MCQ On Basics Of Capital Budgeting Evaluating Cash Flows

Explanation
A project with positive cash flows means that the project is generating more money than the initial capital invested. This indicates that the project is profitable and has a positive rate of return. The net present value (NPV) is a financial metric used to determine the profitability of an investment by comparing the present value of cash inflows to the present value of cash outflows. If the cash flows are more than the capital invested, it implies that the NPV will also be positive, indicating a profitable investment.

Explanation
In mutually exclusive projects, the project that is selected in comparison to others must have a higher net present value. This is because the net present value represents the difference between the present value of cash inflows and the present value of cash outflows over the life of the project. A higher net present value indicates that the project is expected to generate more positive cash flows and provide a greater return on investment compared to the other projects. Therefore, selecting the project with the highest net present value would be the most favorable choice.

Explanation
Economic Value Added (EVA) and Net Present Value (NPV) have a direct relationship. This means that as EVA increases, NPV also increases, and vice versa. EVA measures the value created by a company, while NPV measures the present value of an investment's expected cash flows. When EVA is positive, it indicates that a company is generating value above its cost of capital, which in turn increases the NPV of investments. Conversely, when EVA is negative, it suggests that a company is not creating value, leading to a decrease in NPV. Therefore, the two concepts are directly linked.

Explanation
The payback period is calculated by dividing the uncovered cost at the start of the year by the full cashflow during the recovery year. In this case, the uncovered cost is $200 and the full cashflow is $400. Therefore, the payback period is 200/400 = 0.5 years. Since there are also prior years to full recovery, the payback period is extended by 3 years. Therefore, the total payback period is 0.5 + 3 = 3.5 years.

Explanation
Positive net present value (NPV) in capital budgeting indicates that the present value of cash inflows from an investment exceeds the present value of cash outflows. This means that the investment is expected to generate more cash inflows than the initial investment cost, resulting in positive economic value added. Economic value added measures the profitability of an investment by comparing the return on investment to the cost of capital. Therefore, a positive NPV implies that the investment is expected to create value and generate a positive economic value added.