Chapter 11

Capital Budgeting
Multiple Choice Questions

Instructions: For each question there are several answers. Clearly mark the best
answer.

1. Which of the following are typical consequences of good capital budgeting decisions?
A. The firm increases in value.
B. The firm gains knowledge and experience that may be useful in future decisions.
C. Good capital budgeting decisions help a company define its core competencies.
D. All of the above.

2. Errors in capital budgeting decisions:

A. Tend to average out over time.
B. Decrease the firm's value.
C. Are diminished because the time value of money makes future cash flows less important.
D. Are easily reversed.

3. Which of the following factors is least important to capital budgeting decisions?

A. The time value of money
B. The risk-return tradeoff
C. Net income based on accrual accounting principles
D. Cash flows directly resulting from the decision

4. Which of the following would NOT be considered a capital budgeting decision?

A. Walmart purchases inventory for resale to customers.
B. Morgan Stanley installs elevators to comply with the Americans with Disabilities Act.
C. Caterpillar replaces manufacturing equipment with more efficient new equipment.
D. Pfizer develops a new therapy and brings it to market.

5. Which of the following is a typical capital budgeting decision?

A. Purchase of office supplies
B. Granting credit to a new customer
C. Replacement of manufacturing equipment with more modern and efficient equipment
D. Financing the firm with more long-term debt and less equity

6. Good capital investment opportunities are most likely to exist when:

A. Many firms compete to sell similar products.
B. Interest rates are high and rising.
C. Goods and services can be produced cheaply using readily available tools and technologies.
D. A line of business is expensive to enter and uses proprietary technology.

7. Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta
requires an investment of $500,000 and has a NPV of $150,000. The projects involve
unrelated new product lines.
A. Both projects should be accepted because they have positive NPV's.
B. Neither project should be accepted because they might compete with one another.
C. Only project Delta should be accepted. Alpha's NPV is too low for the investment.
D. The company should look at other investment criteria, not just NPV.

8. Project H requires an initial investment of $100,000 and the produces annual cash flows of
$50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the
produces annual cash flows of $30,000, $40,000, and $50,000. If the required rate of return
is greater than 0% and the projects are mutually exclusive:
A. H will always be preferable to T.
B. T will always be preferable to H.
C. H and T are equally attractive.
D. The project rankings will change with different discount rates.

9. Suppose you determine that the NPV of a project is $1,525,855. What does that mean?
A. In all cases, investing in this project would be better than investing in a project that has an
NPV of $850,000.
B. The project would add value to the firm.
C. Under all conditions, the project's payback would be less than the profitability index.
D. Other investment criteria might need to be considered.

10.Project January has a NPV of $50,000, project December has a NPV of $40,000. Which of
the following circumstances could make it possible to choose December over January?
A. January has a shorter payback period.
B. The projects are mutually exclusive.
C. The projects have unequal lives.
D. The projects are mandated.

11.The present value of the total costs over a five year period for Project April is $50,000. The
net present value of total costs over a 4 year period for Project October is $40,000. The
company uses a discount rate of 9%. Which project should it choose and why?
A. April because it has a higher NPV.
B. April because it has a higher EAC.
C. October because it has a shorter life.
D. October because it has a lower EAC.

12.Project EH! Requires an initial investment of $50,000, and has a net present value of
$12,000. Project BE requires an initial investment of $100,000, and has a net present value
 of $13,000. The projects are mutually exclusive. The firm should accept:
A. Project EH!
B. Project BE.
C. Both projects.
D. Neither project.

13.Project Eh! Requires an initial investment of $50,000, and has a net present value of
$12,000. Project B requires an initial investment of $100,000, and has a net present value of
$13,000. The projects are proposals for increasing revenue and are not mutually exclusive.
The firm should accept:
A. Project Eh!
B. Project B.
C. Both projects.
D. Neither project.

14.Which of the following is the correct equation to solve for the net present value of a project?
A. NPV = CF0 + CF1/(1 + k)1 + CF2/(1 + k)2+...CFn/(1 + k)n
B. NPV = CF0 + CF1(1 + k)1 + CF2(1 + k)2+...CFn(1 + k)n
C. NPV = CF0 - CF1/(1 + k)1 - CF2/(1 + k)2-...CFn/(1 + k)n
D. NPV = CF1/(1 + k)1 + CF2/(1 + k)2 +...CFn/(1 + k)n

15.The equivalent annual cost method is most appropriate in which of the following situations?
In each case, assume that several mutually exclusive options are available.
A. Introducing a new product line
B. Adding another store to a chain of retail stores
C. Installation of federally mandated safety equipment
D. Equipment to reduce production costs

16.Webley Corp. is considering two expansion options, but does not have enough capital to
undertake both, Project W requires an investment of $100,000 and has an NPV of $10,000.
Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley use the
profitability index to decide, it should:
A. Choose D because it has a higher profitability index.
B. Choose W because it has a higher profitability index.
C. Choose D because it has a lower profitability index.
D. Choose W because it has a higher profitability index.

17.If a project has a profitability index greater than 1,

A. The npv will also be positive.
B. The irr will be higher than the required rate of return.
C. The present value of future cash flows will exceed the amount invested in the project.
D. All of the above.
18.Project Black Swan requires an initial investment of $115,000. It has positive cash flows of
$140,000 for each of the next two years. Because of major demolition and environmental
clean-up costs, cash flow for the third and final year of the project is $(170,000). If the
company’s required rate of return is 12%, the project should be:
A. Rejected because the IRR is less than 12%.
B. Accepted because the NPV is positive at 16%.
C. The project is unacceptable at any discount rate.
D. Rejected because there may be more than one IRR.

19.Project Black Swan requires an initial investment of $115,000. It has positive cash flows of
$140,000 for each of the next two years. Because of major demolition and environmental
clean-up costs, cash flow for the third and final year of the project is $(170,000).
A. All possible IRR's for this project are negative.
B. It is not possible to compute an IRR for this project.
C. The project is unacceptable at any required rate of return.
D. This project might have more than one IRR.

20.Project Black Swan requires an initial investment of $115,000. It has positive cash flows of
$140,000 for each of the next two years. Because of major demolition and environmental
clean-up costs, cash flow for the third and final year of the project is $(170,000).
A. All possible IRR's for this project are negative.
B. It is not possible to compute an IRR for this project.
C. This project might have more than one IRR, but only one MIRR.
D. The project is unacceptable at any required rate of return. This project might have more than
one IRR.

21.Project Black Swan requires an initial investment of $115,000. It has positive cash flows of
$140,000 for each of the next two years. Because of major demolition and environmental
clean-up costs, cash flow for the third and final year of the project is $(170,000). The
company accepts all projects with a payback period of 2 years or less.
A. The payback rule would reject this project because of its risks are too high.
B. The payback rule would reject this project because all negative cash flows are added
together.
C. If strictly applied, the payback rule would reject this project.
D. If strictly applied, the payback rule would accept this project.

22.Project H requires an initial investment of $100,000 and produces annual cash flows of
$50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the
produces annual cash flows of $30,000, $40,000, and $50,000. The projects are mutually
exclusive. The company accepts projects with payback periods of 3 years or less.
A. Project H will be accepted.
B. Project T will be accepted.
C. H and T will both be accepted.
D. Neither projected will be accepted.
23.A new forklift under consideration by Home Warehouse requires an initial investment of
$100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Which of the
following will not change if the required rate of return is increased from 10% to 12%?
A. The net present value.
B. The internal rate of return.
C. The profitability index.
D. The modified internal rate of return.

24.Project Ell requires an initial investment of $50,000 and the produces annual cash flows of
$30,000, $25,000, and $15,000. Project Ess requires an initial investment of $60,000 and
then produces annual cash flows of $25,000 per year for the next ten years. The company
ranks projects by their payback periods.
A. Projects with unequal lives cannot be ranked using the payback method.
B. Ess will be ranked higher than Ell.
C. Ell and Ess will be ranked equally.
D. Ell will be ranked higher than Ess.

25.Which of the following series of cash flows could have more than one IRR? (Negative cash
flows are in parentheses.)
A. $(XX,XXX), $X,XXX , $X,XXX, $X,XXX
B. $(XX,XXX), $X,XXX , $X,XXX, $X,XXX, $(XX,XXX)
C. $X,XXX, $X,XXX , $X,XXX, $X,XXX, $(XX,XXX)
D. $XX,XXX, $X,XXX , $X,XXX, $X,XXX

26.Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an
initial cash outlay of $20,000 and a required rate of return of 17%.

Project YProject Z
Year 1 $12,000 $10,000
Year 2 $8,000 $10,000
Year 3 $6,000 0
Year 4 $2,000 0
Year 5 $2,000 0

Payback for Project Y is:

A. Two years.
B. One year.
C. Three years.
D. Four years.

What is payback for Project Z?

A. Two years
B. One year
C. Zero years
D. Project Z does not payback the original investment.

27.The owner of a small construction business has asked you to evaluate the purchase of a new
front end loader. You have determined that this investment has a large, positive, NPV, but
are afraid that your client will not understand the method. A good alternative method in this
circumstance might be
A. the payback method
B. the profitability index
C. the internal rate of return
D. the modified internal rate of return

28.Whenever the IRR on a project equals that project's required rate of return,
A. The NPV equals 0.
B. The NPV equals the initial investment.
C. The profitability index equals 0.
D. The NPV equals 1.

29.Aroma Candles, Inc. is evaluating a project with the following cash flows. The project
involves a new product that will not affect the sales of any other project. Which two methods
would always lead to the same accept/reject decision for this project, regardless of the
discount rate.
YearCash Flows
0 ($120,000)
1 $30,000
2 $70,000
3 $90,000
A. Payback and Discounted Payback
B. NPV and Payback
C. NPV and IRR
D. Discounted Payback and IRR

30.Which of the following is considered to be a deficiency of the IRR?

A. It fails to properly rank capital projects.
B. It could produce more than one rate of return.
C. It fails to utilize the time value of money.
D. It is not useful in accounting for risk in capital budgeting.

31.We compute the profitability index of a capital-budgeting proposal by:

A. Multiplying the IRR by the cost of capital.
B. Dividing the present value of the annual after-tax cash flows by the cost of capital.
C. Dividing the present value of the annual after-tax cash flows by the cost of the project.
D. Multiplying the cash inflow by the IRR.
32.Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital
budgeting methods in which order?
A. IRR, NPV, Payback, Discounted Payback, Profitability Index
B. Payback, Discounted Payback, Profitability Index, IRR, NPV
C. NPV, IRR, Profitability Index, Discounted Payback, Payback
D. NPV, IRR, Payback, Discounted Payback, Profitability Index

33.Which of the following best explains the continuing popularity of the payback method?
A. Mathematical simplicity and some insight into the riskiness of cash flows.
B. Uses all cash flows and takes into account the time value of money.
C. Reliably selects the projects that add most value to the firm.
D. It provides objective selection criteria and is taught as the primary method in most business
schools.

34.With respect to the capital budgeting practices of large U. S. corporations:

A. The profitability index has been gaining in popularity.
B. IRR and NPV have been gaining in popularity.
C. Payback and discounted payback have been gaining in popularity.
D. IRR and NPV have declined in popularity.

35.The capital budgeting manager for XYZ Corporation, a very profitable high technology
company, completed her analysis of Project assuming 5-year depreciation. Her accountant
reviews the analysis and changes the depreciation method to 3-year depreciation. This
change will
A. Increase the present value of the NCFs.
B. Decrease the present value of the NCFs.
C. Have no effect on the NCFs because depreciation is a non-cash expense.
D. Only change the NCFs if the useful life of the depreciable asset is greater than 5 years.

36.Project C requires a net investment of $1,000,000 and has a payback period of 5.6 years.
You analyze Project C and decide that Year 1 free cash flow is $100,000 too low, and Year 3
free cash flow is $100,000 too high. After making the necessary adjustments
A. The payback period for Project C will be longer than 5.6 years.
B. The payback period for Project C will be shorter than 5.6 years.
C. The IRR of Project C will increase.
D. The NPV of Project C will decrease.

37.Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14
percent. Both projects have a required return of 12 percent. Which of the following
statements is most correct?
A. Both projects have a positive net present value (NPV).
B. Project A must have a higher NPV than project B.
C. If the required return were less than 12 percent, Project B would have a higher IRR than
Project A.
D. Project B has a higher profitability index than Project A.

38.Which of the following statements is most correct?

A. If a project's internal rate of return (IRR) exceeds the required return, then the project's net
present value (NPV) must be negative.
B. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
C. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return
equal to the IRR.
D. A project with a NPV = 0 is not acceptable.

39.A capital budgeting project has a net present value of $30,000 and a modified internal rate of
return of 15%. The project's required rate of return is 13%. The internal rate of return is
A. Greater than $30,000.
B. Less than 13%.
C. Between 13% and 15%.
D. greater than 15%

40.The net present value method

A. Is consistent with the goal of shareholder wealth maximization.
B. Recognizes the time value of money.
C. Uses all of a project's cash flows.
D. All of the above.

41.Arguments against using the net present value and internal rate of return methods include
that
A. They fail to use accounting profits.
B. They require detailed long-term forecasts of the incremental benefits and costs.
C. They fail to consider how the investment project is to be financed.
D. They fail to use the cash flow of the project.

42.All of the following are sufficient indications to accept a project except (assume that there is
no capital rationing constraint, and no consideration is given to payback as a decision
tool):
A. The net present value of an independent project is positive.
B. The profitability index of an independent project exceeds one.
C. The IRR of a mutually exclusive project exceeds the required rate of return.
D. The NPV of a mutually exclusive project is positive and exceeds that of all other projects.

43.When reviewing the net present profile for a project

A. The higher the discount rate, the higher the NPV.
B. The higher the discount rate, the higher the IRR.
C. The IRR will always be a point on the horizontal axis line where NPV = 0.
D. The IRR will always be a point on the horizontal axis equal to the required return.
44.We compute the profitability index of a capital budgeting proposal by
A. Multiplying the internal rate of return by the cost of capital.
B. Dividing the present value of the annual after tax cash flows by the cost of capital.
C. Dividing the present value of the annual after tax cash flows by the cash investment in the
project.
D. Multiplying the cash inflow by the internal rate of return.

45.The advantages of NPV are all of the following except:

A. It can be used as a rough screening device to eliminate those projects whose returns do not
materialize until later years.
B. It provides the amount by which positive NPV projects will increase the value of the firm.
C. It allows the comparison of benefits and costs in a logical manner through the use of time
value of money principles.
D. It recognizes the timing of the benefits resulting from the project.

46.The disadvantage of the IRR method is that:

A. The IRR deals with cash flows.
B. The IRR gives equal regard to all returns within a project's life.
C. The IRR will always give the same project accept/reject decision as the NPV.
D. The IRR requires long, detailed cash flow forecasts.

47.The internal rate of return is

A. The discount rate that makes the NPV positive.
B. The discount rate that equates the present value of the cash inflows with the present value of
the cash outflows.
C. The discount rate that makes NPV negative and the PI greater than one.
D. The rate of return that makes the NPV positive.
48.All of the following are criticisms of the payback period criterion except:
A. Time value of money is not accounted for.
B. Cash flows occurring after the payback are ignored.
C. It deals with accounting profits as opposed to cash flows.
D. None of the above; they are all criticisms of the payback period criteria.

49.For the net present value (NPV) criteria, a project is acceptable if NPV is ________, while
for the profitability index a project is acceptable if PI is ________.
A. greater than zero; greater than the required return
B. greater than or equal to zero; greater than zero
C. greater than one; greater than or equal to one
D. greater than or equal to zero; greater than or equal to one

50.If the NPV (Net Present Value) of a project with one sign reversal is positive, then the
project's IRR (Internal Rate of Return) ________ the required rate of return.
A. must be less than
B. must be greater than
C. could be greater or less than
D. Cannot be determined without actual cash flows