Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1)
Payback is considered an unsophisticated capital budgeting because it
1)
A)
gives explicit consideration to the timing of cash flows and therefore the time value of money.
B)
gives explicit consideration to the timing of cash flows and therefore the time value of money.
C)
none of the above.
D)
gives explicit consideration to risk exposure due to the use of the cost of capital as a discount
rate.
2)
What term is used for the ratio of accounting profit to investment expressed as a percentage?
2)
A)
Internal rate of return
B)
Net rate of return
C)
Accounting rate of return
D)
Benefit–cost ratio
C
3)
Which three of the following statements about using the accounting rate of return are true?
3)
A)
Managers’ performances are often judged using ARR.
B)
Many managers have familiarity with it
C)
It gives the most accurate predictions.
D)
It is easy to understand
4)
Which of the following methods is most suitable for analysing projects?
4)
A)
ARR
B)
NPV
C)
Discounted payback
D)
Payback
B
1
C
5)
What is the payback and average accounting rate of return of the following project?
Time(year) 0 1 2 3 4
Cashflow –£20,000 £8,000 £6000 £4,000 £2,000
Assets at
beginning of
year
£20,000 £15,000 £10,000 £5,000
5)
A)
Payback: 4 years, ARR 40%
B)
Payback: 3 years, ARR 40%
C)
Payback: 4 years, ARR 35%
D)
Payback: 4 years, ARR 100%
6)
When the net present value is negative, the internal rate of return is ________ the cost of capital.
6)
A)
less than
B)
equal to
C)
greater than or equal to
D)
greater than
7)
A firm is evaluating two independent projects utilizing the internal rate of return technique. Project
X has an initial investment of €80,000 and cash inflows at the end of each of the next five years of
€25,000. Project Z has a initial investment of €120,000 and cash inflows at the end of each of the next
four years of €40,000. The firm should
7)
A)
accept only X if the cost of capital is at most 15 percent.
B)
accept both if the cost of capital is at most 15 percent.
C)
none of the above
D)
accept only Z if the cost of capital is at most 15 percent.
8)
Which of the following best reflects practice in appraisal and acceptance of projects?
8)
A)
All potentially profitable projects are accepted.
B)
Most projects that reach the report stage are adopted.
C)
All carefully investigated projects are accepted.
D)
Most projects are rejected because they have high levels of NPV.
2
9)
Which three of the following accurately relate to the accounting rate of return?
9)
A)
It is the ratio of accounting profit to investment, expressed as a percentage.
B)
It makes no allowance for the time value of money.
C)
It is calculated and is required by managers because they are often judged retrospectively by
this measure.
D)
It is calculated more often than payback, NPV, or IRR during project appraisal by UK firms.
10)
Which of the following are the three first stages of the investment process?
10)
A)
Screening
B)
Development and classification
C)
Generation of ideas
D)
Auditing
11)
Which of the following options best describes payback?
11)
A)
The length of time for cumulated future cash inflows to equal an initial outflow
B)
The time taken for time–valued money outputs to exceed inputs
C)
The time taken for time–valued money inputs to exceed outputs
D)
The length of time for cumulated future cash outflows to equal an initial inflow
12)
What are the three reasons why IRR is used more than NPV?
12)
A)
It is thought (wrongly) to give a better ranking.
B)
It results in more projects being accepted.
C)
It can be calculated without cost of capital.
D)
A psychological preference for a percentage
3
Explanation:
13)
Which three of the following are drawbacks of payback?
13)
A)
Cash flows beyond the payback cut–off are ignored.
B)
The cut–off point is arbitrarily selected: it has no theoretical base.
C)
It is difficult to calculate and interpret.
D)
It fails to allow for the time value of money.
14)
Which three of the following accurately relate to the use of the accounting rate of return?
14)
A)
The method of calculating the accounting rate of return has been standardised and is widely
accepted.
B)
Accounting rate of return takes account of the time value of money.
C)
Practitioners use a variety of approaches when calculating the accounting rate of return.
D)
Accounting rate of return takes account of assets devoted to a project or business activity.
15)
The cash flow for a project is as shown in the table. The discount rate is 8 per cent.
Year 0 1 2 3 4 5
Cash flow –£6,000 £2,000 £1,000 £2,000 £1200 £4,000
What is the payback and discounted payback of the project?
15)
A)
Payback in 4 years and discounted payback in 2 years
B)
Payback in 4 years and discounted payback in 3 years
C)
Payback in 5 years and discounted payback in 4 years
D)
Payback in 4 years and discounted payback in 5 years
16)
Which three of the following are drawbacks of using the accounting rate of return?
16)
A)
It relates accounting profit to investment.
B)
It uses an arbitrary cut–off rate.
C)
It can be calculated in a variety of ways.
D)
Profit is a poor substitute for cash flow.
4
17)
Which of the following reasons is most likely to cause a firm to founder?
17)
A)
A shortage of good investment ideas
B)
Poor methods of monitoring performance
C)
Poor methods of appraising projects
D)
An excess of good investment ideas
18)
Which of the following statements accurately relates to the topic of risk?
18)
A)
The discount rate may be raised or lowered to allow for the risk of a project, the extent of the
risk premium being based on indisputable theory.
B)
Risk is unpredictable, and thus cannot be allowed for in project planning.
C)
Risk can be quantified using objective probabilities that can be defined mathematically and
inferred from historical data.
D)
Risk is the probability of an outturn being less than anticipated.
19)
Which of the following statements is false?
19)
A)
Two of the above.
B)
If the payback period is less than the maximum acceptable payback period, accept the project.
C)
If the payback period is greater than the maximum acceptable payback period, reject the
project.
D)
If the payback period is less than the maximum acceptable payback period, reject the project
20)
Comparing net present value and internal rate of return
20)
A)
always results in the same ranking of projects.
B)
may give different accept/reject decisions.
C)
is only necessary on mutually exclusive projects.
D)
always results in the same accept/reject decision.
5
21)
The ________ measures the amount of time it takes the firm to recover its initial investment.
21)
A)
internal rate of return
B)
net present value
C)
average rate of return
D)
payback period
22)
A firm is evaluating a proposal which has an initial investment of €35,000 and has cash flows of
€10,000 in year 1, €20,000 in year 2, and €10,000 in year 3. The payback period of the project is
22)
A)
between two and three years.
B)
one year.
C)
two years.
D)
between one and two years.
23)
Which of the following is the most popular method of project appraisal
23)
A)
ARR
B)
Payback
C)
NPV
D)
Discounted payback
24)
Which three of the following are the main attractions of using payback as an appraisal tool?
24)
A)
It makes allowance for the time value of money.
B)
It complements more sophisticated methods.
C)
It is simple and easy to use.
D)
It makes allowance for increased risk of more distance cash flows.
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
25)
For conventional projects, both NPV and IRR techniques will always generate the same accept–reject
decision, but differences in their underlying assumptions can cause them to rank mutually exclusive projects
differently.
25)
26)
The major weakness of payback period in evaluating projects is that it cannot specify the
appropriate payback period in light of the wealth maximisation goal.
26)
6
Explanation:
27)
The payback period of a project that costs €1,000 initially and promises after–tax cash inflows of
€3,000 each year for the next three years is 0.333 years.
27)
28)
Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost
of capital and are therefore often acceptable at higher discount rates compared to projects with
higher cash inflows that occur in the later years.
28)
29)
The payback period of a project that costs £10,000 initially and promises after–tax cash inflows of
£3,000 each year for the next three years is 3.33 years.
29)
7
Answer Key
Testname: C4
8