D362 Corporate Finance - Set 5 - Part 1

Test your knowledge of technical writing concepts with these practice questions. Each question includes detailed explanations to help you understand the correct answers.

Question 1: What is the main disadvantage of using the payback period method for project evaluation?

It is too complex to calculate.

It ignores cash flows after the payback period.

It does not require a discount rate.

It focuses too much on long-term profitability.

Question 2: What is the profitability index (PI) if the net present value (NPV) of a project is $20,000 and the initial investment is $100,000?

0.80

1.20

1.00

1.50

Question 3: Which of the following is a key assumption of the internal rate of return (IRR) method?

Future cash flows are reinvested at the cost of capital.

Future cash flows are reinvested at the IRR.

There are no future cash flows.

The project has zero risk.

Question 4: What is the role of the weighted average cost of capital (WACC) in capital budgeting?

It determines the payback period.

It is used as the discount rate in NPV calculations.

It eliminates the need for calculating NPV.

It only applies to short-term projects.

Question 5: Which of the following best describes capital rationing?

Allocating unlimited funds to all profitable projects.

Limiting the number of projects a firm can undertake due to budget constraints.

Selecting projects based on their profitability index only.

Using NPV as the sole project selection criterion.

Question 6: What is the purpose of the break-even analysis in project evaluation?

To calculate the profitability of multiple projects.

To determine the point where the project generates enough cash to cover its costs.

To evaluate the time needed to recover the initial investment.

To assess the overall risk of the project.

Question 7: What does a profitability index (PI) greater than 1 indicate?

The project is unprofitable.

The project has a negative NPV.

The project is expected to add value to the firm.

The project is likely to have multiple IRRs.

Question 8: When evaluating mutually exclusive projects, which method is generally preferred?

Payback period

Profitability index (PI)

Net present value (NPV)

Internal rate of return (IRR)

Question 9: Which of the following is an advantage of using the payback period method?

It incorporates the time value of money.

It focuses on liquidity and risk.

It gives a precise estimate of profitability.

It is the most accurate measure of project success.

Question 10: A project with non-conventional cash flows may result in:

A negative NPV.

Multiple IRRs.

A positive payback period.

A shorter discounted payback period.

Question 11: What does the term “stand-alone principle” refer to in capital budgeting?

Evaluating a project as if it were an independent entity.

Comparing a project to other projects in the same industry.

Using the weighted average cost of capital for decision-making.

Focusing on long-term project financing.

Question 12: What is a primary benefit of using sensitivity analysis in project evaluation?

It provides a precise estimate of NPV.

It identifies which variables have the most impact on project outcomes.

It eliminates all uncertainty in the decision-making process.

It is simpler to use than scenario analysis.

Question 13: Which of the following describes the concept of opportunity cost in capital budgeting?

The cost of acquiring new assets.

The potential return from an alternative investment.

The discount rate used in NPV calculations.

The expected rate of inflation.

Question 14: In capital budgeting, what does a project’s beta measure?

The project’s profitability.

The project’s unique risk.

The project’s systematic risk.

The project’s future cash flows.

Question 15: Which of the following is true regarding projects with a positive NPV?

The project is guaranteed to succeed.

The project is expected to earn a return greater than the cost of capital.

The project will result in a shorter payback period.

The project will always have a positive IRR.

Question 16: What does the payback period fail to consider?

The project’s initial investment.

The project’s future cash inflows.

The time value of money.

The project’s profitability.

Question 17: When using the NPV method, how is a project's cost of capital typically defined?

The expected rate of return for stockholders.

The discount rate used to evaluate future cash flows.

The rate of inflation.

The internal rate of return (IRR).

Question 18: What is the goal of capital budgeting?

To manage short-term cash flow needs.

To allocate funds to profitable long-term investments.

To reduce project risk to zero.

To calculate the optimal tax rate for the company.

Question 19: What is the main limitation of scenario analysis?

It ignores changes in project risk.

It is difficult to calculate the payback period.

It only considers the best-case scenario.

It relies on assumptions that may not reflect real-world outcomes.

Question 20: What is the primary difference between IRR and NPV?

IRR is easier to calculate than NPV.

NPV focuses on profitability, while IRR focuses on liquidity.

NPV uses the cost of capital, while IRR provides the break-even rate.

IRR is preferred for all projects, while NPV is rarely used.

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