Capital Budgeting

Question 1

Capital budgeting is the

Answer 1

planning process used to determine which of an organization’s long term investments are worth pursuing.

Question 2

Capital budgeting, which is also called investment appraisal, is

Answer 2

the planning process used to determine whether an organization’s long-term investments, major capital, or expenditures are worth pursuing.

Question 3

Major methods for capital budgeting include

Answer 3

Net present value, Internal rate of return, Payback period, Profitability index, Equivalent annuity and Real options analysis.

Question 4

APT:

Answer 4

In finance, arbitrage pricing theory (APT) is a general theory of asset pricing that holds, which holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient.

Question 5

Modified Internal Rate of Return:

Answer 5

The modified internal rate of return (MIRR) is a financial measure of an investment’s attractiveness. It is used in capital budgeting to rank alternative investments of equal size. As the name implies, MIRR is a modification of the internal rate of return (IRR) and, as such, aims to resolve some problems with the IRR.

Question 6

Capital budgeting, which is also called “investment appraisal,” is

Answer 6

the planning process used to determine which of an organization’s long-term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.

Question 7

Many formal methods are used in capital budgeting, including the techniques as followed:

Answer 7

Net present value 
Internal rate of return 
Payback period 
Profitability index 
Equivalent annuity
Real options analysis

Question 8

Net present value (NPV) is used to

Answer 8

estimate each potential project’s value by using a discounted cash flow (DCF) valuation.

Question 9

The internal rate of return (IRR) is defined as

Answer 9

the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency.

Question 10

Payback period in capital budgeting refers to

Answer 10

the period of time required for the return on an investment to “repay” the sum of the original investment.

Question 11

Profitability index (PI), also known as profit investment ratio (PIR) and value investment ratio (VIR), is

Answer 11

the ratio of payoff to investment of a proposed project.

Question 12

Other essential functions of a budget include:

Answer 12

To control resources
To communicate plans to various responsibility center managers
To motivate managers to strive to achieve budget goals
To evaluate the performance of managers
To provide visibility into the company’s performance

Question 13

Accounting revolves around tracking the inflows and outflows of

Answer 13

assets, capital, and resources for an organization to adhere to legal and investor expectations.

Question 14

When measuring the impact of assets, liabilities, and equity, it is useful to know

Answer 14

in which situations to debit or credit the line item based upon the flow of capital.

Question 15

Cash flows analyses, such as the internal rate of return (IRR) or the net present value (NPV) of a given process, are

Answer 15

core tools in capital budgeting for understanding and estimating cash flows.

Question 16

Cash flow analyses can include

Answer 16

investing, operating and financing activities.

Question 17

Net present value (NPV):

Answer 17

This calculation takes all future cash flows from a given operational initiative, and discounts them to their present value based on the weighted average cost of capital.

Question 18

Internal rate of return (IRR):

Answer 18

a calculation that makes the net present value of all cash flows (positive and negative) from a particular investment equal to zero. It can also be described as the rate which will make an investment break even.

Question 19

The International Accounting Standards (IAS) and the Generally Accepted Accounting Principles (GAAP) are legislative descriptions of expectations and norms within the

Answer 19

accounting field.

Question 20

A cash flow is one element of

Answer 20

accounting flows.

Question 21

Investing activities

Answer 21

Payments related to mergers or acquisitions, loans made to suppliers or received from customers, as well as the purchase or sale of assets are all considered investing activities and tracked as incoming or outgoing cash flows.

Question 22

Operating activities

Answer 22

Operating activities can be quite broad, incorporating anything related to the production, sale, or delivery of a given product or service. This includes raw materials, advertising, shipping, inventory, payments to suppliers and employee, interest payments, depreciation, deferred tax, and amortization.

Question 23

Financing activities

Answer 23

Financing activities primarily revolve around cash inflows from banks and shareholders, as well as outflows via dividends to investors. This includes payment for repurchase of company shares, dividends, net borrowing and net repayment of debt.

Question 24

The higher the NPV,

Answer 24

the more attractive the investment proposal.

Question 25

The higher a project’s IRR,

Answer 25

the more desirable it is to undertake the project.

Question 26

As the value of the profitability index increases, so does

Answer 26

the financial attractiveness of the proposed project.

Question 27

Shorter payback periods are preferable to

Answer 27

longer payback periods.

Question 28

The higher the ARR,

Answer 28

the more attractive the investment.

Question 29

NPV formula:

Answer 29

Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore, NPV is the sum of all terms.

Question 30

NPV and PI assume

Answer 30

reinvestment at the discount rate, while IRR assumes reinvestment at the internal rate of return.

Question 31

If trying to decide between alternative investments in order to maximize the value of the firm,

Answer 31

the reinvestment rate would be a better choice.

Question 32

NPV and PI assume reinvestment at the

Answer 32

discount rate.

Question 33

IRR assumes reinvestment at the

Answer 33

internal rate of return.

Question 34

Weighted average cost of capital:

Answer 34

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets.

Question 35

Which definition is a correct description of a capital budgeting method?

Answer 35

The internal rate of return is the discount rate that gives a net present value of zero. The internal rate of return (IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency.

Question 36

Which of the following is a function of corporate capital budgeting?

Answer 36

To rank projects by profitability - Capital Budgeting is most involved in ranking projects and raising funds when long-term investment is taken into account.

Question 37

A firm is trying to choose the most profitable project to invest in. Which feature should be used as the company’s discount rate?

Answer 37

The company’s reinvestment rate. Selection of the discount rate is dependent on the use to which it will be put. If the intent is simply to determine whether a project will add value to the company, using the firm’s weighted average cost of capital may be appropriate. If trying to decide between alternative investments in order to maximize the value of the firm, the corporate reinvestment rate would be a better choice.

Question 38

Which statement reflects the best reason to use the payback method to evaluate investments?

Answer 38

The payback method is easy to use and understandable for most people, regardless of training. Payback period is widely used because of its ease of use despite the recognized limitations: The time value of money is not taken into account.

Question 39

Which investment proposal ranking method is widely used due to its simplicity, despite having several limitations?

Answer 39

Payback period. Payback period is widely used because of its ease of use despite several recognized limitations, such as not taking into account the time value of money.