Question 1

The "value additivity principle" means that the

Accepted Answer

The "value additivity principle" states that the value of the firm as a whole is equal to the sum of the values of all the projects undertaken by the firm. This means that the firm should pursue projects that will increase its overall value. Simply accepting all projects with a positive net present value (choice A) may result in the firm taking on too many projects that do not contribute to its overall value. Choice C is incorrect because the principle does not necessarily imply growth through new projects, but rather through adding value to the existing projects. Choice D is also incorrect because the principle refers to the overall value of the firm, not just its net worth.

Question 2

All of the following are reasons why a firm may face capital rationing except:

Accepted Answer

The discount rate being too high is not a reason why a firm may face capital rationing. The other options - reluctance to issue additional debt, lack of managerial resources, and restrictive covenants that limit borrowing - are all common reasons for capital rationing.

Question 3

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

Accepted Answer

The question is referring to the payback period, which is the amount of time it takes for the cumulative cash inflows to equal the initial cash outlay. Therefore, option B is the correct answer. Option A refers to the profitability index, which is a measure of the present value of future cash inflows relative to the initial investment. Option C combines the payback period with the present value of the cash inflows, which is not what is being asked for in the question. Option D is incorrect because there is a correct answer.

Question 4

Real options in capital budgeting can be classified in all of the following ways except:

Accepted Answer

The other options, abandonment, investment, and shutdown, are all commonly recognized real options in capital budgeting. The purchasing power option, however, is not typically considered a real option in this context.

Question 5

If the net present value of an investment project is positive then the:

Accepted Answer

A positive net present value indicates that the investment is generating returns that are greater than the cost of funding the project. This implies that the project's rate of return is higher than the firm's cost of capital. Option A is incorrect because if the net present value is positive, then the internal rate of return must be greater than the firm's cost of capital, making the project acceptable. Option B is incorrect because the payback method does not consider the time value of money and is, therefore, a poor measure of profitability.

Question 6

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) approach takes into account both the magnitude and timing of cash flows over the entire life of a project in measuring its economic desirability. The IRR is the rate at which the net present value of all cash inflows equals the net present value of all cash outflows. Projects with a higher IRR are more economically desirable. The other options (A, B, and C) do not consider the entire life of the project or use a discounted cash flow approach.

Question 7

The reason for a postaudit is to

Accepted Answer

Postaudit helps financial managers identify errors in their cash flow estimation and correct them for future projects. It is not related to reducing the number of accepted risky projects or determining the correct required rate of return. It can indirectly affect the number of projects submitted as accurate cash flow estimation may lead to better project evaluation and selection.

Question 8

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 is calculated by dividing the present value of the net cash flows over the life of a project by the net investment. If the present value of the net cash flows is less than zero, then the profitability index will be negative.

Question 9

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, therefore increasing the net present value of the project. The other options would either increase expenses (increased net investment), decrease tax benefits (using straight line depreciation rather than MACRS), or decrease liabilities (decrease in expected accounts payable), all of which would decrease the net present value.

Question 10

The internal rate of return does not take into account the

Accepted Answer

The answer of The internal rate of return does not...

Question 11

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 would actually increase competition and make it more difficult for a firm to earn above-normal profits. The other choices (access to superior labor or managerial talents, superior access to financial resources at lower costs, and patent control of superior product designs) would all give a firm an advantage in the market and increase their ability to earn above-normal profits.

Question 12

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

Accepted Answer

The net present value (NPV) approach involves discounting all net cash flows at a rate that reflects the required rate of return, discount rate, or cost of capital, as these terms are often used interchangeably in this context.

Question 13

When dealing with ____ cash flows, the ____ is computed by trial and error.

Accepted Answer

When dealing with uneven cash flows, the internal rate of return is computed by trial and error as there is no formula for calculating it. The other choices are not correct as perpetual cash flows have a constant stream of income and do not require the calculation of internal rate of return, while uniform cash flows can be easily calculated using formulas such as annuity or perpetuity formula. Net present value is also not computed by trial and error, but by discounting all the cash flows to the present using a predetermined interest rate.

Question 14

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 to the initial investment. Therefore, the profitability index is interpreted as the present value return for each dollar of initial investment. Option A is incorrect because the net present value is an absolute value, not a ratio. Option B is incorrect because cash flow return is not a commonly used financial term. Option D is incorrect because there is a correct answer.

Question 15

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 16

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

Accepted Answer

The profitability index is the ratio of the present value of future net cash flows to the net investment. Therefore, the correct choice is C. Choices A and B are incorrect because they reverse the ratio. Choice D is also incorrect because it confuses the order of the variables.

Question 17

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

None of the options listed assume that cash flows are reinvested at the firm's cost of capital. The internal rate of return (IRR) assumes reinvestment at the IRR itself, not the firm's cost of capital.

Question 18

A capital expenditure project has an expected 20 percent internal rate of return and a $10,000 net present value. It has one cash flow sign change.

Accepted Answer

The discount rate used to calculate NPV is less than the IRR (20%) since NPV is positive. There is only one IRR due to one cash flow sign change. IRR assumes reinvestment at the IRR, not the firm's required rate.

Question 19

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 20

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 states that the value of a firm increases by the net present value (NPV) of an independent project. NPV accounts for both inflows and outflows, providing a measure of the project's contribution to the firm's value.

Quiz 10: Capital Budgeting: Decision Criteria and Real Option Considerations

The "value additivity principle" means that the

All of the following are reasons why a firm may face capital rationing except:

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

Real options in capital budgeting can be classified in all of the following ways except:

If the net present value of an investment project is positive then the:

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.

The reason for a postaudit is to

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

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

The internal rate of return does not take into account the

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

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

When dealing with cash flows, the is computed by trial and error.

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

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 profitability index is the ratio of the to the .

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?

A capital expenditure project has an expected 20 percent internal rate of return and a $10,000 net present value. It has one cash flow sign change.

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

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.