Question 1

Capital budgeting is about:

Accepted Answer

Capital budgeting is about management's search for the best capital projects - those that add the greatest value to the company.

Question 2

The opportunity cost of capital is defined as:

Accepted Answer

The return that an investor gives up when their money is invested in one asset rather than the best alternative asset

Question 3

One of the key advantages of using the NPV is the use of a discounted cash flow valuation technique that:

Accepted Answer

NPV uses the discounted cash flow valuation technique to adjust for the time value of money.

Question 4

If the IRR > cost of capital, a project should be:

Accepted Answer

IRR > Cost of capital then accept the project.

Question 5

A post-audit review is:

Accepted Answer

In a post-audit review, management compares the actual performance of a project with what was projected in the capital budgeting proposal.

Question 6

Capital budgeting is:

Accepted Answer

In capital budgeting, we estimate the NPV of the cash flows that a project is expected to produce in the future. In other words, all of the cash flow estimates are forward looking. This is very different from the accounting statement of cash flows, which provides a record of historical cash flows.

Question 7

Incremental capital expenditure is defined as:

Accepted Answer

The investments in property, plant and equipment and other long term assets that must be made if a project is pursued.

Question 8

Incremental depreciation and amortisation are:

Accepted Answer

Incremental depreciation and amortisation are charges that are associated with a project

Question 9

Which statement is true?

Accepted Answer

It is very important to realise that in an NPV analysis we use the expected FCF for each year of the life of the project

Question 10

In an NPV analysis, FCFs are:

Accepted Answer

Not only are the FCFs that we discount forward looking, but they also reflect expected FCFs. Each FCF is a weighted average of the cash flows from each possible future outcome, where the cash flow from each outcome is weighted by the estimated probability that the outcome will be realised. The expected FCF represents the single best estimate of what the actual FCF will be.

Question 11

Sunk cost are:

Accepted Answer

Sunk costs are costs that have already been incurred. All that matters when you evaluate a project at a particular point in time is how much you have to invest in the future and what you can expect to receive in return for that investment. Past investments are irrelevant.

Quiz 6: Capital Budgeting and Cash Flows