CBS CBS Capital Budgeting & Asset Management 1 — Questions and Answers
Question 1: Which capital budgeting method calculates the time required to recover the initial investment from project cash flows?
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback Period (Correct answer)
- Profitability Index
Correct answer: Payback Period
The payback period measures how many years it takes to recoup the original capital outlay from a project's net cash inflows.
Question 2: A project has an NPV of $0. This means the project's return is exactly equal to the:
- Risk-free rate
- Required rate of return (discount rate) (Correct answer)
- Inflation rate
- Prime lending rate
Correct answer: Required rate of return (discount rate)
An NPV of zero indicates the project earns precisely the discount rate used, meaning it meets but does not exceed the required rate of return.
Question 3: Under the Modified Accelerated Cost Recovery System (MACRS), which depreciation method is used in the early years of an asset's life?
- Straight-line
- Sum-of-the-years-digits
- Double-declining balance (Correct answer)
- Units of production
Correct answer: Double-declining balance
MACRS uses the double-declining balance method in early years then switches to straight-line when that method yields a larger deduction.
Question 4: The hurdle rate used in capital budgeting is most commonly defined as the firm's:
- Debt-to-equity ratio
- Weighted Average Cost of Capital (WACC) (Correct answer)
- Gross profit margin
- Quick ratio
Correct answer: Weighted Average Cost of Capital (WACC)
The WACC represents the blended cost of all capital sources and serves as the minimum acceptable return threshold for new investments.
Question 5: Which of the following best describes a sunk cost in capital budgeting analysis?
- A future cost that is contingent on project approval
- A cost already incurred that cannot be recovered regardless of the decision (Correct answer)
- An opportunity cost associated with the chosen project
- A variable cost that changes with production volume
Correct answer: A cost already incurred that cannot be recovered regardless of the decision
Sunk costs are past expenditures that are irrelevant to future capital budgeting decisions because they cannot be recovered.
Question 6: A capital lease differs from an operating lease primarily because a capital lease:
- Requires no down payment
- Transfers substantially all risks and rewards of ownership to the lessee (Correct answer)
- Is always shorter than 12 months
- Does not appear on the balance sheet
Correct answer: Transfers substantially all risks and rewards of ownership to the lessee
A capital (finance) lease transfers the economic risks and rewards of ownership to the lessee, requiring the asset to be recognized on the balance sheet.
CBS CBS Capital Budgeting & Asset Management 1
Which capital budgeting method calculates the time required to recover the initial investment from project cash flows?