Deck 5: Capital Budgeting

Question 1

Capital budgeting is what?

A) The management of a company's cash balances and short-term investment in securities
B) The administration of all of a firm's long-term obligations to creditors and shareholders
C) The process of making pricing decisions for products
D) The process of planning for investments in fixed assets

Answer 1

D

Question 2

What is the compounding factor, or future value factor, of a cash flow to be invested at a rate of 5%, for 4 years?

A) 1.2167
B) 1.225
C) 1.2155
D) 1.1262

Answer 2

C

Question 3

What is the discount factor, or present value factor, of a cash flow to be received 4 years form now, at a rate of 6%

A) 0.7921
B) 0.8638
C) 0.8626
D) 0.6651

Answer 3

A

Question 4

Internal Rate of Return is a "discounted cash flow" (DCF) technique. Which of the following are ALL DCF techniques?

A) Modified IRR and ARR
B) ARR and Profitability Index
C) NPV, Payback and Modified Payback
D) NPV, Modified IRR, Modified Payback, Profitability Index

Question 5

A project with a projected 6-year life would cost $100,000. Its annual cash flows would be $40,000, while its annual income flows would be $30,000. The payback period would be how many years?

A) 2.5
B) 3.33
C) 4
D) 6

Question 6

What is in the denominator (bottom part) of the formula for Accounting Rate of Return?

A) (Project cost + salvage value) / number of project years
B) (Project cost - salvage value) / number of project years
C) (Project cost + salvage value) / 2
D) (Project cost - salvage value) /2

Question 7

Sayer Tool Co. is considering investing in specialized equipment costing $610,000. The equipment has a useful life of five years and a residual value of $69,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are given below. What is the Accounting Rate of Return on the investment? $$\begin{array} { | c c | } \hline \text { Year } & \\\hline 1 & \$ 210,000 \\\hline 2 & \$ 159,000 \\\hline 3 & \$ 160,000 \\\hline 4 & \$ 95,000 \\\hline 5 & \$ 136,000 \\\hline \text { Total } & \$ 760,000 \\\hline\end{array}$$

A) 0.0645
B) 0.129
C) 0.1436
D) 0.1619

Question 8

If investment projects are "mutually exclusive", what does that mean?

A) Those projects are only available to companies that don't need to borrow money for the investment
B) These projects are considered to have a higher-than-normal risk, so companies would apply a higher discount to the projected cash flows
C) If the business decides to invest in one of these projects, they cannot also invest in any of the others
D) A company would only invest in this type of project with a trusted partner, in order to share the risk

Question 9

A project's profitability index is equal to the ratio of the ______ of a project's future cash flows to the project's ______.

A) Present value; initial cash outlay
B) Net present value; initial cash outlay
C) Present value; average investment
D) Net present value; average investment

Question 10

A profitability index of .85 for a project means what?

A) The present value of benefits is 85% greater than the project's costs
B) The project's NPV is greater than zero.
C) The project returns 85 cents in present value for each current dollar invested
D) The payback period is less than one year

Question 11

Which of the following has the highest present value?

A) €150 to be received in 4 years, assuming a 12% cost of capital
B) €150 to be received in 7 years, assuming a 12% cost of capital
C) €150 to be received in 4 years, assuming an 8% cost of capital
D) €150 to be received in 7 years assuming an 8% cost of capital

Question 12

What is the Net Present Value of this project at a 5% cost of capital? Assume the initial investment is made today (on T0) and the other cash flows take place at the end of each year. $$\begin{array} { | l | c | c | l | l | } \hline \text { T0 } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } \\\hline - 8,000 & 6,000 & 4,000 & 1,000 & 1,000 \\\hline\end{array}$$

A) 3029
B) 4000
C) 5054
D) 12000

Question 13

If the "net cashflow" of an investment is defined as "total positive cashflows LESS total negative cashflows", what is then the relationship between net cashflow and NPV?

A) NPV is essentially a discounted version of net cashflow
B) The two terms are similar except that NPV is based on profit, not cashflows
C) Net cash flow is NPV divided by IRR
D) Net cash flow is the initial investment times 1.x, where x is the IRR

Question 14

What is the Internal Rate of Return of the investment with a series of cashflows that results in the following NPVs? - $\$ 600,000$ at a $5 \%$ discount rate;
- $\$ 200,000$ at a $10 \%$ discount rate;
- $( \$ 200,000 )$ at a $15 \%$ discount rate;

A) Less than 5%
B) Between 5% and 10%
C) Between 10% and 15%
D) More than 15%

Question 15

Which of the following are BOTH a problem with IRR?

A) It assumes cashflows are invested at the calculated IRR; and IRR cannot be calculated if projected cashflows are very irregular
B) IRR cannot be calculated if projected cash flows are very irregular; and the time value of money is ignored
C) IRR is expressed only in percentage terms rather than absolute values; and the time value of money is ignored
D) IRR ignores excess cashflows; and it assumes cashflows are invested at the calculated IRR