Finance for Non-Finance Managers Capital Budgeting 2

Question 1

A project requires a $500,000 investment and generates annual cash flows of $100,000 for 7 years. What is the payback period?

Accepted Answer

5 years

Answer

Payback period = Initial investment / Annual cash flow = $500,000 / $100,000 = 5 years.

Question 2

Which capital budgeting method ignores the time value of money entirely?

Accepted Answer

Payback Period

Answer

The simple payback period adds up undiscounted cash flows and does not account for the time value of money.

Question 3

If a project's IRR exceeds the company's required rate of return (hurdle rate), the project should generally be:

Accepted Answer

Accepted, because it creates value

Answer

An IRR above the hurdle rate means the project's return exceeds its cost of capital, indicating it creates shareholder value.

Question 4

What does a Profitability Index (PI) of 0.85 indicate?

Accepted Answer

The project destroys value and should be rejected

Answer

A PI below 1.0 means the present value of future cash flows is less than the initial investment, so the project destroys value.

Question 5

Terminal value in capital budgeting refers to:

Accepted Answer

The salvage value and working capital recovery at project end

Answer

Terminal value captures the after-tax salvage value of assets plus any net working capital released when the project concludes.

Finance for Non-Finance Managers Practice Test