Capital Budgeting Techniques Quiz

What is the primary advantage of using Net Present Value (NPV) to evaluate projects?

It is easy to calculate compared to traditional methods
It uses profits to assess investment viability
It ranks projects based on true profitability (correct)
It ignores risks associated with investments

What is a significant weakness of using Net Present Value (NPV) for investment appraisal?

It requires estimating future cash flows
It uses profits instead of cash flows
It considers varying risks associated with investments
It is more difficult to use compared to traditional methods (correct)

How does Net Present Value (NPV) handle the assessment of future projects within a firm?

By assuming all projects have the same level of risk (correct)
By using different discount rates for projects with varying risks
By ranking projects based on their economic life
By ignoring the impact of the firm's cost of capital

What does Profitability Index (PI) or Benefit Cost Ratio (BCR) aim to accomplish?

Calculating and comparing benefits and costs of a project (D) Signup and view all the answers

Why is it a weakness to use a firm's cost of capital as the discount rate for all future projects according to the text?

It assumes all future projects bear the same risks as current projects (C) Signup and view all the answers

What key aspect distinguishes Net Present Value (NPV) from traditional methods of evaluating projects?

Uses cash flows and discounts them using the firm's cost of capital (B) Signup and view all the answers

What is the formula to calculate the payback period for a project with constant annual cash inflows?

$\text{PBP} = \frac{\text{Initial Investment}}{\text{annual constant cash inflows}}$ (C) Signup and view all the answers

In the context of project evaluation, what does PBP stand for?

Payback Period (D) Signup and view all the answers

What assumption is made when calculating the payback period for projects with unequal cash inflows?

Cash inflows will be evenly generated (C) Signup and view all the answers

Why does the payback period method choose ventures with the shortest payback period?

To reduce uncertainty in future cash returns (D) Signup and view all the answers

What is an advantage of using the payback period method for project evaluation?

It is easy to understand and calculate (A) Signup and view all the answers

What criterion does management use to determine whether to accept future projects based on the payback period?

Projects with a shorter payback period than management's maximum acceptable PBP (B) Signup and view all the answers

What is the initial investment capital required for the new medical facility?

Ksh 20 million (C) Signup and view all the answers

What method is used for calculating depreciation?

Straight line method (B) Signup and view all the answers

What is the cost of capital for the project?

12% (C) Signup and view all the answers

Which of the following is NOT required to calculate the Net Present Value (NPV)?

Accounting rate of return (A) Signup and view all the answers

What is the total expected cash inflow over the 5-year period?

Ksh 30 million (B) Signup and view all the answers

What is the corporate tax rate given in the question?

30% (B) Signup and view all the answers

What is the primary weakness of the Accounting Rates of Return (ARR) method?

It fails to consider the time value of money (B) Signup and view all the answers

Which of the following statements about the ARR method is correct?

It is based solely on data from financial statements (C) Signup and view all the answers

If a project has an ARR of 18% and the management's minimum required ARR is 15%, what should be the decision?

Accept the project (B) Signup and view all the answers

How is the average investment calculated in the ARR method?

$\frac{\text{Initial Investment + Residual Value}}{2}$ (C) Signup and view all the answers

Which of the following is a strength of the ARR method?

It uses returns from the entire life of the project (C) Signup and view all the answers

If two mutually exclusive projects have ARRs of 22% and 25%, which project should be chosen according to the ARR method?

The project with an ARR of 25% (B) Signup and view all the answers

What is the Average Rate of Return (ARR) for this project?

14% (A) Signup and view all the answers

What is the tax shield in year 2?

Sh. 1,200,000 (C) Signup and view all the answers

What is the payback period for this project?

3 years 4 months (A) Signup and view all the answers