CTP Long-Term Capital Investments 4 — Questions and Answers
Question 1: A company's WACC is 10%. It evaluates a project with IRR of 9%. The project should be:
- Accepted because the IRR is positive
- Rejected because IRR is below the cost of capital (Correct answer)
- Accepted if the payback period is under 3 years
- Evaluated further using sensitivity analysis only
Correct answer: Rejected because IRR is below the cost of capital
When IRR is below the WACC (hurdle rate), the project does not generate sufficient returns to cover the cost of capital and should be rejected.
Question 2: The crossover rate between two projects is the discount rate at which:
- Both projects have a zero NPV
- Both projects have equal NPV (Correct answer)
- The project with higher IRR always dominates
- The payback periods of both projects are equal
Correct answer: Both projects have equal NPV
The crossover rate is where the NPV profiles of two projects intersect, meaning both yield the same NPV at that discount rate.
Question 3: Which of the following BEST describes the incremental approach to analyzing a replacement decision?
- Evaluate the new machine in isolation using its own cash flows
- Compare cash flows of the new machine versus continuing with the old machine (Correct answer)
- Use the book value of the old machine as the investment cost
- Accept the project if the new machine has a positive NPV alone
Correct answer: Compare cash flows of the new machine versus continuing with the old machine
Replacement decisions require incremental analysis comparing the differential cash flows between keeping the old and adopting the new asset.
Question 4: In a lease-versus-buy analysis for a long-term capital asset, the treasury professional should compare:
- Lease payments versus the asset's book value
- PV of after-tax lease payments versus after-tax cost of debt financing (Correct answer)
- Operating cash flows under each option without tax effects
- IRR of leasing versus IRR of buying
Correct answer: PV of after-tax lease payments versus after-tax cost of debt financing
The correct comparison is the present value of after-tax costs of leasing versus borrowing to buy, discounted at the after-tax cost of debt.
Question 5: Scenario analysis in capital budgeting differs from sensitivity analysis because scenario analysis:
- Changes only one variable at a time
- Evaluates NPV under multiple simultaneous changes in key assumptions (Correct answer)
- Assigns specific probabilities to each outcome
- Uses historical data exclusively
Correct answer: Evaluates NPV under multiple simultaneous changes in key assumptions
Scenario analysis evaluates NPV under optimistic, base, and pessimistic scenarios where multiple variables change simultaneously.
Question 6: Post-audit reviews of capital investment projects serve which primary purpose?
- Reversing poor investment decisions already made
- Comparing actual results to projections to improve future forecasting (Correct answer)
- Eliminating sunk costs from ongoing projects
- Setting the required rate of return for future projects
Correct answer: Comparing actual results to projections to improve future forecasting
Post-audits compare projected versus actual cash flows, helping organizations improve the accuracy of future capital budgeting estimates.
Question 7: Which statement about the NPV method is CORRECT?
- NPV assumes reinvestment at the IRR
- NPV can produce multiple solutions for a single project
- NPV directly measures value added to the firm in dollar terms (Correct answer)
- NPV is less reliable than IRR for mutually exclusive projects
Correct answer: NPV directly measures value added to the firm in dollar terms
NPV directly measures the dollar amount of value created or destroyed by an investment, making it the theoretically superior capital budgeting method.
CTP Long-Term Capital Investments 4
A company's WACC is 10%.
It evaluates a project with IRR of 9%.
The project should be: