Question 1

Which of the following statements about the "payback period" is true?

Accepted Answer

The payback period does not consider the time value of money, meaning that it does not take into account the fact that money received in the future is worth less than money received today.

Question 2

Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000. The current market value of the old machine is $25,000 but the book value is $32,000. What is the net cash outflow for the new machine with consideration for the sale of the old machine?

Accepted Answer

B

Question 3

For acceptable investments, the discount rate assumption under the internal rate of return is generally:

Accepted Answer

A

Question 4

Which of the following is not a step in creating the net present value profile?

Accepted Answer

The steps in creating the net present value profile include determining the net present value at different discount rates (including zero and normal), and determining the internal rate of return. However, determining the payback period is not a step in creating the net present value profile.

Question 5

Cash flow can be said to equal:

Accepted Answer

The answer of Cash flow can be said to equal:
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Question 6

Under the capital cost allowance system:

Accepted Answer

The capital cost allowance system breaks down recovery periods for different types of assets into categories, which have prescribed rates at which they can be depreciated. This allows for more accurate depreciation of assets based on their actual useful life, rather than a fixed period of time. The other options listed are incorrect: A is incorrect because the life span over which an asset may be amortized varies based on the asset category; B is incorrect because not all assets have salvage values; D is incorrect because tax effect of accounting depreciation is not included in the capital cost allowance system.

Question 7

An investment project has a positive net present value. The internal rate of return is:

Accepted Answer

A project with a positive NPV means that the present value of cash inflows is greater than the present value of cash outflows. The IRR is the discount rate that makes the NPV zero. Since the project has a positive NPV, the IRR must be greater than the cost of capital.

Question 8

Capital rationing:

Accepted Answer

Capital rationing involves setting a limit on the amount of funds to be allocated for capital expenditures. This can lead to suboptimal investment decisions as potentially profitable projects may be rejected due to the funding limit. Therefore, it is not the best way to arrive at capital budgeting decisions.

Question 9

Using higher discount rates,:

Accepted Answer

The answer of Using higher discount rates,:
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Question 10

The net present value profile:

Accepted Answer

The net present value profile graphically shows the relationship between the discount rate and the net present value. It is a useful tool for analyzing different discount rates and determining the optimal rate for a project. It is not a substitute for the internal rate of return (IRR) and it can still work for projects with negative net present values. The cost of debt is not related to the net present value profile.

Question 11

Which statement is true about amortization?

Accepted Answer

The answer of Which statement is true about amortization?
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Question 12

The net present value method is a better method of evaluation than the internal rate of return method because:

Accepted Answer

The NPV method discounts cash flows at the firm's more conservative cost of capital, taking into account the time value of money and the risks associated with the investment. The internal rate of return method only considers the rate at which the net present value of the cash flows equals zero, without taking into account the size or timing of the cash flows, which can lead to misleading results. Thus, the NPV method is generally preferred over the internal rate of return method for investment evaluation.

Question 13

Which of the following is not a time-adjusted method for ranking investment proposals?

Accepted Answer

Payback period is not a time-adjusted method for ranking investment proposals since it only looks at the amount of time it takes to recoup the initial investment, without considering the timing of cash inflows and outflows. The other options (net present value, internal rate of return, and profitability index) are all time-adjusted methods that take into account the time value of money.

Question 14

The _________ assumes returns are reinvested at the cost of capital.

Accepted Answer

The answer of The _________ assumes returns are reinvested at...

Question 15

The reason cash flow is used in capital budgeting is because:

Accepted Answer

Cash flow is used in capital budgeting because it helps to evaluate the present value of cash outlays versus the resultant cash inflows. This allows for a better understanding of the profitability and viability of a capital investment project. The use of income to purchase new machines (option A) does not necessarily relate to cash flow, while options C and D are incorrect as they do not accurately reflect the purpose of cash flow in capital budgeting.

Question 16

In using the internal rate of return method, it is assumed that cash flows can be reinvested at:

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a project equal to zero. This implies that the IRR is the rate at which cash flows can be reinvested in order to achieve an NPV of zero. Therefore, in using the IRR method, it is assumed that cash flows can be reinvested at the IRR.

Question 17

A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised, the net cash outflow (purchase price less proceeds from the sale of the old asset plus CCA effects) would:

Accepted Answer

The answer of A firm is selling an old asset...

Question 18

The longer the life of an investment:

Accepted Answer

The answer of The longer the life of an investment:
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Question 19

If projects are mutually exclusive:

Accepted Answer

If projects are mutually exclusive, it means that selecting one project automatically eliminates the possibility of selecting the other project. Therefore, the best choice in this scenario is B - the selection of one alternative precludes the selection of other alternatives. This emphasizes the importance of selecting the best alternative among the mutually exclusive projects.

Question 20

As the cost of capital increases:

Accepted Answer

As the cost of capital increases, the required rate of return for investments also increases. This means that projects will have to generate higher returns to cover the cost of capital. Therefore, only the most profitable projects will be accepted, resulting in fewer projects being selected.

Quiz 12: The Capital Budgeting Decision