CAPITAL BUDGETING

1. What does the term capital budgeting mean in the context of making capital expenditure decisions?
A. The process of choosing assets
B. The process of allocating the funds among assets
C. The process of acquiring the funds to finance the business
D. None of the given choices
2. The long-term planning process for making and financing investments that affects a company’s financial
results over a number of years is referred to as:

A. Capital budgeting C. Master budgeting

B. Strategic planning D. Long-range planning

3. Capital budgeting is the process:

A. Used in a sell or process further decision
B. Of determining how much capital stock to issue
C. Of making capital expenditure decisions
D. Of eliminating unprofitable product line
4. Competing investment projects where accepting one project eliminates the possibility of taking the
remaining projects is referred to as:

A. Common projects C. Mutually-inclusive projects

B. Mutually-exclusive projects D. Independent projects

5. A project that when accepted or rejects will not affect the cash flows of another project refers to:

A. Independent projects C. Mutually-exclusive projects

B. Dependent projects D. Sustaining project

6. A capital investment decision is essentially a decision to exchange current:

A. Assets for current liabilities
B. Cash outflows for the promise of receiving future cash inflows
C. Cash flows from operating activities for future cash inflows from investing activities
D. Cash inflows for future cash outflows
7. The higher the risk element in a project, the

A. More attractive the investment is C. Higher the cost of capital is

B. Higher the net present value is D. Higher the discount rate required is

8. The normal methods of analyzing investments

A. Cannot be used by not-for-profit entities
B. Do not apply if the project will not produce revenues
C. Cannot be used if the company plans to finance the project with funds already available internally
D. Require forecasts of cash flows expected from the project
9. Deciding whether or not an investment meets a predetermined company standard is called a

A. Screening decision C. Profitability decision

B. Payback decision D. Preference decision

10. The primary capital budgeting method that uses discounted cash flow technique is the:

A. Net Present Value method C. Annual Rate of Return method

B. Cash Payback technique D. Profitability Index method

11.Cost of capital is the:

A. Amount the company must pay for its plant assets
 B. Dividends a company must pay on its equity securities
C. Cost of company must incur to obtain its capital resources
D. Cost of company is charged by investment bankers who handle the issuance of equity or long-term
debt securities

12.If Troy Company expects to get a one-year bank loan to help cover the initial financing of one of its capital
projects, the analysis of the project should
A. Offset the loan against any investment in inventory or receivables required by the project
B. Show the loan as an increase in the investment
C. Show the loan as a cash outflow in the second year of the project’s life
D. Ignore the loan
13.The only future costs that are relevant to deciding whether to accept an investment are those that will
A. Be different if the project is accepted rather than rejected
B. Be saved if the project is accepted rather than rejected
C. Be deductible for tax purposes
D. Affect net income in the period that they are incurred
14.Arbitrary Company uses IRR to evaluate long-term decisions and establishes a cutoff rate of return. Such a
cutoff rate is
A. At least equal to its cost of capital
B. At least equal to the rate used by similar companies
C. Greater than the IRR on projects accepted in the past
D. Greater than the current book rate of return
15.In capital budgeting, sensitivity analysis is used to:
A. Determine whether an investment is profitable
B. See how a decision would be affected by changes in variables
C. Test the relationship of the IRR and NPV
D. Evaluate mutually exclusive investments
16.How should the following projects be listed in their order of increasing risk?

A. New venture, replacement, expansion C. Replacement, expansion, new venture

B. Replacement, new venture, expansion D. Expansion, replacement, new venture

17.An approach that uses a number of outcome estimates to get a sense of the variability among potential
returns is

A. The discounted cash flow technique C. Risk analysis

B. The net present value method D. Sensitivity analysis

18.Post-audit of capital projects

A. Is usually conclusive
B. Is done using different evaluation techniques than that were used in making the original capital
budgeting decision
C. Provides a formal mechanism by which the company can determine whether existing projects should
be supported or terminated
D. Preference decision
19.A thorough valuation of how well a project’s actual performance matches the projections made when the
project was proposed is called a

A. Pre-audit C. Sensitivity analysis

B. Post-audit D. Risk analysis

20.A major difference between an investment in working capital and one is depreciable assets is that
 A. An investment in working capital is never returned, while most depreciable assets have some
residual value
B. An investment in working capital is returned in full at the end of a project’s life, while an investment
in depreciable assets has no residual value
C. An investment in working capital is not tax-deductible when made, nor taxable when returned, while
an investment in depreciable assets does allow tax deductions
D. Because an investment in working capital is usually returned in full at the end of the project’s life, it is
ignored in computing the amount of the investment required for the project

21.Which of the following would not be included as part of the periodic cash inflows associated with an
investment project?
A. Savings for fixed and variable production costs
B. Savings in selling, general, and administrative costs
C. Receipts from sales
D. Opportunity costs of undertaking the project
22.The periodic cash flows associated with an investment project include which of the following?
A. Savings in taxes caused by deductibility of depreciation on tax return
B. Income tax effect of gain (loss) on disposal of existing assets in an asset replacement decision
C. Purchase of asset and freight cost
D. All of these are periodic cash flows in an investment project
23.Project Alpha has an expected cash flow of Php500,000 at the end of Year 5. Project Bravo has expected
cash flows of Php100,000 to be received at the end of each year for the next five years. What can be said of
the net present value of Project Alpha compared to Project Bravo?
A. They are the same because both cash flows total Php500,000 over the lives of the projects
B. Project Alpha is preferred because of the largest lump-sum payment in Year 5
C. Project Bravo is preferred because of the periodic payments made consistently throughout the year
and are made earlier
D. Both Project Alpha and Project Bravo have the same internal rate of return and either should be
accepted
24.The NPV and IRR methods give
A. The same decision (accept or reject) for any single investment
B. The same choice from among mutually exclusive investments
C. Different rankings of projects with unequal lives
D. The same rankings of projects with different required investments
25.The net present value (NPV) model can be used to evaluate and rank two or more proposed projects. The
approach that computes the total impact on cash flows for each option and then converts these total cash
flows to their present values is called the

A. Different approach C. Contribution approach

B. Incremental approach D. Total project approach

26.Which statement is most correct concerning depreciation in a capital budgeting analysis?

A. Depreciation is not a cash flow and does not affect the tax cash flow
B. Depreciation is not a cash flow but does affect the tax cash flow
C. Depreciation is a cash flow but does not affect the tax cash flow
D. Depreciation is a cash flow and does affect the tax cash flow
27. If there were no income taxes
A. Depreciation would be ignored in capital budgeting
B. The NPV method would not work
C. Income would be discounted instead of cash flow
D. All potential investments would be desirable
28.Assuming that a project has already been evaluated using the following techniques, the evaluation under
which technique is least likely to be affected by an increase in the estimated residual value of the project?

A. Payback Period C. Net Present Value

B. Internal Rate of Return D. Profitability Index

29.Which of the following, when used as the discount rate, equates the net present value of a series of cash
flows to zero?

A. Investment Rate of Return C. Internal Rate of Return

B. External Rate of Return D. Breakeven Time

30.If a company’s required rate of return is 12 percent and in using the profitability index method, a project’s
index is greater than 1.0, this indicates that the project’s rate of return is
A. Equal to 12 percent
B. Greater than 12 percent
C. Less than 12 percent
D. Dependent on the size of the investment
31.If the present value of the future cash flows for an investment equals the required investment, the IRR
A. Equals the cutoff rate
B. Equals the cost of borrowed capital
C. Equals zero
D. Is lower than the company’s cutoff rate return
32.All other things being equal, as cost of capital increases
A. More capital projects will probably be acceptable
B. Fewer capital projects will probably be acceptable
C. The number of capital projects that are acceptable will change, but the direction of the change is not
determinable just by knowing the direction of the change in cost of capital
D. The company will probably want to borrow money rather than issue stock
33.Which of the following is true of an investment?
A. The higher the cost of capital, the lower the net present value
B. The lower the cost of capital, the higher the IRR
C. The longer the project’s life, the shorter its payback period
D. The higher the project’s net present value, the shorter its life
34.If a project has an internal rate of return of 12 percent and a positive net present value, which of the
following statements is true regarding the discount rate used for the net present value computation?
A. The discount rate must have been greater than 12 percent
B. The discount rate must have been lower than 12 percent
C. The discount rate must have been equal to 12 percent
D. The discount rate must
35.The relationship between payback period and IRR is that
A. Have been higher than the IRR
B. A payback period of less than one-half the life of a project will yield an IRR lower than the target rate
C. The payback period is the present vale factor for the IRR
D. A project whose payback period does not meet the company’s cutoff rate for payback will not meet
the company’s criterion for IRR
E. None of the given choices
36.In choosing from among mutually exclusive investments, the manager should normally sect the one with
the highest

A. Net Present Value B. Internal Rate of Return

 C. Profitability Index D. Book Rate of Return

37.The proper treatment of an investment in receivables and inventory is to

A. Ignore it
B. Add it to the required investment in fixed assets
C. Add it to the required investment in fixed assets and subtract it from the annual cash flows
D. Add it to the investment in fixed assets and add the present value of the recovery to the present
value of the annual cash flows

38.XYZ Co. is adopting just-in-time approach. When evaluating an investment project that would reduce
inventory, how should XYZ treat the reduction?
A. Ignore it
B. Decrease the cost of the investment and decrease cash flows at the end of the project’s life
C. Decrease the cost of the investment
D. Decrease the cost of the investment and increase the cash flow at the end of the project’s life
39.Which of the following is NOT a defect of the payback method?
A. It ignores cash flows because it uses net income
B. It ignores profitability
C. It ignores the present values of cash flows
D. It ignores the pattern of cash flows beyond the payback period
40.The technique which is most concerned with liquidity is the

A. Payback Method C. Internal Rate of Return

B. Net Present Value Technique D. Book Rate of Return

41.The profitability index

A. Does not take into account the discounted cash flows
B. Is calculated by dividing total cash flows by the initial investment
C. Allows comparison of the relative desirability of projects that require varying initial investments
D. Will never be greater than 1.0
42.White Bubbles, Inc. is considering the purchase of an equipment that costs Php200,000. Annual cash
savings of Php50,000, with a present value at 15 percent of Php189,230, are expected for the next six years.
Given this information, which of the following statements is true?
A. This investment offers an actual rate of return of 15 percent
B. This investment offers an actual rate of return of less than 15 percent
C. This investment offers an actual rate of return of more than 15 percent
D. This investment offers a negative rate of return
43.CBN Products, Inc. is considering to invest in one of two projects. Both projects have a net present value of
Php25,000; however, Project Alpha requires an initial investment of Php700,000 while Project Delta
requires an initial investment of Php300,000. Based on this information, which of the following statements
is true?
A. Project Delta will have a higher profitability index
B. Project Alpha will have a higher profitability index
C. Both projects will have the same profitability index
D. There is not enough information to determining the profitability index of either project
44.Problems associated with justifying investments in high-the projects often include
A. Discount rates that are too low and time horizons that are too long
 B. Discount rates that are too high and time horizons that are too long
C. Discount rates that are too high and time horizons that are too short
D. Discount rates that are too low and time horizons that are too short
45.In addition to incremental revenues, cash inflows from capital investments can be generated from all of the
following sources except
A. Debt Financing
B. Cost Savings
C. Salvage Value
D. Reduction in the amount of working capital

46.Camel Company, a local company that specializes in home repairs is considering replacing its older van with
a new and larger one. The estimated cost of the new van will be Php65,000. Using a discount rate of 18
percent, the company calculates a net present value for the new van of Php(5,000). Based on this
information, which of the following statements is true?
A. The actual rate of return on the new van is negative
B. If the company purchases the can, they are guaranteed a rate of return of at least 18%
C. Using a higher discount rate should cause the net present value to become positive
D. If the actual cost of the new van ends up being less than Php60,000 the net present value becomes
positive
47. Diliman Plumbers, Inc. is considering the purchase of a machine costing approximately Php40,000. Using a
discount rate of 20 percent, the present value of future cash inflows is calculated to be Php40,000. To yield
at least a 20 percent return, the actual cost of the machine should not exceed the Php40,000 estimated by
more than:

A. Php40,000 C. Php8,000
B. Php80,000 D. Php0

48.The appropriate discount rate that the analysts use in computing the present value of future cash flows is
compromised of which of the following?
A. An increase in the rate reflecting the inflation expected to occur over the life of the project
B. A risk factor reflecting the riskiness of the project
C. A pure rate of interest reflecting the productive capability of the capital asset
D. All of the given choices are components of the discount rate
49.If a payback period for a project is greater than is expected useful life, the
A. A project will always be profitable
B. Entire initial investment will not be recovered
C. Project would only be acceptable if the company’s cost of capital was low
D. Project’s return will always exceed the company’s cost of capital
50.The payback method, as a capital budgeting technique, assumes that all intermediate cash inflows are
reinvested to yield a return equal to:

A. Zero C. The Discount Rate

B. The Time-Adjusted Rate of Return D. The Cost of Capital

51.Which of the following capital budgeting methods is the least theoretically correct?

A. Payback Method C. Internal Rate of Return

B. Net Present Value D. None of the given choices
52. Why do NPV method and IRR method sometimes give different rankings of mutually-exclusive investment
projects?
A. The NPV method does not assume reinvestment of cash flows while the IRR method assumes the
cash flows will be reinvested at the internal rate of return
B. The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method
assumes a reinvestment rate equal to the internal rate of return
C. The IRR method does not assume reinvestment of the cash flows while the NPV method assumes the
reinvestment rate is equal to the discount rate
D. The NPV method assumes a reinvestment rate equal to the bank loan interest rate while the IRR
method assumes a reinvestment rate equal to the discount rate
53. The primary advantages of the average rate of return method are its ease of computation and the fact
that:
A. It is especially useful to managers whose primary concern is liquidity
B. There is less possibility of los from changes in economic conditions and obsolescence when the
commitment is short-term
C. It emphasizes the amount of income earned over the life of the proposal
D. Rankings of proposals are necessary

54.When evaluating depreciation methods, the manager who are concerned about capital investment
decisions most likely
A. Choose straight-line depreciation so there is minimum impact on the decision
B. Use units of production so more depreciation expense will be allocated to the later years
C. Use accelerated methods to have as much depreciation in the early years of an asset’s life
D. Assume that the choice of depreciation method has no impact on the capital investment decision
55.A weakness of the internal rate of return method for screening investment projects is that it:
A. Does not consider the time value of money
B. Implicitly assumes that the company is able to reinvest cash flows from the project at the company’s
discount rate
C. Implicitly assumes that the company is able to reinvest cash flows from the project at the internal
rate of return
D. Fails to consider the timing of cash flows
56.If the internal rate of return on an investment is zero:
A. Its NPV is positive
B. Its annual cash flows equal its required investment
C. It is generally a wise investment
D. Its cash flows decrease over its life
57.Which of the following would decrease the net present value of a project?
A. A decrease in the income tax rate
B. A decrease in the initial investment
C. An increase in the useful life of the project
D. An increase in the discount rate
58.The length of time needed for a long-term project to recapture its initial investment amount is called the:

A. Discount Period C. Payback Period

B. Present Value D. Internal Rate of Return

59.Which of the following is not a typical cash outflow associated with a capital investment?
A. Repairs and maintenance needed for purchased equipment
B. Additional operating costs resulting from the capital investment
C. Salvage value received when the newly purchased equipment is sold
D. Purchase price of the new equipment
60.The internal rate of return method assumes that intermediate cash flows are immediately reinvested at:
A. The actual rate of return earned by the project
B. The company’s discount rate
C. The lower of the company’s discount rate or internal rate of return
D. An average of the internal rate of return and the discount rate
61.When using the net present value method, the interest rate used to discount cash flows should not be
thought of as the:

A. Hurdle Rate C. Internal Rate of Return

B. Minimum Required Rate of Return D. Discount Rate

62.Which of the following statements is false regarding the interest rate used in net present value
calculations?
A. Some companies use their cost of capital as the discount rate
B. It may be adjusted for uncertainty
C. It should be equal to the maximum required rate of return needed to make the investment profitable
D. It may be higher or lower than the investment’s actual internal rate of return

63.When using the net present value method for a particular investment decision, if the present value of all
cash inflows is greater than the present value of all cash outflows, then:
A. The discount rate used is too high
B. The investment provides an actual rate of return greater than the discount rate
C. The investment provides an actual rate of return equal to the discount rate
D. The discount rate was too low
64.All other things being equal, as cost of capital decreases:
A. More capital projects will probably be acceptable
B. Fewer capital projects will probably be acceptable
C. The number of capital projects that are acceptable will change but the direction of the change is not
determinable just by knowing the direction of the change in the cost of capital
D. The company will probably want to borrow money rather than issue stock
65.Depreciation charges indirectly affect the after-tax cash flow because the company
A. Can deduct depreciation expenses on their financial statements, reducing reported income before
tax
B. Can deduct depreciation expenses on their financial statements, increasing cash inflows
C. Can deduct depreciation expenses on their income tax returns, reducing cash outflows for taxes
D. Cannot deduct depreciation expenses on their income tax returns
66.In evaluating high-tech projects,
A. Only tangible benefits should be considered
B. Only intangible benefits should be considered
C. Both tangible and intangible benefits should be considered
D. Neither tangible nor intangible benefits should be considered
67.An analysis of a proposal by the net present value method indicated that the present value of future cash
inflows exceeded the amount to be invested. Which of the following statements best describes the results
of this analysis?
A. The proposal is desirable and the rate of return expected from the proposal exceeds the minimum
rate used for the analysis
 B. The proposal is desirable and the rate of return expected from the proposal is less than the minimum
rate used for the analysis
C. The proposal is undesirable and the rate of return expected from the proposal is less than the
minimum rate used for the analysis
D. The proposal is undesirable and the rate of return expected from the proposal exceeds the minimum
rate used for the analysis
68.The rate that produces a zero net present value when a project’s discounted cash operating advantage is
compare to its discounted net investment is the:

A. Cost of Capital C. Cutoff Rate

B. Discount Rate D. Internal Rate of Return

69.NPV indicates that a project is deemed desirable when the net present value is:
A. Greater than or equal to zero
B. Less than zero
C. Greater than or equal to the risk-adjusted cost of capital
D. Less than or equal to the risk-adjusted cost of capital
70.Sensitivity analysis is
A. An appropriate response to uncertainty in cash flow projections
B. Useful in measuring the variance of the Fisher rate
C. Typically conducted in the post investment audit
D. Useful to compare projects requiring vastly different levels of initial investment

71.Which of the following is not a typical cash inflow in capital investment decisions?

A. Incremental Revenues C. Salvage Value

B. Cost of Reductions D. Additional Working Capital

72.When comparing NPV and IRR, which is incorrect?

A. With NPV, the discount rate can be adjusted to take into account increased risk and the uncertainty
of cash flows
B. With IRR, cash flows can be adjusted to account for risk
C. NPV can be used to compare investments of various size or magnitude
D. Both NPV and IRR can be used for screening decisions
73.In which circumstances should the tax consequences be considered when making the capital investment
decisions?

A. Positive Net Income C. Depreciation

B. Disposal of an Asset D. All of the given choices

74.Mutually-exclusive projects are those that

A. If accepted, preclude the acceptance of competing projects
B. If accepted, can have a negative effect on the company’s profit
C. If accepted, can also lead to the acceptance of a competing project
D. Require all managers to consider
75.Which of the following is a cost that requires a future outlay of cash that is a relevant one for future
decision making?

A.Opportunity Cost C.Out-of-pocket Cost

B.Relevant Benefits D.Incremental Revenue
76.Which of the following capital budgeting methods assumes that intermediate cash inflows are reinvested at
the minimum acceptable rate of return?

A. Net Present Value Method C. Payback Method

B. Unadjusted Rate of Return Method D. Internal Rate of Return Method

77.If the net present value (NPV) of an investment is zero, then the internal rate of return (IRR) is:

A. Less than the discount rate C. Equal to the discount rate

B. Higher than the discount rate D. Negative

78.The calculation of the profitability index (PI) I most helpful for which type of decisions?

A. Screening C. Qualitative
B. Preference D. Short-term

79.Which pf the following represents the biggest challenge in the decision to purchase new equipment?
A. Estimating employee training for the new project
B. Estimating cash flows for the future
C. Estimating transportation costs of the new equipment
D. Estimating maintenance costs for the new equipment
80.Which of the following is a potential use of the payback method?
A. Help managers control the risks of estimating cash flows
B. Help minimize the impact of the investment on liquidity
C. Help control the risk of obsolescence
D. All of the answers are correct