Question 1

The internal rate of return for a project is the discount rate that makes the net present value of the project equal to zero.

Accepted Answer

This is the definition of internal rate of return (IRR) which is a commonly used financial metric in capital budgeting.

Question 2

The preference rule for ranking projects by the profitability index is: the higher the profitability index,the more desirable the project.

Accepted Answer

The profitability index is calculated by dividing the present value of the expected cash inflows by the initial investment required. Therefore, the higher the profitability index, the more value a project is expected to generate per unit of investment. As a result, the higher the profitability index, the more desirable the project.

Question 3

In comparing two investment alternatives,the difference between the net present values of the two alternatives obtained using the total cost approach will be the same as the net present value obtained using the incremental cost approach.

Accepted Answer

This statement is true as both approaches use the same discount rate and consider the same cash flows. The only difference is in the way costs are accounted for. The total cost approach considers all costs, while the incremental cost approach only considers the additional costs associated with the investment. However, the net present value difference between the two alternatives will be the same in both approaches.

Question 4

The payback method of making capital budgeting decisions gives full consideration to the time value of money.

Accepted Answer

The payback method does not take into account the time value of money, as it only looks at the amount of time it takes to recover the initial investment. It does not consider the present value of future cash flows.

Question 5

If new equipment is replacing old equipment,any salvage received from sale of the old equipment should not be considered in computing the payback period of the new equipment.

Accepted Answer

The answer of If new equipment is replacing old equipment,any...

Question 6

The present value of a cash flow decreases as it moves further into the future.

Accepted Answer

This is due to the time value of money, which takes into account the fact that money is worth more in the present than in the future due to various factors such as inflation, interest rates, and opportunity costs.

Question 7

An increase in the discount rate will result in an increase in the present value of a given cash flow.

Accepted Answer

An increase in the discount rate will result in a decrease in the present value of a given cash flow. This is because a higher discount rate means that the future cash flow is worth less in today's dollars.

Question 8

One of the strengths of the simple rate of return method is that it takes into account the time value of money in computing the return on an investment project.

Accepted Answer

The simple rate of return method does not take into account the time value of money in computing the return on an investment project.

Question 9

The discount rate used in net present value analysis should normally match or exceed the company's minimum required rate of return.

Accepted Answer

This is because the discount rate represents the minimum rate of return required to compensate for the time value of money and the risk associated with an investment. If the discount rate is lower than the minimum required rate of return, the investment may not generate enough return to justify the investment.

Question 10

Preference decisions in capital budgeting involve selecting from alternative projects that have already be determined as acceptable investments.

Accepted Answer

That is correct. Preference decisions involve selecting the best choice among acceptable investments that have already been identified in the capital budgeting process.

Question 11

A post audit of an investment project can provide feedback as to the quality of an entity's capital budgeting process.

Accepted Answer

A post audit of an investment project helps to evaluate the success of the investment and provides valuable feedback about the accuracy of the initial capital budgeting process. It helps the entity to improve its future investment decisions by learning from past mistakes and successes. Therefore, it is true that a post audit can provide feedback regarding the quality of a capital budgeting process.

Question 12

When using internal rate of return to evaluate investment projects,if the internal rate of return is less than the required rate of return,the project should be accepted.

Accepted Answer

If the internal rate of return is less than the required rate of return, the project should be rejected as it is not generating enough return to meet the minimum required by the investor.

Question 13

One of the strengths of the simple rate of return method is that it uses data about cash flows rather than accounting net income.

Accepted Answer

The simple rate of return method primarily focuses on accounting net income rather than cash flows for evaluating investments.

Question 14

Screening decisions in capital budgeting involve determining whether a project meets some minimal pre-set standard of acceptance.

Accepted Answer

Screening decisions in capital budgeting involve setting a minimum standard that a project must meet in order to be considered for further evaluation and investment. Projects that do not meet this standard are usually rejected at this stage.

Question 15

A major limitation of the payback method is that it cannot be used in situations where future budgeted cash flows are uneven.

Accepted Answer

The statement is false. A major limitation of the payback method is that it ignores the time value of money and does not consider cash flows beyond the payback period.

Question 16

When the net present value method is used,the internal rate of return is the discount rate used to compute the net present value of a project.

Accepted Answer

The answer of When the net present value method is...

Question 17

The present value of a given sum to be received in five years will be exactly twice as great as the present value of an equal sum to be received in ten years.

Accepted Answer

The answer of The present value of a given sum...

Question 18

The payback period is the length of time it takes for an investment to recoup its own initial cost out of the cash receipts it generates.

Accepted Answer

The definition of payback period is accurate.

Question 19

The cost of capital is the average rate of return a company must pay on its short-term bank borrowings.

Accepted Answer

The cost of capital refers to the total amount of funds a company has to spend to obtain financing from different sources, including both equity and debt. It is the average rate of return required by an investor in order to invest in a particular project or business. While the cost of debt is a component of the cost of capital, it only refers to the interest rate a company pays on its debt, not just short-term bank borrowings.

Question 20

Projects with shorter payback periods are always more profitable than projects with longer payback periods.

Accepted Answer

This statement is false. Shorter payback periods may provide quicker returns on investment, but they do not necessarily indicate higher profitability. Longer payback periods may have higher overall returns and profitability in the long run.

Quiz 10: Decentralization