Deck 11: Capital Budgeting

Question 1

Which of the following is a feature of a capital investment?

A) It is minimal.
B) It is an inflow of funds.
C) It is durable.
D) It is expensed.

Answer 1

It is durable.

Question 2

Which of the following is a feature of an expense investment?

A) It is durable.
B) It is spread over many years.
C) It is significant.
D) It is impermanent.

Answer 2

It is impermanent.

Question 3

Which of the following is a typical opportunity investment?

A) maintaining a plant
B) launching a new product
C) building a cafeteria
D) building a warehouse

Answer 3

launching a new product

Question 4

Which of the following is NOT a compulsory investment?

A) constructing a new plant
B) removing pollution from the production facilities
C) spending money on safety equipment
D) increasing production capacity to meet marketing needs

Question 5

What type of investment is an expenditure of $ 5,000 on an advertising program?

A) a capital investment
B) an opportunity investment
C) a compulsory investment
D) an expense investment

Question 6

Why would a company choose to make an opportunity investment?

A) for cosmetic reasons
B) to improve operating efficiencies
C) for strategic reasons
D) for legislative reasons

Question 7

What is the ultimate reason for injecting funds into capital projects?

A) to maintain the level of expenses
B) to improve the return on investment
C) to reduce the amount of income taxes
D) to increase the level of CCA

Question 8

Which of the following is NOT a key step in the capital budgeting process?

A) the environmental analysis
B) adding the sunk costs to cash outflows
C) goal setting
D) determining the weighted average cost of capital

Question 9

Which of the following is an example of a cash outflow in capital budgeting?

A) advertising
B) travel
C) equipment
D) salaries

Question 10

Which of the following is an example of a significant cash outflow involved in capital projects?

A) supplies
B) capital cost allowance
C) office accessories
D) working capital

Question 11

What is the capital cost allowance considered to be in capital budgeting?

A) a cash outflow
B) a cash expense
C) a tax relief
D) an addition to capital assets

Question 12

How are the cash inflows for a particular project determined?

A) by adding capital cost allowance to profit for the year
B) by deducting administrative expenses from revenue
C) by deducting depreciation from profit before taxes
D) by adding capital cost allowance to the profit before taxes

Question 13

What is a sunk cost?

A) a cost that is NOT included in a capital project budget
B) a cost that is included as an expense investment in a capital project
C) a cost that is part of cash outflow
D) a cost that is part of the payback calculation

Question 14

What capital budgeting technique is NOT considered to be a time-value-of-money yardstick?

A) ROA
B) PI
C) NPV
D) IRR

Question 15

What do accounting methods use to determine the financial return of a proposed capital project?

A) projected income tax returns
B) projected operating budgets
C) cash flow forecasts
D) projected financial statements

Question 16

How do the accounting methods measure projects?

A) in terms of the return on assets
B) in terms of the return on cash flow
C) in terms of the return on retained earnings
D) in terms of the return on appreciated investments

Question 17

Which statement is an argument in favour of using the accounting methods?

A) They are reliable.
B) They are accurate.
C) They provide a true yield.
D) They are simple to calculate.

Question 18

Which statement is an argument against using the accounting methods?

A) They are complicated to use.
B) They focus on profit for the year rather than cash flow.
C) They can be used for auditing purposes.
D) They do NOT take into account the fact that money has a time value.

Question 19

Which is NOT a method for calculating the rates of return obtained from using various accounting methods?

A) annual profit for the year divided by capital assets
B) average profit for the year divided by capital assets
C) average capital employed divided by annual profit for the year
D) annual profit for the year divided by amortized assets

Question 20

What does the payback method measure?

A) the time needed for the cash outflow of a project to be totally recovered by profit for the year
B) the time needed for the cash outflow of a project to be totally recovered by revenue
C) the time needed for the cash outflow of a project to be totally recovered by cash inflows
D) the time needed for the cash outflow of a project to be totally recovered by profit before taxes

Question 21

What is a disadvantage of the payback method?

A) It ignores cash inflows earned before the payback period.
B) It is difficult to calculate.
C) It can be used to cheaply separate desirable projects from less desirable ones.
D) It ignores cash inflows earned after the payback period.

Question 22

What formula is used to calculate the payback period?

A) P = NCF/I
B) I = NCF/P
C) I = P/NCF
D) P = I/NCF

Question 23

What rough estimate is provided by the payback reciprocal?

A) the number of years to recover the initial cash outflow
B) the number of years to recover the initial cash inflow
C) the return on investment of a capital project
D) the break-even point in terms of years

Question 24

What does the discounted payback method calculate?

A) the number of years required for a capital investment to generate enough discounted cash outflow to just cover the initial cash inflow
B) the number of years required for a capital investment to generate enough compounded cash inflows to just cover the initial cash outflow
C) the number of years required for a capital investment to generate enough discounted net present value of the cash inflows
D) the number of years required for a capital investment to generate enough discounted cash inflows to just cover the initial cash outflow

Question 25

What discount rate is used to measure the difference between the sum of all cash inflows and cash outflows when using the net present value technique?

A) the internal rate of return
B) the inflation rate
C) the weighted average cost of capital
D) the weighted average payback return

Question 26

What two items does the net present value method measure?

A) cash outflow and depreciation
B) cash outflow and cash inflow
C) weighted average cost of capital and weighted average cost of financing
D) cash outflow and working capital

Question 27

Which statement supports the use of the net present value method?

A) It uses historical financial statements to do the calculation.
B) It examines the total lifespan of the project.
C) It takes into account profit for the year instead of cash flow.
D) It is easier to use than the accounting rates of return.

Question 28

What does the net present value calculation NOT take into consideration?

A) the residual value of the project
B) cash outflows
C) cash inflows
D) the level of risk

Question 29

What must the cash outflow equal when the internal rate of return is achieved?

A) the undiscounted cash inflow
B) the net future value
C) the discounted cash inflows
D) the net present value

Question 30

What factors are used with the cash inflows to calculate the internal rate of return?

A) PI factors
B) inflation factors
C) discount factors
D) Bank of Canada factors

Question 31

What does the internal rate of return calculation NOT take into consideration?

A) the weighted average cost of capital
B) cash inflows
C) the residual value of the assets
D) cash outflows

Question 32

What does the internal rate of return compare?

A) the NPV of one project to the NPB of another project
B) the return of one project to the weighted average cost of capital
C) the return of one project to the PI index
D) the lifespan of one project to another project

Question 33

What is divided into the present value of the cash inflows when calculating the profitability index?

A) the present value of the undiscounted profit before taxes
B) the net present value of the cash flow
C) the future value of the cash outflows
D) the present value of the cash outflows

Question 34

What is the hurdle rate sometimes used to calculate?

A) the payback period
B) the profitability index
C) the net present value
D) the accounting rate of return

Question 35

Project A has a net present value of $10,500, while project B has a net present value of $25,000. The company can select only one project. Which project should it select, and why?

A) project A because it has a higher NPV than project B
B) project B because it has a higher NPV than project A
C) project A because it has a lower NPV than project B
D) project B because it has a lower NPV than project A

Question 36

What flaw is shared by the traditional payback method and the accounting rate of return method?

A) They consider the future value of the cash inflows.
B) They focus on factors that are NOT visible.
C) They are easy to use.
D) They do NOT consider the present value of the cash flows.

Question 37

Which of the following are capital expenditures?

A) repairs to a building
B) advertising
C) equipment
D) salaries

Question 38

A capital investment may be defined as a project that requires extensive financial resources (outflow) in return for expected flow of financial benefits (inflow).

Question 39

A capital investment does NOT differ significantly from an expense investment.

Question 40

An expense investment is NOT a tax-deductible cost.

Question 41

Some of the characteristics of capital investments include the following: nature of commitment is durable, expenditure can be capitalized, has a significant financial impact.

Question 42

An expense investment is considered small and the cash turnover is done once and it is immediate.

Question 43

The two major types of capital projects are capital investments and expense investments.

Question 44

A compulsory investment is done primarily to respond to an opportunity.

Question 45

Opportunity investments are strategic in nature and usually have far-reaching financial implications.

Question 46

Some of the more important steps involved in capital budgeting include environmental analysis, formulation of capital expenditure portfolio, project measurement and ranking, weighted average cost of capital and project approval.

Question 47

Cash inflow is usually considered as the initial cash commitment required for launching a capital project.

Question 48

A cash outflow may include the purchase of land, buildings and machinery.

Question 49

Working capital should NOT be considered as a cash outflow when evaluating capital projects.

Question 50

A new project will generate additional cash because of increased revenue or produce savings resulting from more efficient operations.

Question 51

In capital budgeting, the "residual value" represents the sale of an asset or a business at the end of its physical life.

Question 52

One way that the residual value of an asset can be ascertained is by asking engineers to make their assessment based on historical experience.

Question 53

The economic life span of a project does NOT play a key role in determining the financial return of a project.

Question 54

A sunk cost is an investment incurred prior to making the decision to proceed with a capital project.

Question 55

Some of the more important time-value-of money yardsticks are the accounting methods.

Question 56

In capital budgeting, the accounting methods make use of data presented on "his past financial statements to express the economic results of a capital project.

Question 57

There are different ways to calculate the accounting rates of return for capital projects.

Question 58

One reason why the accounting methods are used to evaluate capital projects is that they take into consideration the fact that money has a time value.

Question 59

One of the main arguments against the accounting methods is that the returns focus only on one specific year while a project usually has a longer physical life span.

Question 60

The payback method measures the period of time it takes for the cash inflow of a project to be totally recovered by the anticipated cash outflow.

Question 61

The payback method measures time risk and NOT risk conditions.

Question 62

To calculate the payback period (if you have a regular stream of cash inflows), all you need to do is to divide the original investment by the annual cash inflow.

Question 63

The payback reciprocal technique gives a rough estimate of the return on investment of a capital project.

Question 64

One of the more important arguments in favour of the payback method is that it measures the "true economic worth" of a capital project because it focuses on its entire life span.

Question 65

The payback reciprocal can be defined as "the number of years required for a capital project to generate enough discounted cash inflow to cover the initial cash outflow".

Question 66

The net present value technique measures the difference between the sum of all cash inflow and the cash outflow discounted at a predetermined interest rate.

Question 67

The net present value technique helps to establish whether a specific project will bring a return that is less than the cost of borrowed funds.

Question 68

One of the arguments in favour of the net present value is that it tells exactly the "return" on a capital project.

Question 69

One of the arguments against the net present value is the fact that the time value of money concept is more difficult to grasp than the accounting methods such as "return" on assets.

Question 70

The internal rate of return is a time-value-of-money yardstick that uses a specific interest rate used to discount all future cash inflows so that their present value equals the initial cash outflow.

Question 71

The internal rate of return shows the economic merits of several projects and can compare their returns to other financial indicators, such as the weighted average cost of capital and the company's aggregate rate of return.

Question 72

One of the arguments in favour of the internal rate of return is that it is easy to predict the internal and external environmental conditions ten or even twenty years ahead of time.

Question 73

The profitability index calculates the ratio of the present value of the cash inflow to the initial cash outflow discounted at a predetermined rate of interest.

Question 74

The profitability index is considered a poor method for ranking capital projects.

Question 75

If the profitability index of a project shows more than 1, it means that the project's return exceeds the cost of borrowed funds.

Question 76

The two more important capital budgeting techniques that cope with risk are the internal rate of return and the payback method.

Question 77

Sensitivity analysis is a capital budgeting technique that involves the identification of profitability variations as a result of one or more changes in a project's base case to certain key elements of a capital project.

Question 78

Risk analysis is the process of attaching probabilities to individual estimates in capital project's base case.

Question 79

Some of the key variables used to analyze profitability variations in sensitivity and risk analysis are salaries, advertising programs and utility costs.

Question 80

Two key reasons can prevent a business from proceeding with a large number of capital projects: cash insufficiency and hurdle rate.