6.

All other factors equal, a large number is

preferred to a smaller number for all capital project
MULTIPLE CHOICE
evaluation measures except

1. Which of the following capital budgeting

a. net present value.
techniques ignores the time value of money?
b. payback period.
a. payback period
c. internal rate of return.
b. net present value
d. profitability index.
c. internal rate of return

d. profitability index ANSWER:

ANSWER: b EASY
a EASY

7. The payback method assumes that all cash

2. Which of the following capital budgeting
inflows are reinvested to yield a return equal to
techniques may potentially ignore part of a

project’s relevant cash flows?

a. the discount rate.

b. the hurdle rate.

a. net present value
c. the internal rate of return.
b. internal rate of return
d. zero.
c. payback period

d. profitability index ANSWER: c EASY

ANSWER: d EASY
3. In comparing two projects, the is often used to
evaluate the relative riskiness of the projects.

a. payback period 8. The payback method measures

b. net present value

c. internal rate of return a. how quickly investment dollars may be

recovered.
d. discount rate ANSWER: a EASY
b. the cash flow from an investment.
4. Which of the following capital budgeting
techniques does not routinely rely on the assumption c. the economic life of an investment.
that all cash flows occur at the end of the period?
d. the profitability of an investment.

a. internal rate of return

ANSWER: a EASY
b. net present value

c. profitability index
9. period of four years, then
d. payback period ANSWER: d EASY

5. Assume that a project consists of an initial cash

a. A is more profitable than B.
outlay of $100,000 followed by equal annual cash
inflows of $40,000 for 4 years. In the formula X = b. A is less profitable than B.
$100,000/$40,000, X represents the
c. A and B are equally profitable.
a. payback period for the project.
d. the relative profitability of A and B cannot be
b. profitability index of the project. determined from the information given.
c. internal rate of return for the project.

d. project’s discount rate. ANSWER: d EASY

ANSWER: a EASY
10. The payback period is the a. method of financing the project under
consideration

b. timing of cash flows relating to the project

a. length of time over which the investment will
provide cash inflows. c. impact of the project on income taxes to be
paid
b. length of time over which the initial investment
is recovered. d. amounts of cash flows relating to the project
ANSWER: a EASY
c. shortest length of time over which an
investment may be depreciated. 15. As to a capital investment, net cash inflow is
equal to the
d. shortest length of time over which the net
present value will be positive.

a. cost savings resulting from the investment.

ANSWER: b EASY b. sum of all future revenues from the investment.

c. net increase in cash receipts over cash

payments.
11. Which of the following capital budgeting
techniques has been criticized because it fails to d. net increase in cash payments over cash
consider investment profitability? receipts.

a. payback method ANSWER: c EASY

b. accounting rate of return

c. net present value method 16. In a discounted cash flow analysis, which of the
following would not be consistent with
d. internal rate of return ANSWER: a EASY
adjusting a project’s cash flows to account for higher-
12. The time value of money is explicitly recognized
than-normal risk?
through the process of
a. increasing the expected amount for cash
outflows
a. interpolating.
b. increasing the discounting period for expected
b. discounting. cash inflows

c. annuitizing. c. increasing the discount rate for cash outflows

d. budgeting. d. decreasing the amount for expected cash

inflows ANSWER: c MEDIUM

ANSWER: b EASY
17. to use to find the project’s internal rate of
return.

a. a screening decision
a. assuming equal annual cash flow patterns. b. a trial-and-error approach
b. investing only in short-term projects. c. a post investment audit
c. assigning greater value to more immediate cash d. a time line ANSWER: b EASY
flows.

d. ignoring depreciation and tax implications of

the investment. 18. The interest rate used to find the present value
of a future cash flow is the

a. prime rate.
ANSWER: c EASY
b. discount rate.

c. cutoff rate.
14. When using one of the discounted cash flow
methods to evaluate the desirability of a capital d. internal rate of return.
budgeting project, which of the following factors is
generally not important?
ANSWER: b EASY
 c. increase the expected value of the future cash
flow before it is discounted.
19. A firm’s discount rate is typically based on
d. extend the acceptable length for the payback
period.
a. the interest rates related to the firm’s bonds.

b. a project’s internal rate of return.

ANSWER: a EASY
c. its cost of capital.

d. the corporate Aa bond yield.

24. A change in the discount rate used to evaluate a
specific project will affect the project’s

ANSWER: c EASY
a. life.

20. In capital budgeting, a firm’s cost of capital is b. payback period.

frequently used as the
c. net present value.

d. total cash flows.

a. internal rate of return.

b. accounting rate of return.

ANSWER: c EASY
c. discount rate.

d. profitability index.
25. firm’s stock unchanged is known as the

a. cost of capital.
ANSWER: c EASY
b. net present value.

c. payback rate.
21. reinvested at the
d. internal rate of return.
a. cost of capital.

b. discount rate.
ANSWER: a MEDIUM
c. internal rate of return.

d. rate on the corporation’s short-term debt.

26. The pre-tax cost of capital is higher than the
after-tax cost of capital because

ANSWER: b EASY
a. interest expense is deductible for tax purposes.

22. Which of the following changes would not b. principal payments on debt are deductible for
decrease the present value of the future depreciation tax purposes.
deductions on a specific depreciable asset?
c. the cost of capital is a deductible expense for
tax purposes.

a. a decrease in the marginal tax rate d. dividend payments to stockholders are

deductible for tax purposes.
b. a decrease in the discount rate

c. a decrease in the rate of depreciation

ANSWER: a EASY
d. an increase in the life expectancy of the
depreciable asset ANSWER: b MEDIUM

23. To reflect greater uncertainty (greater risk) 27. The basis for measuring the cost of capital
about a future cash inflow, an analyst could derived from bonds and preferred stock, respectively, is
the

a. increase the discount rate for the cash flow.

a. pre-tax rate of interest for bonds and stated
b. decrease the discounting period for the cash annual dividend rate less the expected earnings per
flow. share for preferred stock.
b. pre-tax rate of interest for bonds and stated a. value of the common stock.
annual dividend rate for preferred stock.
b. current budget for capital expansion.
c. after-tax rate of interest for bonds and stated
c. cost of debt outstanding.
annual dividend rate less the expected earnings per
share for preferred stock. d. proposed mix of debt, equity, and existing funds
used to implement the project.
d. after-tax rate of interest for bonds and stated
annual dividend rate for preferred stock.

ANSWER: b EASY
ANSWER: d MEDIUM

32. The is the highest rate of return that can be

earned from the most attractive, alternative capital
28. The combined weighted average interest rate
project available to the firm.
that a firm incurs on its long-term debt, preferred stock,
and common stock is the

a. accounting rate of return

a. cost of capital. b. internal rate of return
b. discount rate. c. hurdle rate
c. cutoff rate. d. opportunity cost of capital ANSWER: d
MEDIUM
d. internal rate of return.

33. cash inflows occur at

ANSWER: a EASY
a. mid year.

b. the beginning of the year.

29. based on the
c. year end.
a. mix of capital components that was used to
finance a project from last year. d. irregular intervals.
b. overall capital structure of the corporation.

c. cost of capital for other corporations with ANSWER: c EASY

similar investments.

d. mix of capital components for all capital

acquired in the most recent fiscal year. 34. The salvage value of an old lathe is zero. If
instead, the salvage value of the old lathe was

$20,000, what would be the impact on the net present

ANSWER: b EASY value of the proposal to purchase a new lathe?

30. Debt in the capital structure could be treated as a. It would increase the net present value of the
if it were common equity in computing the weighted proposal.
average cost of capital if the debt were
b. It would decrease the net present value of the
proposal.
a. callable. c. It would not affect the net present value of the
proposal.
b. participating.
d. Potentially it could increase or decrease the net
c. cumulative.
present value of the new lathe.
d. convertible.

ANSWER: a EASY
ANSWER: d MEDIUM

35. The net present value method of evaluating

31. The weighted average cost of capital approach proposed investments
to decision making is not directly affected by the
a. measures a project’s internal rate of return.

b. ignores cash flows beyond the payback period. ANSWER: c MEDIUM

c. applies only to mutually exclusive investment

proposals.
38. If a project generates a net present value of
d. discounts cash flows at a minimum desired rate zero, the profitability index for the project will
of return.

a. equal zero.
ANSWER: d EASY
b. equal 1.

c. equal -1.
36. Which of the following statements is true
d. be undefined.
regarding capital budgeting methods?

ANSWER: b EASY
a. The Fisher rate can never exceed a company’s
cost of capital.

b. The internal rate of return measure used for 39. If the profitability index for a project exceeds 1,
capital project evaluation has more conservative then the project’s
assumptions than the net present value method,
especially for projects that generate a positive net
present value. a. net present value is positive.
c. The net present value method of project b. internal rate of return is less than the project’s
evaluation will always provide the same ranking of discount rate.
projects as the profitability index method.
c. payback period is less than 5 years.
d. The net present value method assumes that all
cash inflows can be reinvested at d. accounting rate of return is greater than the
project’s internal rate of return.
the project’s cost of capital.

ANSWER: a EASY
ANSWER: d EASY

40. If a project’s profitability index is less than 1,

the project’s

Page | 9 a. discount rate is above its cost of capital.

b. internal rate of return is less than zero.

and the investments follow: c. payback period is infinite.
Fisher rate for the three projects 7% d. net present value is negative.
Cost of capital 8%

ANSWER: d EASY
Based on this information, we know that

a. all three projects are acceptable.

b. none of the projects are acceptable. Page | 10

c. the capital budgeting evaluation techniques
profitability index, net present value, and internal rate
of return will provide a consistent ranking of the
projects.

d. the net present value method will provide a a. the ratio of net cash flows to the srcinal
ranking of the projects that is superior to the ranking investment.
obtained using the internal rate of return method.
b. the ratio of the present value of cash flows to
the srcinal investment.

c. a capital budgeting evaluation technique that

a. internal rate of return is higher than the
doesn’t use discounted values.
discount rate.
d. a mandatory technique when capital rationing
b. discount rate is higher than the hurdle rate of
is used.
return.

c. internal rate of return is lower than the

ANSWER: b EASY discount rate of return.

d. hurdle rate of return is higher than the discount

rate.
42. Which method of evaluating capital projects
assumes that cash inflows can be reinvested at the
discount rate?
ANSWER: a EASY

a. internal rate of return

46. The rate of interest that produces a zero net
b. payback period present value when a project’s discounted

c. profitability index cash operating advantage is netted against its

discounted net investment is the
d. accounting rate of return ANSWER: c
MEDIUM

43. If the total cash inflows associated with a a. cost of capital.

project exceed the total cash outflows
b. discount rate.
associated with the project, the project’s
c. cutoff rate.

d. internal rate of return.

a. net present value is greater than zero.

b. internal rate of return is greater than zero.

ANSWER: d EASY
c. profitability index is greater than 1.

d. payback period is acceptable.

47. For a profitable company, an increase in the
rate of depreciation on a specific project could

ANSWER: b EASY

a. increase the project’s profitability index.

44. The net present value and internal rate of b. increase the project’s payback period.
return methods of decision making in capital budgeting
c. decrease the project’s net present value.
are superior to the payback method in that they
d. increase the project’s internal rate of return.

a. are easier to implement.

ANSWER: d MEDIUM
b. consider the time value of money.

c. require less input.

48. Which of the following capital expenditure
d. reflect the effects of sensitivity analysis.
planning and control techniques has been criticized
because it might mistakenly imply that earnings are
reinvested at the rate of return earned by the
ANSWER: b EASY
investment?

a. payback method

b. accounting rate of return

c. net present value method

Page | 11
d. internal rate of return ANSWER: d EASY
 d. irregular intervals over the life of the
investment.

ANSWER: c EASY

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of return, the project’s is zero.

Page | 13

except
a. profitability index

b. internal rate of return

c. present value of the investment

a. the liquidation of working capital at the end of a
d. net present value ANSWER: d EASY
project’s life.
50. As the marginal tax rate goes up, the benefit
b. the initial (outlay) cost of an investment.
from the depreciation tax shield
c. the sale of an asset at its book value.

d. a cash payment for salaries and wages.

a. decreases.

b. increases.
ANSWER: d EASY
c. stays the same.

d. can move up or down depending on whether

the firm’s cost of capital is high or 54. The after-tax net present value of a project is
affected by
low.

a. tax-deductible cash flows.

ANSWER: b MEDIUM
b. non-tax-deductible cash flows.

c. accounting accruals.
51. When a profitable corporation sells an asset at
a loss, the after-tax cash flow on the sale will d. all of the above.

a. exceed the pre-tax cash flow on the sale. ANSWER: d MEDIUM

b. be less than the pre-tax cash flow on the sale.

c. be the same as the pre-tax cash flow on the 55. A project’s after-tax net present value is
sale. increased by all of the following except

d. increase the corporation’s overall tax liability.

a. revenue accruals.

ANSWER: a MEDIUM b. cash inflows.

c. depreciation deductions.

52. In a typical (conservative assumptions) after-tax d. expense accruals.

discounted cash flow analysis, depreciation expense is
assumed to accrue at
ANSWER: a EASY

a. the beginning of the period.

56. Multiplying the depreciation deduction by the
b. the middle of the period.
tax rate yields a measure of the depreciation tax
c. the end of the period.
a. shield.

b. benefit. a. buy computer; buy software package

c. payable. b. buy computer #1; buy computer #2

d. loss. c. buy computer; buy computer security system

d. buy computer; repave parking lot ANSWER:

d EASY
ANSWER: b EASY

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Page | 15

a. adding back the depreciation amount.

a. interest payments to bondholders
b. deducting the depreciation amount.
b. preferred stock dividends
c. adding back the quantity (t × depreciation
deduction), where t is the corporate tax rate. c. common stock dividends

d. deducting the quantity [(1– t) × depreciation d. all of the above ANSWER: a EASY
deduction], where t is the corporate tax rate.
62. Sensitivity analysis is

ANSWER: a EASY
a. an appropriate response to uncertainty in cash
flow projections.

58. Income taxes are levied on b. useful in measuring the variance of the Fisher
rate.

c. typically conducted in the post investment

a. net cash flow.
audit.
b. income as measured by accounting rules.
d. useful to compare projects requiring vastly
c. net cash flow plus depreciation. different levels of initial investment.

d. income as measured by tax rules.

ANSWER: a MEDIUM

ANSWER: d EASY
63. If management judges one project in a mutually
inclusive set to be acceptable for investment,
59. Which of the following best represents a
screening decision?
a. all the other projects in the set are rejected.

a. determining which project has the highest net b. only one other project in the set can be
present value accepted.

b. determining if a project’s internal rate of return c. all other projects in the set are also accepted.
exceeds the firm’s cost of capital
d. only one project in the set will be rejected.
c. determining which projects are mutually
exclusive
ANSWER: c EASY
d. determining which are the best projects
ANSWER: b EASY

60. Below are pairs of projects. Which pair best 64. All other factors equal, which of the following
represents independent projects? would affect a project’s internal rate of
return, net present value, and payback period?

a. an increase in the discount rate

b. a decrease in the life of the project

c. an increase in the initial cost of the project

d. all of the above ANSWER: c EASY

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