Sample Questions and Answers
Which of the following capital budgeting methods does NOT consider the time value of money?
A) Net present value (NPV)
B) Internal rate of return (IRR)
C) Payback period
D) Profitability index (PI)
Answer: C
If the internal rate of return (IRR) for a project is equal to the required rate of return, what should be the decision?
A) Accept the project
B) Reject the project
C) The decision is ambiguous; further analysis is needed
D) The project’s NPV is zero
Answer: D
A project has a profitability index (PI) of 1.5 and an initial investment of $200,000. What is the present value of future cash inflows?
A) $250,000
B) $300,000
C) $350,000
D) $400,000
Answer: B
A project with a cost of capital of 10% has an internal rate of return (IRR) of 12%. What is the relationship between the IRR and the NPV?
A) The NPV will be positive
B) The NPV will be zero
C) The NPV will be negative
D) The NPV cannot be determined without additional information
Answer: A
Which of the following capital budgeting methods is considered the most conservative?
A) Payback period
B) Net present value (NPV)
C) Internal rate of return (IRR)
D) Profitability index (PI)
Answer: A
What is the main advantage of the internal rate of return (IRR) method?
A) It provides an exact dollar value of profitability
B) It accounts for the time value of money
C) It is easy to calculate
D) It does not require assumptions about the reinvestment rate
Answer: B
A company is deciding between two projects. Project A has an NPV of $300,000, and Project B has an NPV of $150,000. What should be the decision?
A) Accept Project A and reject Project B
B) Accept both projects since both have positive NPVs
C) Reject both projects since the NPVs are too low
D) Accept Project B and reject Project A
Answer: A
Which of the following best describes the net present value (NPV) method?
A) It measures the expected profitability of a project relative to its risk
B) It compares the present value of future cash inflows to the initial investment
C) It determines the payback period for a project
D) It calculates the internal rate of return (IRR) for a project
Answer: B
If a project has a high internal rate of return (IRR) but a low profitability index (PI), what does this indicate?
A) The project is expected to generate high returns relative to the investment
B) The project is not a good investment because the PI is below 1
C) The project will break even
D) The project should be accepted regardless of the PI
Answer: B
Which of the following methods is best for comparing mutually exclusive projects with different sizes and investment amounts?
A) Internal rate of return (IRR)
B) Net present value (NPV)
C) Profitability index (PI)
D) Payback period
Answer: B
Which of the following is true about the profitability index (PI)?
A) It is the ratio of discounted cash inflows to the initial investment
B) It is the rate of return at which the NPV is zero
C) A PI greater than 1.0 indicates the project is not profitable
D) It does not account for the time value of money
Answer: A
Which of the following is an example of a limitation of the IRR method?
A) It does not take into account the time value of money
B) It assumes that cash flows are reinvested at the IRR
C) It is difficult to calculate for large projects
D) It requires a discount rate
Answer: B
If a company’s cost of capital is 8%, and a project has an IRR of 9%, what does this suggest about the project’s NPV?
A) The NPV will be positive
B) The NPV will be zero
C) The NPV will be negative
D) The project should be rejected
Answer: A
In capital budgeting, which method can be used to compare the profitability of projects with unequal durations?
A) Net present value (NPV)
B) Internal rate of return (IRR)
C) Profitability index (PI)
D) Equivalent annual cost (EAC)
Answer: D
Which of the following methods is best suited for evaluating projects with different risk profiles?
A) Payback period
B) Net present value (NPV)
C) Internal rate of return (IRR)
D) Profitability index (PI)
Answer: B
A company is evaluating two mutually exclusive projects. Project X has an NPV of $150,000, and Project Y has an NPV of $100,000. Which project should be selected?
A) Project X
B) Project Y
C) Both projects should be accepted
D) Neither project should be accepted
Answer: A
A company is evaluating two independent projects. Project A has an NPV of $50,000, and Project B has an NPV of $30,000. What should be the decision?
A) Accept both projects because both have positive NPVs
B) Accept only Project A
C) Accept only Project B
D) Reject both projects
Answer: A
If a project’s internal rate of return (IRR) is greater than the company’s required rate of return, what is the expected effect on the project’s NPV?
A) The NPV will be zero
B) The NPV will be negative
C) The NPV will be positive
D) The NPV will be zero at the IRR
Answer: C
Which of the following is true about the payback period method?
A) It does not consider the time value of money
B) It is suitable for long-term projects
C) It calculates the NPV of a project
D) It is complex to calculate
Answer: A
What is the most important factor to consider when choosing between mutually exclusive projects with different cash flow patterns?
A) Internal rate of return (IRR)
B) Net present value (NPV)
C) Payback period
D) Profitability index (PI)
Answer: B
What does the term ‘capital budgeting’ refer to?
A) A method for setting the company’s marketing strategy
B) The process of planning and managing a firm’s long-term investments
C) The process of managing cash flows in the short term
D) A method for budgeting fixed operating expenses
Answer: B
A project requires an initial investment of $500,000 and is expected to generate annual cash inflows of $125,000 for 5 years. If the company’s cost of capital is 8%, what is the NPV of the project?
A) $45,000
B) $30,000
C) $40,000
D) $50,000
Answer: A
Which of the following is NOT a factor that affects the cost of capital in capital budgeting decisions?
A) Risk-free rate
B) Market conditions
C) Size of the project
D) Inflation expectations
Answer: C
If the NPV of a project is positive, the project:
A) Will not provide sufficient returns
B) Should be accepted
C) Has a zero IRR
D) Has a high IRR
Answer: B
Which capital budgeting method evaluates projects based on the total value created per dollar invested?
A) Net present value (NPV)
B) Internal rate of return (IRR)
C) Profitability index (PI)
D) Payback period
Answer: C
A company’s project has an NPV of $200,000. If the required rate of return is increased, what will likely happen to the NPV?
A) It will increase
B) It will remain the same
C) It will decrease
D) It will become zero
Answer: C
Which of the following is an advantage of using the NPV method over the payback period?
A) It is easier to calculate
B) It considers the time value of money
C) It does not require future cash flow estimates
D) It is more intuitive
Answer: B
Which method considers the opportunity cost of capital when evaluating investments?
A) Payback period
B) Net present value (NPV)
C) Internal rate of return (IRR)
D) Profitability index (PI)
Answer: B
In capital budgeting, the net present value (NPV) method assumes that:
A) Cash flows are reinvested at the internal rate of return (IRR)
B) All future cash flows are discounted at the cost of capital
C) Future cash flows occur at the beginning of each period
D) Cash flows are always positive
Answer: B
Which of the following capital budgeting methods considers risk by adjusting the discount rate?
A) Internal rate of return (IRR)
B) Payback period
C) Risk-adjusted discount rate (RADR)
D) Profitability index (PI)
Answer: C
If a project’s internal rate of return (IRR) is greater than the required rate of return, the project:
A) Should be accepted
B) Should be rejected
C) Should be reconsidered based on other methods
D) Will break even
Answer: A
What does a negative NPV imply about a project?
A) The project will increase shareholder wealth
B) The project will decrease shareholder wealth
C) The project has no effect on shareholder wealth
D) The project should be accepted regardless of the NPV
Answer: B
Which of the following capital budgeting methods is most appropriate for projects with different sizes of investments?
A) Net present value (NPV)
B) Internal rate of return (IRR)
C) Payback period
D) Profitability index (PI)
Answer: D
Which of the following is true about the internal rate of return (IRR) method?
A) It assumes that all cash flows are reinvested at the project’s IRR
B) It calculates the future value of cash flows
C) It does not account for the time value of money
D) It always provides a clear decision in case of mutually exclusive projects
Answer: A
If the profitability index (PI) is less than 1.0, the project:
A) Should be accepted
B) Should be rejected
C) Has an IRR greater than the required rate of return
D) Will generate a positive NPV
Answer: B
Which of the following is true when a project’s payback period is less than the company’s desired payback period?
A) The project should always be accepted
B) The project is considered riskier
C) The project has a higher likelihood of breaking even quickly
D) The project will likely produce a higher NPV
Answer: C
When evaluating a capital project, which of the following is an important consideration when calculating the net present value (NPV)?
A) The company’s marketing strategy
B) The time horizon of the project
C) The present value of all future liabilities
D) The company’s overall debt structure
Answer: B
Which of the following methods can be used to compare two projects with different durations and cash flow patterns?
A) Internal rate of return (IRR)
B) Net present value (NPV)
C) Equivalent annual cost (EAC)
D) Payback period
Answer: C
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