Finance for Non-Finance Managers Capital Budgeting 5

Question 1

A company's Weighted Average Cost of Capital (WACC) is most commonly used in capital budgeting as:

Accepted Answer

The discount rate to calculate NPV of average-risk projects

Answer

WACC represents the blended cost of all capital sources and serves as the appropriate discount rate for projects with risk similar to the firm's average.

Question 2

The 'replacement decision' in capital budgeting involves comparing:

Accepted Answer

Keeping existing equipment versus investing in new equipment

Answer

A replacement decision evaluates whether the incremental cash flows from new equipment justify its cost relative to continuing with existing assets.

Question 3

Capital rationing occurs when a firm:

Accepted Answer

Has more profitable projects than available capital to fund them all

Answer

Capital rationing means the firm faces a binding budget constraint and must choose among competing positive-NPV projects it cannot all fund.

Question 4

Which cash flow item is typically included in a project's Year 0 (initial) cash flow?

Accepted Answer

Cost of installing and commissioning the new asset

Answer

Year 0 captures the upfront costs including purchase price, installation, shipping, and NWC increases required to launch the project.

Question 5

If inflation rises significantly, which adjustment to the capital budgeting analysis is most critical?

Accepted Answer

Use nominal cash flows with a nominal discount rate, or real flows with a real rate — but not mix them

Answer

Consistency is essential: nominal cash flows must be discounted at a nominal rate, and real cash flows at a real rate — mixing them produces incorrect NPV results.

Finance for Non-Finance Managers Practice Test

Finance for Non-Finance Managers Practice Test

Finance for Non-Finance Managers Capital Budgeting 5