Capital Budgeting

MULTIPLE CHOICE QUESTIONS. Identify the letter of the choice that best completes the statement or answers the question.

1. Which of the following involves deciding which long-term investments to undertake and how to finance them? [A]
Operational planning. [B] Capital budgeting. [C] Investment planning. [D] Continuous budgeting.
2. What is the process by which a firm considering acquiring a new plant or new equipment must decide whether to
make the investment, then decide how to raise the funds required for the investment? [A] Zero-based budgeting. [B]
Capital budgeting. [C] Annual budgeting. [D] Management by objectives.
3. In general terms, a sound capital investment will [A] Earn back its original capital outlay. [B] Earn a return greater than
existing capital investments. [C] Earn back its original capital outlay and provide a reasonable return on the original
investment. [C] Earn back its original capital outlay by the midpoint of its useful life.
4. In making long-term decisions about investing and financing, a firm should do which of the following? [A] Decide
whether to make the investment, then decide how to raise the funds required for the investment. [B] Decide how to
raise the funds required for the investment, then decide whether to make the investment. [C] Decide how to raise the
funds required for the investment at the same time as deciding whether to make the investment. [D] None of the
above.
5. What does the term capital mean in the context of making capital expenditure decisions? [A] Long-term assets. [B]
The funds with which a firm acquires assets. [C] The source of funds typically reported as long-term liabilities and
owners’ equity. [D] None of the above.
6. 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 above.
7. Which of the following is an assumption of capital budgeting? [A] The firm can raise new funds at the same opportunity
costs as the opportunity cost of the funds it already has on hand. [B] The firm can raise new funds at the 30-year BSP
funds rate. [C] The firm can raise new funds at the prime interest rate. [D] The firm can raise new funds at the same
interest rate as the mean of the interest rates of the funds it already has on hand.
8. The required rate of return used in the net present value model can also be called the [A] Hurdle rate. [B] Minimum
acceptable rate of return. [C] Cost of capital. [D] All of the above.
9. The interest rate that sets the present value of a project's cash inflows equal to the present value of the project's cost
is called the ____. [A] Present value. [B] Discount rate. [C] Company cost of capital. [D] Internal rate of return.
10. Which of the following is true regarding the internal rate of return for a project? [A] If the internal rate of return is
less than the required rate of return, the project will be rejected. [B] If the internal rate of return is equal to the
required rate of return, the net present value of the project is zero. [C] If the internal rate of return is more than the
required rate of return, the project will be accepted. [D] All of these.
11. What is the process by which an organization decides on its major programs and the approximate resources to devote
to them? [A] Capital budgeting. [B] Strategic planning. [C] Program planning and budgeting. [D] Zero-based budgeting.
12. Organizational policies, procedures, and performance measures should support accurate estimations, and should
consider the effect these factors have on planners when evaluating which of the following? [A] Capital investment
projects. [B] Raw material purchases. [C] Hiring temporary labor. [D] Indirect material purchases.
13. The capital investment decision making model that assumes that each cash inflow is reinvested at the required rate
of return is [A] Net present value. [B] Internal rate of return. [C] Payback period. [D] Accounting rate of return.
14. The capital investment decision making model that assumes that each cash inflow is reinvested at the project's own
rate of return is [A] Net present value. [B] Accounting rate of return. [C] Payback period. [D] Internal rate of return.
15. The best model for choosing the best of several competing projects is [A] Net present value. [B] Internal rate of return.
[C] Payback period. [D] Accounting rate of return.
16. If the cash flows of a project are received evenly over the life of the project, the formula for the calculating the payback
period is [A] Original investment/annual cash flow. [B] Original investment X annual cash flow. [C] Original investment
+ annual cash flow. [D] Original investment - annual cash flow.
17. The most widely used non-discounting model for capital investment decision making is the [A] Net present value. [B]
Accounting rate of return. [C] Payback period. [D] Internal rate of return
18. Which of the following is a capital investment decision method that in evaluating investments involving cash flows
over time where there is a significant time difference between cash payment and receipt? [A] Zero-based budgeting.
[B] Linear programming. [C] Discounted cash flow. [D] Program planning and review.
19. In making capital budgeting decisions, the discounted cash flow method aids in evaluating investments involving cash
flows over time where there is a significant time difference between cash payment and receipt. Analysts use which
two discounted cash flow methods? [A] The future value method and the internal rate of return method. [B] The net
present value method and the external rate of return method. [C] The net present value method and the internal rate
of return method. [D] The future value method and the external rate of return method.
20. Which interest rate is used by analysts when computing the present value of future cash flows? [A] Prime interest
rate. [B] Bank rate. [C] Discount rate. [C] Real rate.

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21. The appropriate discount rate that analysts use in computing the present value of future cash flows is comprised of
which of the following? [A] An increase 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 capital
assets. [D] All of the above.
22. Which of the following best identifies the reason for using probabilities in the capital-budget decision? [A] Uncertainty.
[B] Cost of capital. [C] Time value of money. [D] Projects with unequal lives.
23. Competing investment projects where accepting one project eliminates the possibility of taking the remaining projects
is referred to as [A] Common projects. [B] Mutually exclusive projects. [C] Joint projects. [D] Opportunity costs.
24. When is the discount rate used? [A] When determining the applicable treasury rate. [B] When computing the present
value of future cash flows. [C] To reduce the price of an investment. [D] When determining the future value of the
firm’s cash inflows and outflows.
25. The appropriate discount rate that analysts use in computing the present value of future cash flows is composed of
an increase reflecting the inflation expected to occur over the life of the project. Thus, [A] The higher the expected
inflation, the higher should be the discount rate. [B] The higher the expected inflation, the lower should be the
discount rate. [C] The lower the expected inflation, the higher should be the discount rate. [D] All of the above.
26. The profitability index is most useful [A] When the NPV method and the IRR method give conflicting signals on mutually
exclusive projects. [B] In capital rationing situations. [C] When the cash flow pattern is unusual. [D] When project
scales are of concern.
27. The appropriate discount rate that analysts use in computing the present value of future cash flows is composed of a
pure interest rate and a premium for the risk of the investment, but no increase to reflect expected inflation. What is
this rate called? [A] Risk-free rate. [B] Real interest rate. [C] Nominal interest rate. [D] None of the above.
28. What is the appropriate decision to make it the present value of the future cash inflows exceeds the present value of
the future cash outflows for a proposal? [A] Accept the alternative. [B] Reject the alternative. [C] Find a better
alternative. [D] Decrease the firm's cost of capital.
29. If the firm must choose one from a set of mutually exclusive alternatives with the same life span, which alternative
should be selected? [A] Select the alternative with the largest net present value of cash flows. [B] Select the alternative
with the smallest net present value of cash flows. [C] Select the alternative with the largest net present value of cash
inflows. [D] Select the alternative with the smallest net present value of cash outflows.
30. The cash flows associated with an investment project include which of the following? [A] Initial cash flows. [B] Periodic
cash flows. [C] Terminal cash flows. [D] All of the above.
31. What would the initial cash flows associated with an investment project include? [A] Asset, freight and installation
costs. [B] Cash proceeds from disposing of existing assets made redundant or unnecessary by the new project. [C]
Income tax effect of gain(loss) on disposal of existing assets. [D] All of the above.
32. What would the periodic cash flows associated with an investment project include? [A] Receipts from sales. [B]
Opportunity costs of undertaking this particular project. [C] Expenditures for fixed and variable production costs. [D]
All of the above.
33. The terminal cash flows associated with an investment project include which of the following? [A] Income tax effects
resulting from periodic cash flows. [B] Loss in tax savings from lost depreciation. [C] Tax loss on disposal of equipment.
[D] All of the above.
34. Which of the following are steps needed for using the net present value method for making long-term decisions using
discounted cash flows? [A] Estimate the amounts of future cash inflows and future cash outflows in each period for
each alternative under consideration. [B] Discount the future cash flows to the present using the project’s discount
rate. [C] Accept or reject the proposed project, or select one from a set of mutually exclusive projects. [D] All of the
above.
35. Which of the following would not be considered a periodic cash flow? [A] Receipts from sales. [B] Expenditures for
heat, light, and electricity. [C] Income taxes paid on taxable income. [D] Initial lump-sum investment in a project.
36. If the net present value of a proposed project is positive, then the actual rate of return [A] Is higher than the cost of
capital. [B] Is lower than the cost of capital. [C] Is equal to the cost of capital. [D] Is negative.
37. Project A has an expected cash flow of P500,000 at the end of year 5. Project B has an expected cash flow of P100,000
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 A
compared to project B? [A] They are the same because both cash flows total P500,000 over the lives of the projects.
[B] Project A is preferred because of the largest lump-sum payment in year 5. [C] Project B is preferred because of the
periodic payments made consistently throughout the years and are made earlier. [D] The both have the same internal
rate of return and either should be accepted.
38. A company purchased an asset at a cost of P80,000. Annual operating cash flows are expected to be P30,000 each
year for 4 years. At the end of the asset life, there will be no residual (salvage) value. What is the net present value if
the cost of capital is 12 percent? [A] P40,000. [B] P24,400. [C] P11,120. [D] P5,650.
39. A not-for-profit company purchased an asset at a cost of P60,000. Annual operating cash flows are expected to be
P20,000 each year for 4 years. At the end of the asset life, there will be no residual (salvage) value. What is the net
present value if the cost of capital is 10 percent? [A] (P1,960). [B] P3,397. [C] P12,400. [D] P23,400.
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40. The steps of the net present value method for making long-term decisions include [A] Estimate the amounts of future
cash inflows and future cash outflows in each period for each alternative under consideration. [B] Requiring the use
of the applicable treasury rate as the discount rate in computing the present value of future cash flows. [C] If the
present value of the future cash inflows exceeds the present value of the future cash outflows for a proposal, reject
the alternative. [D] Ignore depreciation because it is not a cash flow and does not affects the after-tax cash flow.
41. Which of the following is a likely errors in the calculation of net present value? [A] The amount of cash flows. [B] The
timing of cash flows. [C] The discount rate. [D] All of the above.
42. Which errors will likely have the largest effect on the net present value of changes in assumptions and estimates? [A]
Errors in predicting the amounts of future cash flows. [B] Errors in predicting the timing of future cash flows. [C] Errors
in predicting the discount rate. [D] Errors in sensitivity analysis.
43. The calculation of the net present value of a proposed project does not require estimates of which of the following?
[A] The amount of future cash flows. [B] The timing of future cash flows. [C] The cost of capital rate. [D] The amount
of sunk costs already incurred.
44. A planned factory expansion project has an estimated initial cost of P500,000. Using a discount rate of 20 percent, the
present value of the future cost savings from the expansion is P520,000. To yield exactly the 20 percent time-adjusted
rate of return, the actual investment expenditure should not exceed the P500,000 estimate by more than [A]
P160,000. [B] P20,000. [C] P1,075. [D] P43,000.
45. In which area will analysts likely err when making capital investment decisions? [A] Predicting or estimating amounts.
[B] The timing of cash flows. [C] The discount rate. [D] All of the above.
46. At the end of a five-year life, a company will dispose of an asset and recognize a gain of P6,000. If the company's cost
of capital is 15 percent and its tax rate is 30 percent, what is the present value of the future cash flow? [A] P14,078.
[B] P6,000. [C] P2,087. [D] P895.
47. Which of the following statements is correct regarding capital investments? [A] Capital investments should be funded
out of excess cash reserves. [B] Capital investments should have a positive internal rate of return. [C] Capital
investments should achieve short-term objectives. [D] Capital investments should implement a company's strategy.
48. For the internal rate of return to rank projects the same way as the net present value rule, which condition must exist?
[A] The cutoff rate used for the internal rate equals the cost of capital. [B] Projects are mutually exclusive. [C] Projects
have different lives. [D] There must be more than one internal rate of return.
49. Which of the following is the discount rate that equates the net present value of a series of cash flows to zero? [A]
Investment rate of return. [B] External rate of return. [C] Internal rate of return. [D] International rate of return.
50. Which of the following is the discount rate that discounts the future cash flows to a present value just equal to the
initial investment? [A] Investment rate of return. [B] External rate of return. [C] Internal rate of return. [D]
International rate of return.
51. When using the internal rate of return to evaluate investment alternatives, which rate would analysts specify? [A]
Hurdle rate. [B] Bank rate. [C] Prime interest rate. [D] Time-adjusted rate.
52. The Information Technology Club, Inc. is considering an investment that requires P20,000 and promises to return
P28,090 in 3 years. The company's income tax rate is 40 percent. What is the approximate internal rate of return? [A]
8 percent. [B] 10 percent. [C] 12 percent. [D] 15 percent.
53. A project requires an initial investment of P43,000 and has the following expected stream of cash flows:
Year 1 P20,000
Year 2 P30,000
The internal rate of return for the project is closest to [A] 0 percent. [B] 10 percent. [C] 15 percent. [D] 20 percent.
54. What is true concerning the internal rate of return (IRR) method? [A] The IRR method determines the discount rate
that equates the net present value of the series to the initial investment. [B] The IRR method determines the discount
rate that equates the net present value of the series to hurdle rate. [C] The IRR method determines the discount rate
that equates the net present value of the series to cut-off rate. [D] The IRR method determines the discount rate that
equates the net present value of the series to zero.
55. The decision to accept or reject an investment proposal that computes the investment’s net present value, using the
organization’s adjusted cost of capital as the discount rate and undertakes the investment if its net present value is
positive, or rejects the investment if its net present value is negative is called the [A] Net present value method. [B]
Future value method. [C] Internal rate of return method. [D] External rate of return method.
56. If net present value is negative, it means that the return on the investment is [A] Less than the discount rate. [B] More
than the discount rate. [C] Equal to the discount rate. [D] Acceptable.
57. The decision to accept or reject an investment proposal can be made using either the internal rate of return method
or the net present value method under most circumstances. The following is/are circumstance(s) that may arise where
the two methods need not give the same answer and the net present value method’s answer is always the correct
one. [A] Mutually exclusive projects. [B] Projects with different lifetimes. [C] Projects with intermixing of inflows and
outflows. [D] All of the above are possible circumstances.
58. What is a general type of long-term capital investment that companies make? [A] Replacement and minor
improvements. [B] Training and development of employees. [C] Advertising campaigns. [D] All of the above.
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59. Which of the following would not be classified as a capital expenditure for decision-making purposes? [A] Purchase of
a building. [B] Investment in a management training program. [C] Purchase of 90-day Treasury Bills. [D] Development
of a major advertising campaign.
60. When the risk of obsolescence is high, managers will want [A] A shorter payback period. [B] A longer payback period.
[C] A payback period equal to the life of the investment. [D] All of these.