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Cap Budgeting Exercise

The document discusses various capital budgeting techniques used to evaluate investment projects, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index. It provides examples of true/false and multiple choice questions related to applying these techniques and interpreting their results. Key points covered include that NPV and IRR may provide different decisions for projects with multiple sign reversals of cash flows, and that the profitability index can be useful when capital is rationed.

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234 views

Cap Budgeting Exercise

The document discusses various capital budgeting techniques used to evaluate investment projects, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index. It provides examples of true/false and multiple choice questions related to applying these techniques and interpreting their results. Key points covered include that NPV and IRR may provide different decisions for projects with multiple sign reversals of cash flows, and that the profitability index can be useful when capital is rationed.

Uploaded by

ripplerage
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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CAPITAL BUDGETING TECHNIQUES

Exercise

TRUE/FALSE
1. The capital budgeting process is of critical importance because often multi-million
dollar investments are involved.

2. One drawback of the payback method is that some cash flows may be ignored.

3. If two projects are mutually exclusive then the IRR is more important than the NPV in
deciding the project that should be chosen.

4. The required rate of return reflects the costs of funds needed to finance a project.

5. The profitability index provides an advantage over the net present value method by
reporting the present value of benefits per dollar invested.

6. The net present value of a project will increase as the required rate of return is
decreased (assume only one sign reversal).

7. Whenever the internal rate of return on a project equals that project's required rate of
return, the net present value equals zero.

8. One of the disadvantages of the payback method is that it ignores time value of money.

9. An IRR that is reported for a project with multiple sign reversals is likely to be
ambiguous.

10. The profitability index can be helpful when a financial manager encounters a situation
where capital rationing is required.

MULTIPLE CHOICE (THEORIES AND PROBLEMS)

11. The net present value always provides the correct decision provided that
a. cash flows are constant over the asset's life
b. the required rate of return is greater than the internal rate of return
c. capital rationing is not imposed
d. the internal rate of return is positive

12. The net present value method


a. is consistent with the goal of shareholder wealth maximization
b. recognizes the time value of money
c. uses all of a project’s cash flows
d. all of the above

13. If the internal rate of return is greater than the required rate of return
a. the present value of all the cash inflows will be less than the initial outlay
b. the payback will be less than the life of the investment
c. a and b
d. none of the above

14. Arguments against using the net present value and internal rate of return methods
include that
a. they fail to use accounting profits.
b. they require detailed long-term forecasts of the incremental benefits and costs.
c. they fail to consider how the investment project is to be financed.
d. they fail to use the cash flow of the project.

15. All of the following are sufficient indications to accept a project except (assume that
there is no capital rationing constraint, and no consideration is given to payback as a
decision tool):
a. The net present value of an independent project is positive
b. The profitability index of an independent project exceeds one
c. The IRR of a mutually exclusive project exceeds the required rate of return
d. The NPV of a mutually exclusive project is positive and exceeds that of all other
projects
e. Only a above IS sufficient

16. If the NPV (Net Present Value) of a project that _____________ is positive, then the
project's IRR (Internal Rate of Return) must be ____________ than the required rate of
return.
a. has one sign reversal; less
b. has one sign reversal; greater
c. is independent; less
d. is independent; greater

17. Which of the following is always true of NPV and IRR:


a. They lead to the same accept/reject decision for independent projects
b. They lead to the same accept/reject decision for multiple sign reversal projects
c. They lead to the same accept/reject decision for mutually exclusive projects
d. They lead to the same accept/reject decision for one-sign-reversal projects
e. None of the above

18. If the cash flow pattern for a project has two sign reversals, then there can be as many
as ____ positive IRRs.
a. 1
b. 2
c. 3
d. 4

19. A project has an initial outlay of $100,000. It has a single payoff at the end of year 4 of
$200,000. What is the internal rate of return for the project (round to the nearest %)?
a. 15%
b. 17%
c. 19%
d. 21%

20. Hal E. Burton can purchase a new machine (to be placed in an undisclosed location) for
$1,000,000 that will provide an annual net cash flow of $300,000 per year for five
years. The machine will be sold for $100,000 at the end of year five. What is the net
present value of the machine if the required rate of return is 11.5%. (Round your
answer to the nearest $1,000.)
a. $94,000
b. $127,000
c. $153,000
d. $483,000
e. $594,000

21. NPV and IRR lead to the same accept/reject decision for projects that are:
a. Light and variable
b. Lemon and lime
c. Sweet and sour
d. Independent with one sign reversal

22. Given the following annual net cash flows, determine the internal rate of return to the
nearest whole percent of a project with an initial outlay of $750,000.
YEAR NET CASH FLOW
1 $500,000
2 $150,000
3 $250,000
a. 9%
b. 11%
c. 13%
d. 15%

23. A machine that costs $1,000,000 has a 3-year life. It will generate after tax annual cash
flows of $400,000 at the end of each year. It will be salvaged for $100,000 at the end of
year 3. If your required rate of return for the project is 10%, what is the NPV of this
investment? (Round your answer to the nearest $10).
a. $57,920
b. $63,040
c. $69,870
d. $75,770

24. Initial Outlay Cash Flow in Period


1 2 3 4
$4,000,000 $1,546,170 $1,546,170 $1,546,170 $1,546,170

The Internal Rate of Return (to nearest whole percent) is:


a. 10%
b. 18%
c. 20%
d. 24%

25. What is the payback period for a project with an initial investment of $150,000 that
provides an annual cash inflow of $20,000 for the first three years and $30,000 per year
for years four through eight?
a. 5 years
b. 6 years
c. 7 years
d. 8 years
E N D

KEY

1 True
2 True

3 False
4 True
5 True
6 True
7 True
8 True
9 True
10 True
11 C
12 D
13 D
14 B
15 C
16 B
17 E
18 B
19 C
20 C
21 D
22 B
23 C
24 C
25 B

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