Question 1

One criticism of the payback method is that it ignores cash flows that occur after the payback point has been reached.

Accepted Answer

The payback method only considers the time it takes to recoup the initial investment and does not take into account any cash flows that occur after the payback point has been reached. Therefore, it is criticized for ignoring the long-term profitability and returns on investment.

Question 2

An investment project with a project profitability index of -0.05 has an internal rate of return that is less than the discount rate.

Accepted Answer

True

Question 3

In preference decision situations, a project with a lower net present value may be preferable to a project with a higher net present value.

Accepted Answer

This can occur if the project with the lower net present value has a faster payback period or a higher internal rate of return, which are also important factors in decision making.

Question 4

The internal rate of return is computed by finding the discount rate that maximizes the difference between the present value of a project's cash outflows and the present value of its cash inflows.

Accepted Answer

The answer of The internal rate of return is computed...

Question 5

In calculating the payback period where new equipment is replacing old equipment, any salvage value to be received on disposal of the old equipment should be added to the cost of the new equipment.

Accepted Answer

The answer of In calculating the payback period where new...

Question 6

When discounted cash flow methods of capital budgeting are used, the working capital required for a project is ordinarily counted as a cash inflow at the beginning of the project and as a cash outflow at the end of the project.

Accepted Answer

The working capital required for a project is usually treated as a cash outflow at the beginning of the project and as a cash inflow at the end of the project in discounted cash flow methods of capital budgeting.

Question 7

For capital budgeting decisions, the simple rate of return method is superior to the net present value method.

Accepted Answer

The net present value method is generally considered superior to the simple rate of return method as it considers the time value of money and provides a more accurate representation of the profitability of an investment. The simple rate of return method only considers the accounting profit and does not account for the time value of money.

Question 8

In the payback method, depreciation is deducted from net operating income when computing the annual net cash flow.

Accepted Answer

The answer of In the payback method, depreciation is deducted...

Question 9

The internal rate of return method assumes that the cash flows generated by the project are immediately reinvested elsewhere at a rate of return that equals the internal rate of return.

Accepted Answer

This assumption is a key feature of the internal rate of return method. It assumes that the cash flows generated by the project can be reinvested elsewhere at the same rate of return as the project itself. This assumption is used to calculate the discount rate that makes the net present value of the project equal to zero.

Question 10

The simple rate of return in any one year may be less than or greater than the internal rate of return of a project.

Accepted Answer

The simple rate of return only takes into account the net inflows and outflows of cash for a single period, while the internal rate of return considers the time value of money and the entire cash flow stream over the life of the project. Therefore, it is possible for the simple rate of return to differ from the internal rate of return in any given year.

Question 11

When cash flows are uneven and vary from year to year, the net present value method is easier to use than the internal rate of return method.

Accepted Answer

The net present value method takes into account the time value of money and discounts future cash flows to their present value, making it easier to compare different cash flow scenarios. The internal rate of return method assumes a constant rate of return and can be difficult to apply to uneven cash flow patterns.

Question 12

The payback method of making capital budgeting decisions does not give full consideration to the time value of money.

Accepted Answer

The payback method only considers the time it takes for an investment to recoup its initial costs, without factoring in the opportunity cost of tying up capital over time, and any potential fluctuations in cash flows. It does not take into account the concept of present value or future value, which are important components of the time value of money.

Question 13

The basic premise of the payback method is that the more quickly the cost of an investment is recovered the more desirable is the investment.

Accepted Answer

The payback method measures the length of time required for an investment to recover its initial cost. It assumes that the sooner the investment breaks even, the better it is.

Question 14

Discounted cash flow techniques do not take into account recovery of initial investment.

Accepted Answer

Discounted cash flow techniques, such as net present value (NPV) and internal rate of return (IRR), do take into account the recovery of the initial investment. The calculation of these techniques involves discounting the future cash flows back to their present value, which includes the recovery of the initial investment.

Question 15

The salvage value of new equipment should be considered when using the internal rate of return method to evaluate a project.

Accepted Answer

The salvage value of new equipment is an important cash flow to consider in the internal rate of return (IRR) method. The IRR is based on the assumption that investment cash flows are recovered at the end of the project's life, which includes any salvage value from equipment or other assets purchased as part of the project. Failure to consider salvage value may lead to incorrect IRR calculations and project evaluation.

Question 16

If the internal rate of return exceeds the required rate of return for a project, then the net present value of that project is negative.

Accepted Answer

If the internal rate of return exceeds the required rate of return for a project, then the net present value of that project is positive, indicating that the project is potentially profitable.

Question 17

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

Accepted Answer

If the internal rate of return is greater than the required rate of return, it means that the project is expected to generate returns higher than the minimum required by the investor, hence it should be accepted.

Question 18

The required rate of return is the minimum rate of return that an investment project must yield to the acceptable.

Accepted Answer

This is true. The required rate of return is also known as the hurdle rate or the minimum acceptable rate of return. It is the rate of return that must be achieved by an investment project in order for it to be considered worthwhile for an investor. If the expected rate of return is lower than the required rate of return, the investment project may be rejected.

Question 19

Preference decisions follow screening decisions and seek to rank investment proposals in order of their desirability.

Accepted Answer

Preference decisions involve evaluating and ranking investment proposals in order of their desirability, after screening decisions have been made to determine which proposals meet specific criteria.

Question 20

When considering a number of investment projects, the project that has the shortest payback period does not necessarily have the highest net present value.

Accepted Answer

The payback period measures the amount of time it takes to recover the initial investment, while the net present value takes into account the time value of money and calculates the present value of future cash flows. Therefore, a project with a shorter payback period may not necessarily have higher net present value if it generates smaller cash flows over a longer period of time.

Quiz 7: Capital Budgeting Decisions