CIA CIA Capital Investment & Decision Making 2

Question 1

The Weighted Average Cost of Capital (WACC) is used in capital budgeting as:

Accepted Answer

The discount rate that reflects the blended cost of all financing sources

Answer

WACC weights the cost of each capital component (debt, equity, preferred stock) by its proportion in the firm's capital structure to derive an overall financing cost.

Question 2

Which of the following is an example of an 'opportunity cost' relevant to a capital investment decision?

Accepted Answer

Revenue foregone from using a factory building for a new project instead of renting it out

Answer

Opportunity cost is the value of the next-best alternative foregone, such as rental income lost by using a building internally rather than leasing it to a third party.

Question 3

A project's Modified Internal Rate of Return (MIRR) differs from the standard IRR because MIRR:

Accepted Answer

Assumes reinvestment of cash inflows at the cost of capital rather than the IRR itself

Answer

MIRR corrects the IRR's unrealistic reinvestment assumption by using the firm's cost of capital as the reinvestment rate for interim cash flows.

Question 4

In capital investment analysis, the 'profitability index' (PI) is calculated as:

Accepted Answer

Present value of future cash inflows divided by the initial investment

Answer

The profitability index (or benefit-cost ratio) shows the value created per dollar invested, with PI > 1 indicating a value-creating project.

Question 5

When evaluating capital projects with unequal lives, the most appropriate technique is:

Accepted Answer

Equivalent Annual Annuity (EAA) or replacing on a common time horizon

Answer

The EAA method converts each project's NPV into an annualized figure, enabling a fair comparison between projects of different durations.

(CIA) Certified Industrial Accountant Practice Test

(CIA) Certified Industrial Accountant Practice Test

CIA CIA Capital Investment & Decision Making 2