CPFM Capital Budgeting Decisions 2

Question 1

A project requires $50,000 today and returns $60,000 in one year. At a 10% discount rate, what is its NPV?

Accepted Answer

$5,454

Answer

NPV = $60,000/1.10 - $50,000 = $54,545 - $50,000 = $5,454.

Question 2

Which method ignores the time value of money entirely?

Accepted Answer

Payback period

Answer

The basic payback period sums undiscounted cash flows until the investment is recovered.

Question 3

When NPV and IRR rank two mutually exclusive projects differently, which method should generally prevail?

Accepted Answer

NPV, because it measures dollar value added

Answer

NPV directly measures wealth created and is preferred for mutually exclusive choices.

Question 4

A capital project has an IRR of 12% and the firm's cost of capital is 14%. The project should be:

Accepted Answer

Rejected

Answer

IRR below the cost of capital means the project destroys value and should be rejected.

Question 5

The profitability index of a project equals:

Accepted Answer

PV of future cash flows divided by initial investment

Answer

PI = present value of future cash flows / initial investment; a value above 1 indicates a positive NPV.

CPFM Practice Test