Free Capital Budgeting Questions and Answers

Question 1

One could say that a company's future success depends on its capital expenditures.

Accepted Answer

TRUE

Answer

True. Capital expenditures are investments made by a company in long-term assets like property, plant, and equipment. These investments are fundamental for a company's future growth, expansion, and ability to remain competitive. By upgrading technology, expanding production capacity, or developing new facilities, capital expenditures enable a company to enhance efficiency, innovate, and meet future market demands, directly impacting its long-term success and profitability.

Question 2

Results of internal rate of return and net present value in the evaluation of independent projects result in

Accepted Answer

same decision

Answer

For independent projects, both Net Present Value (NPV) and Internal Rate of Return (IRR) methods typically lead to the same accept or reject decision. If a project has a positive NPV, its IRR will be greater than the cost of capital, indicating it is acceptable. Conversely, if a project has a negative NPV, its IRR will be less than the cost of capital, leading to its rejection. This consistency holds true as long as the projects are independent and conventional (i.e., not subject to unusual cash flow patterns).

Question 3

A project's profitability index (PI) of.92 indicates that___.

Accepted Answer

The projects returns 92 cents in present value for each current dollar invested(cost)

Answer

The Profitability Index (PI) measures the present value of benefits per dollar of cost. A PI of 0.92 means that for every dollar invested in the project, the company expects to receive only 92 cents in present value of future cash inflows. Since the PI is less than 1, it indicates that the project's present value of benefits is less than its initial cost, resulting in a negative Net Present Value (NPV), and thus the project should be rejected.

Question 4

As long as the rate of return on the firm's least profitable investment project is lower than the marginal cost of capital, the firm should continue to increase its level of capital investment.

Accepted Answer

FALSE

Answer

False. A firm should only undertake investment projects whose expected rate of return is greater than or equal to its marginal cost of capital. Investing in projects where the return is lower than the cost of capital would destroy shareholder value. Therefore, if the rate of return on the firm's least profitable project is already below the marginal cost of capital, the firm should stop increasing its capital investment, as further investments would be unprofitable.

Question 5

The projected net present value and capital rates are shown on a graph that is referred to as

Accepted Answer

Net present value profile

Answer

The graph that plots a project's Net Present Value (NPV) against different discount rates (or capital rates) is known as the Net Present Value profile. This visual tool helps managers understand how sensitive a project's profitability is to changes in the cost of capital. It also clearly shows the project's Internal Rate of Return (IRR) at the point where the NPV profile intersects the x-axis (where NPV equals zero).

Finance for Non-Finance Managers Practice Test

Finance for Non-Finance Managers Practice Test

Free Capital Budgeting Questions and Answers