MAS-CAPITAL BUDGETING PROF.

EG LINDO
REVIEWERS(THEORY)
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MULTIPLE CHOICE

1. Which of the following capital budgeting techniques ignores the time value of money?

a. payback period
b. net present value Page | 1
c. internal rate of return
d. profitability index

ANSWER: a EASY

2. Which of the following capital budgeting techniques may potentially ignore part of a
project’s relevant cash flows?

a. net present value

b. internal rate of return
c. payback period
d. profitability index

ANSWER: c EASY

3. In comparing two projects, the ___________ is often used to evaluate the relative
riskiness of the projects.

a. payback period
b. net present value
c. internal rate of return
d. discount rate

ANSWER: a EASY

4. Which of the following capital budgeting techniques does not routinely rely on the
assumption that all cash flows occur at the end of the period?

a. internal rate of return

b. net present value
c. profitability index
d. payback period

ANSWER: d EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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5. Assume that a project consists of an initial cash outlay of $100,000 followed by equal
annual cash inflows of $40,000 for 4 years. In the formula X = $100,000/$40,000, X
represents the

a. payback period for the project.

b. profitability index of the project. Page | 2
c. internal rate of return for the project.
d. project’s discount rate.

ANSWER: a EASY

6. All other factors equal, a large number is preferred to a smaller number for all capital
project evaluation measures except

a. net present value.

b. payback period.
c. internal rate of return.
d. profitability index.

ANSWER: b EASY

7. The payback method assumes that all cash inflows are reinvested to yield a return equal
to

a. the discount rate.

b. the hurdle rate.
c. the internal rate of return.
d. zero.

ANSWER: d EASY

8. The payback method measures

a. how quickly investment dollars may be recovered.

b. the cash flow from an investment.
c. the economic life of an investment.
d. the profitability of an investment.

ANSWER: a EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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9. If investment A has a payback period of three years and investment B has a payback
period of four years, then

a. A is more profitable than B.

b. A is less profitable than B.
c. A and B are equally profitable. Page | 3
d. the relative profitability of A and B cannot be determined from the information
given.

ANSWER: d EASY

10. The payback period is the

a. length of time over which the investment will provide cash inflows.
b. length of time over which the initial investment is recovered.
c. shortest length of time over which an investment may be depreciated.
d. shortest length of time over which the net present value will be positive.

ANSWER: b EASY

11. Which of the following capital budgeting techniques has been criticized because it fails to
consider investment profitability?

a. payback method
b. accounting rate of return
c. net present value method
d. internal rate of return

ANSWER: a EASY

12. The time value of money is explicitly recognized through the process of

a. interpolating.
b. discounting.
c. annuitizing.
d. budgeting.

ANSWER: b EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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13. The time value of money is considered in long-range investment decisions by

a. assuming equal annual cash flow patterns.

b. investing only in short-term projects.
c. assigning greater value to more immediate cash flows.
d. ignoring depreciation and tax implications of the investment. Page | 4

ANSWER: c EASY

14. When using one of the discounted cash flow methods to evaluate the desirability of a
capital budgeting project, which of the following factors is generally not important?

a. method of financing the project under consideration

b. timing of cash flows relating to the project
c. impact of the project on income taxes to be paid
d. amounts of cash flows relating to the project

ANSWER: a EASY

15. As to a capital investment, net cash inflow is equal to the

a. cost savings resulting from the investment.

b. sum of all future revenues from the investment.
c. net increase in cash receipts over cash payments.
d. net increase in cash payments over cash receipts.

ANSWER: c EASY

16. In a discounted cash flow analysis, which of the following would not be consistent with
adjusting a project’s cash flows to account for higher-than-normal risk?

a. increasing the expected amount for cash outflows

b. increasing the discounting period for expected cash inflows
c. increasing the discount rate for cash outflows
d. decreasing the amount for expected cash inflows

ANSWER: c MEDIUM
MAS-CAPITAL BUDGETING PROF. EG LINDO
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17. When a project has uneven projected cash inflows over its life, an analyst may be forced
to use ___________________ to find the project’s internal rate of return.

a. a screening decision
b. a trial-and-error approach
c. a post investment audit Page | 5
d. a time line

ANSWER: b EASY

18. The interest rate used to find the present value of a future cash flow is the

a. prime rate.
b. discount rate.
c. cutoff rate.
d. internal rate of return.

ANSWER: b EASY

19. A firm’s discount rate is typically based on

a. the interest rates related to the firm’s bonds.

b. a project’s internal rate of return.
c. its cost of capital.
d. the corporate Aa bond yield.

ANSWER: c EASY

20. In capital budgeting, a firm’s cost of capital is frequently used as the

a. internal rate of return.

b. accounting rate of return.
c. discount rate.
d. profitability index.

ANSWER: c EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
REVIEWERS(THEORY)
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21. The net present value method assumes that all cash inflows can be immediately
reinvested at the

a. cost of capital.
b. discount rate.
c. internal rate of return. Page | 6
d. rate on the corporation’s short-term debt.

ANSWER: b EASY

22. Which of the following changes would not decrease the present value of the future
depreciation deductions on a specific depreciable asset?

a. a decrease in the marginal tax rate

b. a decrease in the discount rate
c. a decrease in the rate of depreciation
d. an increase in the life expectancy of the depreciable asset

ANSWER: b MEDIUM

23. To reflect greater uncertainty (greater risk) about a future cash inflow, an analyst could

a. increase the discount rate for the cash flow.

b. decrease the discounting period for the cash flow.
c. increase the expected value of the future cash flow before it is discounted.
d. extend the acceptable length for the payback period.

ANSWER: a EASY

24. A change in the discount rate used to evaluate a specific project will affect the project’s

a. life.
b. payback period.
c. net present value.
d. total cash flows.

ANSWER: c EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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25. For a project such as plant investment, the return that should leave the market price of the
firm’s stock unchanged is known as the

a. cost of capital.
b. net present value.
c. payback rate. Page | 7
d. internal rate of return.

ANSWER: a MEDIUM

26. The pre-tax cost of capital is higher than the after-tax cost of capital because

a. interest expense is deductible for tax purposes.

b. principal payments on debt are deductible for tax purposes.
c. the cost of capital is a deductible expense for tax purposes.
d. dividend payments to stockholders are deductible for tax purposes.

ANSWER: a EASY

27. The basis for measuring the cost of capital derived from bonds and preferred stock,
respectively, is the

a. pre-tax rate of interest for bonds and stated annual dividend rate less the expected
earnings per share for preferred stock.
b. pre-tax rate of interest for bonds and stated annual dividend rate for preferred
stock.
c. after-tax rate of interest for bonds and stated annual dividend rate less the
expected earnings per share for preferred stock.
d. after-tax rate of interest for bonds and stated annual dividend rate for preferred
stock.

ANSWER: d MEDIUM

28. The combined weighted average interest rate that a firm incurs on its long-term debt,
preferred stock, and common stock is the

a. cost of capital.
b. discount rate.
c. cutoff rate.
d. internal rate of return.

ANSWER: a EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
REVIEWERS(THEORY)
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29. The weighted average cost of capital that is used to evaluate a specific project should be
based on the

a. mix of capital components that was used to finance a project from last year.
b. overall capital structure of the corporation.
c. cost of capital for other corporations with similar investments. Page | 8
d. mix of capital components for all capital acquired in the most recent fiscal year.

ANSWER: b EASY

30. Debt in the capital structure could be treated as if it were common equity in computing
the weighted average cost of capital if the debt were

a. callable.
b. participating.
c. cumulative.
d. convertible.

ANSWER: d MEDIUM

31. The weighted average cost of capital approach to decision making is not directly affected
by the

a. value of the common stock.

b. current budget for capital expansion.
c. cost of debt outstanding.
d. proposed mix of debt, equity, and existing funds used to implement the project.

ANSWER: b EASY

32. The ___________________ is the highest rate of return that can be earned from the most
attractive, alternative capital project available to the firm.

a. accounting rate of return

b. internal rate of return
c. hurdle rate
d. opportunity cost of capital

ANSWER: d MEDIUM
MAS-CAPITAL BUDGETING PROF. EG LINDO
REVIEWERS(THEORY)
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33. If an analyst desires a conservative net present value estimate, she will assume that all
cash inflows occur at

a. mid year.
b. the beginning of the year.
c. year end. Page | 9
d. irregular intervals.

ANSWER: c EASY

34. The salvage value of an old lathe is zero. If instead, the salvage value of the old lathe was
$20,000, what would be the impact on the net present value of the proposal to purchase a
new lathe?

a. It would increase the net present value of the proposal.

b. It would decrease the net present value of the proposal.
c. It would not affect the net present value of the proposal.
d. Potentially it could increase or decrease the net present value of the new lathe.

ANSWER: a EASY

35. The net present value method of evaluating proposed investments

a. measures a project’s internal rate of return.

b. ignores cash flows beyond the payback period.
c. applies only to mutually exclusive investment proposals.
d. discounts cash flows at a minimum desired rate of return.

ANSWER: d EASY

36. Which of the following statements is true regarding capital budgeting methods?

a. The Fisher rate can never exceed a company’s cost of capital.

b. The internal rate of return measure used for capital project evaluation has more
conservative assumptions than the net present value method, especially for
projects that generate a positive net present value.
c. The net present value method of project evaluation will always provide the same
ranking of projects as the profitability index method.
d. The net present value method assumes that all cash inflows can be reinvested at
the project’s cost of capital.

ANSWER: d EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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37. A company is evaluating three possible investments. Information relating to the company
and the investments follow:

Fisher rate for the three projects 7%

Cost of capital 8%
Page | 10
Based on this information, we know that

a. all three projects are acceptable.

b. none of the projects are acceptable.
c. the capital budgeting evaluation techniques profitability index, net present value,
and internal rate of return will provide a consistent ranking of the projects.
d. the net present value method will provide a ranking of the projects that is superior
to the ranking obtained using the internal rate of return method.

ANSWER: c MEDIUM

38. If a project generates a net present value of zero, the profitability index for the project
will

a. equal zero.
b. equal 1.
c. equal -1.
d. be undefined.

ANSWER: b EASY

39. If the profitability index for a project exceeds 1, then the project’s

a. net present value is positive.

b. internal rate of return is less than the project’s discount rate.
c. payback period is less than 5 years.
d. accounting rate of return is greater than the project’s internal rate of return.

ANSWER: a EASY

40. If a project’s profitability index is less than 1, the project’s

a. discount rate is above its cost of capital.

b. internal rate of return is less than zero.
c. payback period is infinite.
d. net present value is negative.

ANSWER: d EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
REVIEWERS(THEORY)
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41. The profitability index is

a. the ratio of net cash flows to the original investment.

b. the ratio of the present value of cash flows to the original investment.
c. a capital budgeting evaluation technique that doesn’t use discounted values.
d. a mandatory technique when capital rationing is used. Page | 11

ANSWER: b EASY

42. Which method of evaluating capital projects assumes that cash inflows can be reinvested
at the discount rate?

a. internal rate of return

b. payback period
c. profitability index
d. accounting rate of return

ANSWER: c MEDIUM

43. If the total cash inflows associated with a project exceed the total cash outflows
associated with the project, the project’s

a. net present value is greater than zero.

b. internal rate of return is greater than zero.
c. profitability index is greater than 1.
d. payback period is acceptable.

ANSWER: b EASY

44. The net present value and internal rate of return methods of decision making in capital
budgeting are superior to the payback method in that they

a. are easier to implement.

b. consider the time value of money.
c. require less input.
d. reflect the effects of sensitivity analysis.

ANSWER: b EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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45. If an investment has a positive net present value, the

a. internal rate of return is higher than the discount rate.

b. discount rate is higher than the hurdle rate of return.
c. internal rate of return is lower than the discount rate of return.
d. hurdle rate of return is higher than the discount rate. Page | 12

ANSWER: a EASY

46. The rate of interest that produces a zero net present value when a project’s discounted
cash operating advantage is netted against its discounted net investment is the

a. cost of capital.
b. discount rate.
c. cutoff rate.
d. internal rate of return.

ANSWER: d EASY

47. For a profitable company, an increase in the rate of depreciation on a specific project
could

a. increase the project’s profitability index.

b. increase the project’s payback period.
c. decrease the project’s net present value.
d. increase the project’s internal rate of return.

ANSWER: d MEDIUM

48. Which of the following capital expenditure planning and control techniques has been
criticized because it might mistakenly imply that earnings are reinvested at the rate of
return earned by the investment?

a. payback method
b. accounting rate of return
c. net present value method
d. internal rate of return

ANSWER: d EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
REVIEWERS(THEORY)
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49. If the discount rate that is used to evaluate a project is equal to the project’s internal rate
of return, the project’s _____________ is zero.

a. profitability index
b. internal rate of return
c. present value of the investment Page | 13
d. net present value

ANSWER: d EASY

50. As the marginal tax rate goes up, the benefit from the depreciation tax shield

a. decreases.
b. increases.
c. stays the same.
d. can move up or down depending on whether the firm’s cost of capital is high or
low.

ANSWER: b MEDIUM

51. When a profitable corporation sells an asset at a loss, the after-tax cash flow on the sale
will

a. exceed the pre-tax cash flow on the sale.

b. be less than the pre-tax cash flow on the sale.
c. be the same as the pre-tax cash flow on the sale.
d. increase the corporation’s overall tax liability.

ANSWER: a MEDIUM

52. In a typical (conservative assumptions) after-tax discounted cash flow analysis,

depreciation expense is assumed to accrue at

a. the beginning of the period.

b. the middle of the period.
c. the end of the period.
d. irregular intervals over the life of the investment.

ANSWER: c EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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53. The pre-tax and after-tax cash flows would be the same for all of the following items
except

a. the liquidation of working capital at the end of a project’s life.

b. the initial (outlay) cost of an investment.
c. the sale of an asset at its book value. Page | 14
d. a cash payment for salaries and wages.

ANSWER: d EASY

54. The after-tax net present value of a project is affected by

a. tax-deductible cash flows.

b. non-tax-deductible cash flows.
c. accounting accruals.
d. all of the above.

ANSWER: d MEDIUM

55. A project’s after-tax net present value is increased by all of the following except

a. revenue accruals.
b. cash inflows.
c. depreciation deductions.
d. expense accruals.

ANSWER: a EASY

56. Multiplying the depreciation deduction by the tax rate yields a measure of the
depreciation tax

a. shield.
b. benefit.
c. payable.
d. loss.

ANSWER: b EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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57. Annual after-tax corporate net income can be converted to annual after-tax cash flow by

a. adding back the depreciation amount.

b. deducting the depreciation amount.
c. adding back the quantity (t × depreciation deduction), where t is the corporate tax
rate. Page | 15
d. deducting the quantity [(1– t) × depreciation deduction], where t is the corporate
tax rate.

ANSWER: a EASY

58. Income taxes are levied on

a. net cash flow.

b. income as measured by accounting rules.
c. net cash flow plus depreciation.
d. income as measured by tax rules.

ANSWER: d EASY

59. Which of the following best represents a screening decision?

a. determining which project has the highest net present value

b. determining if a project’s internal rate of return exceeds the firm’s cost of capital
c. determining which projects are mutually exclusive
d. determining which are the best projects

ANSWER: b EASY

60. Below are pairs of projects. Which pair best represents independent projects?

a. buy computer; buy software package

b. buy computer #1; buy computer #2
c. buy computer; buy computer security system
d. buy computer; repave parking lot

ANSWER: d EASY
MAS-CAPITAL BUDGETING PROF. EG LINDO
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61. Which of the following are tax deductible under U.S. tax law?

a. interest payments to bondholders

b. preferred stock dividends
c. common stock dividends
d. all of the above Page | 16

ANSWER: a EASY

62. Sensitivity analysis is

a. an appropriate response to uncertainty in cash flow projections.

b. useful in measuring the variance of the Fisher rate.
c. typically conducted in the post investment audit.
d. useful to compare projects requiring vastly different levels of initial investment.

ANSWER: a MEDIUM

63. If management judges one project in a mutually inclusive set to be acceptable for
investment,

a. all the other projects in the set are rejected.

b. only one other project in the set can be accepted.
c. all other projects in the set are also accepted.
d. only one project in the set will be rejected.

ANSWER: c EASY

64. All other factors equal, which of the following would affect a project’s internal rate of
return, net present value, and payback period?

a. an increase in the discount rate

b. a decrease in the life of the project
c. an increase in the initial cost of the project
d. all of the above

ANSWER: c EASY