) measures how long it takes for an investment to recoup its initial cost, but does not take into account any cash flows beyond that point. The average rate of return (B) is the total return earned over the life of the investment, divided by the number of years of the investment. It is a rough estimate of the project's profitability, but does not consider the timing or magnitude of cash flows. The cost of capital (C) is the weighted average cost of financing a business or project, including both equity and debt. It is used as a benchmark for determining whether a project's return is sufficient to cover its cost of capital.

Question 16

The IRR

Accepted Answer

The IRR is the internal rate of return, which is the discount rate that makes the net present value (NPV) of a project equal to zero. Therefore, it is the return that causes the NPV to be zero.

Question 17

When the net present value for a project is negative, the internal rate of return is _________ the cost of capital.

Accepted Answer

When the net present value (NPV) is negative, it means the project is not generating enough cash flows to cover the initial investment as well as the required rate of return (i.e. cost of capital). In order to make the project feasible, the internal rate of return (IRR) needs to be higher than the cost of capital so that the present value of cash inflows is greater than the present value of cash outflows. Therefore, if the NPV is negative, the IRR must be less than the cost of capital.

Question 18

Which of the following is the best expression of the net present value (NPV) acceptance criterion?

Accepted Answer

The NPV acceptance criterion compares the present value of cash inflows and outflows to determine the profitability of a project. A positive NPV indicates that the project is expected to generate more cash inflows than outflows over its life, and a negative NPV indicates the opposite. Therefore, choosing the option where NPV is greater than or equal to zero (D) is the best expression of the NPV acceptance criterion. Choices A, B, and C do not take into account the time value of money or the entire life of the project, and may lead to poor investment decisions.

Question 19

When the net present value is negative, the internal rate of return is __________ the cost of capital.

Accepted Answer

When the net present value is negative, the investment is not generating enough return to cover the costs of the project. Therefore, the internal rate of return is less than the cost of capital.

Question 20

What is the NPV for the following project if its cost of capital is 12% and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?

Accepted Answer

The NPV is calculated by discounting the future cash flows back to their present value and then subtracting the initial investment. Using a discount rate of 12%, the NPV for this project is negative, indicating that the project's returns do not cover its costs, including the cost of capital. The correct calculation leads to an NPV of approximately ($1,494,336).

Quiz 17: Capital Budgeting Analysis