Question

1. For a typical capital investment project, the bulk of the investment-related cash outflow occurs:

1. During the initiation stage of the project
2. During the operation stage of the project
3. Either during the initiation stage or the operation stage
4. During neither the initiation stage nor the operation stage
5. Evenly during all three stages: initiation, operation, and final disposal

2. The time value of money is explicitly considered in which of the following capital budgeting methods?

1. Payback method
2. Net present value (NPV) method
3. Operating cash-flow method
4. Book (accounting) rate of return method
5. Residual income method

3. The internal rate of return is the discount rate at which the net present value of an investment project is zero. True/False
4. Scenario analysis focuses on the effect of an independent change in a single variable at a time. True/False
5. The inputs to the decision models used in capital budgeting are subject to uncertainty. True/False
6. The payback period of an investment is the length of time required for its cumulative after-tax cash inflows to equal its initial cash outlay. True/False
7. The accounting (book) rate of return (ARR) is equal to the ratio of some measure of accounting profit to some measure of invested capital. True/False
8. A capital investment analysis does not need to take into consideration the firm’s strategic positioning and competitive advantage. True/False
9. Discount rate equals the interest rate used to in DCF models to convert estimated future values back to a present-value basis. True/False
10. The hurdle rate is a general term used to describe the rate used to discount anticipated future cash flows to present value. True/False

Answer 1

1. A Capital Investment Project is a long term, capital intensive investment project with a purpose to build upon, add to, or improve a capital asset. Capital Investment Projects are defined by their large scale and large cost relative to other investments that involve less planning and resources.

Therefore, for a typical capital investment project, the bulk of the investment-related cash outflows occurs during the initial stage of the project.

2. The Net Present Value Method of the capital budgeting shows companies the difference between the cost of a project and the cash flow it is expected to bring in. It works by taking the initial investment amount and comparing it to the present value of the future cash flow generated by moving forward with that investment. NPV is based on the idea that future cash is not worth as much as present cash.

Therefore, the time value of money is explicitly considered in Net Present Value Method.

3.

The given statement is True as the Internal Rate of Return is the discount rate at which net present value of an investment project is zero.

The given statement is False as Scenario Analysis differs from sensitivity analysis as it allows for changing more than one variables at once while sensitivity analysis measures the effect of change in one variable while keeping all the factors constant.

The given statement is False as the inputs to the decision model used in capital budgeting are subject to certainty.

The given statement is True as the payback period of an investment is the length of time required for its cumulative after tax cash inflows to equal its initial cash outlay.

The given statement is True as the accounting rate of return is equal to the ratio of annual net profit from the investment or project to the initial investment.

The given statement is False as the capital investment analysis needs to take into consideration the firm's strategic positioning and competitive advantage.

The given statement is True as discount rate is the interest rate used to in DCF models to convert estimated future values back to a present value basis.

The given statement is True as the hurdle rate is a general term used to describe the rate used to discount anticipated future cash flows to present value.