Capital Budgeting Techniques Quiz
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Questions and Answers

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?

    <p>Calculating and comparing benefits and costs of a project</p> 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?

    <p>It assumes all future projects bear the same risks as current projects</p> Signup and view all the answers

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

    <p>Uses cash flows and discounts them using the firm's cost of capital</p> Signup and view all the answers

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

    <p>$\text{PBP} = \frac{\text{Initial Investment}}{\text{annual constant cash inflows}}$</p> Signup and view all the answers

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

    <p>Payback Period</p> Signup and view all the answers

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

    <p>Cash inflows will be evenly generated</p> Signup and view all the answers

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

    <p>To reduce uncertainty in future cash returns</p> Signup and view all the answers

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

    <p>It is easy to understand and calculate</p> Signup and view all the answers

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

    <p>Projects with a shorter payback period than management's maximum acceptable PBP</p> Signup and view all the answers

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

    <p>Ksh 20 million</p> Signup and view all the answers

    What method is used for calculating depreciation?

    <p>Straight line method</p> Signup and view all the answers

    What is the cost of capital for the project?

    <p>12%</p> Signup and view all the answers

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

    <p>Accounting rate of return</p> Signup and view all the answers

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

    <p>Ksh 30 million</p> Signup and view all the answers

    What is the corporate tax rate given in the question?

    <p>30%</p> Signup and view all the answers

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

    <p>It fails to consider the time value of money</p> Signup and view all the answers

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

    <p>It is based solely on data from financial statements</p> 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?

    <p>Accept the project</p> Signup and view all the answers

    How is the average investment calculated in the ARR method?

    <p>$\frac{\text{Initial Investment + Residual Value}}{2}$</p> Signup and view all the answers

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

    <p>It uses returns from the entire life of the project</p> 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?

    <p>The project with an ARR of 25%</p> Signup and view all the answers

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

    <p>14%</p> Signup and view all the answers

    What is the tax shield in year 2?

    <p>Sh. 1,200,000</p> Signup and view all the answers

    What is the payback period for this project?

    <p>3 years 4 months</p> Signup and view all the answers

    If the discount rate is 12%, what is the Net Present Value (NPV) of the project?

    <p>-Sh. 159,151</p> Signup and view all the answers

    What is the present value of cash inflows (PVCIF) for this project?

    <p>Sh. 19,840,849</p> Signup and view all the answers

    What is the initial investment for this project?

    <p>Sh. 20,000,000</p> Signup and view all the answers

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