Knowledge On Preliminary Concepts In Capital Budgeting

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Knowledge On Preliminary Concepts In Capital Budgeting - Quiz

This quiz has 10 multiple choice questions. The goal of this quiz is to test knowledge on Preliminary Concepts in Capital Budgeting

Questions and Answers
  • 1. 

    Capital Budgeting is -

    • A. 

      A sort of budget

    • B. 

      Determination of long term investment project

    • C. 

      Raising capital for a firm

    Correct Answer
    B. Determination of long term investment project
    Explanation
    Capital budgeting is a process, through which firms decide on their long term investments.

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  • 2. 

    You are given three Projects – A, B & C. For Project A, Net Present Value (NPV) is $20,000; For Project B, NPV is $30,000; For Project C, NPV is $40,000. Which project shall you choose?

    • A. 

      Project A

    • B. 

      Project B

    • C. 

      Project C

    Correct Answer
    C. Project C
    Explanation
    Project C has the highest NPV. So, this is chosen.

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  • 3. 

    You are given three Projects – A, B & C. Suppose Project A has Profitability Index (PI) of 2.14, Project B has PI of 3.25 and Project C has PI of 3.19. Which project shall you choose?

    • A. 

      Project A

    • B. 

      Project B

    • C. 

      Project C

    Correct Answer
    B. Project B
    Explanation
    Project B has the highest Profitability Index. So, it is chosen.

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  • 4. 

    You are given three Projects – A, B & C.Suppose Project A has Pay Back Period (PBP) of 2 years, Project B has PBP of 3.5 years and Project C has PBP of 3 years. Which project shall you choose?

    • A. 

      Project A

    • B. 

      Project B

    • C. 

      Project C

    Correct Answer
    A. Project A
    Explanation
    Project A is chosen, as it has the lowest Payback Period.

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  • 5. 

    Suppose interest rate is 10% compounded annually and you are investing $1000 now. What amount of money your investment will grow in 4 years time?

    • A. 

      $1331.00

    • B. 

      $1464.10

    • C. 

      $1400.00

    Correct Answer
    B. $1464.10
    Explanation
    After Year 1, $1000 becomes (at 10% interest): 1000 + 1000 x 10% = $1100
    After Year 2: 1100 + 1100 x 10% = $1210
    After Year 3: 1210 + 1210 x 10% = $1331
    After Year 4: 1331 + 1331 x 10% = $1464.10

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  • 6. 

    Suppose interest rate is 10%. 4 years from now, you expect to receive $1000. What is it's discounted value to you at present?

    • A. 

      $683.01

    • B. 

      $826.45

    • C. 

      $1000

    Correct Answer
    A. $683.01
    Explanation
    Future Cash Flows are discounted by the interest rate using the formula: FV/(1+r)^n. Here, FV=$1000, r=10%, n=4. So, Present Value = 1000/1.1^4 = $683.01

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  • 7. 

    If a Project A has greater NPV than that for a Project B, then Project A has greater PBP than that for Project B. This statement is -

    • A. 

      Always True

    • B. 

      Always False

    • C. 

      Not necessarily always True

    Correct Answer
    C. Not necessarily always True
    Explanation
    NPV and PBP are two different capital budgeting methods, with different concepts. So, not necessarily NPV and PBP will always choose the same project as the best project.

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  • 8. 

    Money has a time value, means -

    • A. 

      There is an interest rate, that discounts the value of future cash flows

    • B. 

      Cash flow now is not equivalent to same amount of cash flow in future

    • C. 

      Both of above

    Correct Answer
    C. Both of above
    Explanation
    Increased interest rate causes decrease in the value of future money in present time. For this same reason, cash now is not equivalent to cash in later periods. Thus, money has time value.

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  • 9. 

    If compounding occurs quarterly, then the amount to which money grows for an investment is -

    • A. 

      Greater than the amount to which money grows for an investment that compounds annually

    • B. 

      Less than the amount to which money grows for an investment that compounds annually

    • C. 

      Equal to the amount to which money grows for an investment that compounds annually

    Correct Answer
    A. Greater than the amount to which money grows for an investment that compounds annually
    Explanation
    Quarterly compounding means there are 4 compounding per year. The frequent the compounding occurs, the faster the money grows. So, quarterly compounding results in higher rise than annual compounding.

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  • 10. 

    In the evaluation of projects, conflict occurs when -

    • A. 

      NPV, PI, and PBP all select the same project as the best option

    • B. 

      NPV, PI, and PBP select different projects as the best option

    • C. 

      None of the above

    Correct Answer
    B. NPV, PI, and PBP select different projects as the best option
    Explanation
    Conflict means different capital budgeting approaches select different projects as the best option.

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