Multiple Choice Questions on Capital Budgeting

2. The term mutually exclusive investments mean:
a. Choose only the best investments.
b. Selection of one investment precludes the selection of an alternative.
c. The elite investment opportunities will get chosen.
d. There are no investment options available.

ABC Company is considering two investments both of which cost $10,000. The cash flows are as follows:

Year Project A Project B
1 $6,000 $5,000
2 4,000 3,000
3 3,000 8,000

3. Based on the payback method, which of the two projects should be chosen?
a. Project A which has a payback period of 2.0 years.
b. Project A which has a payback period of 2.25 years.
c. Project B which has a payback period of 2.0 years.
d. Project B which has a payback period of 2.25 years.

4. Based on the net present value method, assuming a cost of capital of 10%, which of the two projects should be chosen?
a. Project A which has a net present value of $11,011.
b. Project A which has a net present value of $1,011.
c. Project B which has a net present value of $13,031
d. Project B which has a net present value of $3,031.

5. Which method provides more confidence, the payback method or the net present value method?
a. Payback because it provides a good timetable.
b. Payback because it tells you when you break even.
c. Net present value because it considers all inflows and outflows and the time value of money.
d. Net present value because it does not need to use cost of capital.

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $45,000. The annual cash flows have the following projections.

Year Cash Flow
1 $15,000
2 20,000
3 25,000
4 10,000
5 5,000

6. What is the net present value of selecting the new machine, assuming cost of capital of 10%?
a. $11,883
b. $13,883
c. $15,883
d. $17,883

7. What is the internal rate of return?
a. About 7%
b. About 10%
c. About 23%
d. About 27%

8. Should Pan American buy the machine?
a. Yes. NPV is positive and IRR exceeds cost of capital.
b. Yes. NPV is positive and IRR is less than cost of capital.
c. No. NPV does not provide enough information.
d. No. IRR is higher than the cost of capital.

Big Sky Construction Company is considering two new investments. Project E calls for the purchase of earth-moving equipment. Project H represents the investment in a hydraulic lift. Big Sky wishes to use a new present value profile in comparing the projects. The investment and cash flow patterns are as follows:

Project E
($20,000 investment) Project H
($20,000 investment)
Year Cash Flow
1 $ 5,000
2 6,000
3 7,000
4 10,000 Year Cash Flow
1 $16,000
2 5,000
3 4,000

9. What is the NPV of both projects using zero discount rate?
a. $8,000 for project E and $5,000 for project H
b. $8,000 for project H and $5,000 for project E
c. $28,000 for project E and $25,000 for project H
d. $20,000 for both projects.

10. What is the NPV of both projects using 9% discount rate?
a. $22,121 for project E and $21,970 for project H
b. $20,000 for both projects.
c. $2,121 for project E and $1,970 for project H
d. $8,000 for project E and $5,000 for project H

11. The IRR of project E is _______
a. About 9%
b. About 13%
c. About 16%
d. About 20%

12. If the two projects are mutually exclusive, which project would you accept using NPV, assuming cost of capital of 18%.
a. Project E
b. Project H
c. Both
d. Neither

13. Risk-averse managers will generally require _____ return from risky investments.
a. Lower
b. Zero
c. Higher
d. Negative

14. The concept of risk can be incorporated into the capital budgeting process by using higher discount rates for riskier investments.
a. True
b. False

15. If risk is to be analyzed in a qualitative way, which is the least risky?
a. New equipment
b. New market
c. Repair of old machinery
d. New product in a foreign market

Best Technology Corp. is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given.

Possible
Market Reaction Sales
in Units
Probabilities
Low response 20 .10
Moderate response 40 .20
High response 65 .40
Very high response
80 .30

16. What is the expected value of unit sales for new product?
a. 20
b. 30
c. 45
d. 60

17. What is the standard deviation of unit sales?
a. 370
b. 160
c. 19.2
d. 5.8

18. Project A has an expected return of $1,000 and a standard deviation of $590. Project B has expected return of $3,000 and a standard deviation of $750. Using coefficient of variation, which has a lower risk?
a. Project A, because coefficient of variation is higher.
b. Project A, because coefficient of variation is lower.
c. Project B, because coefficient of variation is higher.
d. Project B, because coefficient of variation is lower.

19. A company with a beta of 1.50 is considered to have lower level of risk than the stock market in general.
a. True
b. False

20. A company is considering the purchase one of two companies. Both of these companies have an expected return of 15% with the same standard deviation of returns. Company 1 has a positive correlation of returns with the acquiring company, while company 2 has a negative correlation. Which company should the acquiring company purchase if it must purchase one of them?
a. Company 1 because it reduces risk
b. Company 1 because it increases return
c. Company 2 because it reduces risk
d. Company 2 because it increases return