Deck 4: The Decision-Making Process for Investment Appraisal

Question 1

What are the three reasons why IRR is used more than NPV?

A) It is thought (wrongly) to give a better ranking.
B) It results in more projects being accepted.
C) It can be calculated without cost of capital.
D) A psychological preference for a percentage

Answer 1

A, C, D

Question 2

What term is used for the ratio of accounting profit to investment expressed as a percentage?

A) Internal rate of return
B) Net rate of return
C) Accounting rate of return
D) Benefit- cost ratio

Answer 2

C

Question 3

Which of the following statements is false?

A) Two of the above.
B) If the payback period is less than the maximum acceptable payback period, accept the project.
C) If the payback period is greater than the maximum acceptable payback period, reject the project.
D) If the payback period is less than the maximum acceptable payback period, reject the project

Answer 3

D

Question 4

Which of the following best reflects practice in appraisal and acceptance of projects?

A) All potentially profitable projects are accepted.
B) Most projects that reach the report stage are adopted.
C) All carefully investigated projects are accepted.
D) Most projects are rejected because they have high levels of NPV.

Question 5

Which of the following statements accurately relates to the topic of risk?

A) The discount rate may be raised or lowered to allow for the risk of a project, the extent of the risk premium being based on indisputable theory.
B) Risk is unpredictable, and thus cannot be allowed for in project planning.
C) Risk can be quantified using objective probabilities that can be defined mathematically and inferred from historical data.
D) Risk is the probability of an outturn being less than anticipated.

Question 6

Which three of the following are drawbacks of using the accounting rate of return?

A) It relates accounting profit to investment.
B) It uses an arbitrary cut- off rate.
C) It can be calculated in a variety of ways.
D) Profit is a poor substitute for cash flow.

Question 7

Which three of the following accurately relate to the use of the accounting rate of return?

A) The method of calculating the accounting rate of return has been standardised and is widely accepted.
B) Accounting rate of return takes account of the time value of money.
C) Practitioners use a variety of approaches when calculating the accounting rate of return.
D) Accounting rate of return takes account of assets devoted to a project or business activity.

Question 8

Comparing net present value and internal rate of return

A) always results in the same ranking of projects.
B) may give different accept/reject decisions.
C) is only necessary on mutually exclusive projects.
D) always results in the same accept/reject decision.

Question 9

Which three of the following statements about using the accounting rate of return are true?

A) Managers' performances are often judged using ARR.
B) Many managers have familiarity with it
C) It gives the most accurate predictions.
D) It is easy to understand

Question 10

A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of €80,000 and cash inflows at the end of each of the next five years of €25,000. Project Z has a initial investment of €120,000 and cash inflows at the end of each of the next four years of €40,000. The firm should

A) accept only X if the cost of capital is at most 15 percent.
B) accept both if the cost of capital is at most 15 percent.
C) none of the above
D) accept only Z if the cost of capital is at most 15 percent.

Question 11

Payback is considered an unsophisticated capital budgeting because it

A) gives explicit consideration to the timing of cash flows and therefore the time value of money.
B) gives explicit consideration to the timing of cash flows and therefore the time value of money.
C) none of the above.
D) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate.

Question 12

The cash flow for a project is as shown in the table. The discount rate is 8 per cent. What is the payback and discounted payback of the project?

A) Payback in 4 years and discounted payback in 2 years
B) Payback in 4 years and discounted payback in 3 years
C) Payback in 5 years and discounted payback in 4 years
D) Payback in 4 years and discounted payback in 5 years

Question 13

Which of the following options best describes payback?

A) The length of time for cumulated future cash inflows to equal an initial outflow
B) The time taken for time- valued money outputs to exceed inputs
C) The time taken for time- valued money inputs to exceed outputs
D) The length of time for cumulated future cash outflows to equal an initial inflow

Question 14

What is the payback and average accounting rate of return of the following project?

A) Payback: 4 years, ARR 40%
B) Payback: 3 years, ARR 40%
C) Payback: 4 years, ARR 35%
D) Payback: 4 years, ARR 100%

Question 15

Which three of the following accurately relate to the accounting rate of return?

A) It is the ratio of accounting profit to investment, expressed as a percentage.
B) It makes no allowance for the time value of money.
C) It is calculated and is required by managers because they are often judged retrospectively by this measure.
D) It is calculated more often than payback, NPV, or IRR during project appraisal by UK firms.

Question 16

Which of the following methods is most suitable for analysing projects?

A) ARR
B) NPV
C) Discounted payback
D) Payback

Question 17

When the net present value is negative, the internal rate of return is the cost of capital.

A) less than
B) equal to
C) greater than or equal to
D) greater than

Question 18

Which of the following reasons is most likely to cause a firm to founder?

A) A shortage of good investment ideas
B) Poor methods of monitoring performance
C) Poor methods of appraising projects
D) An excess of good investment ideas

Question 19

Which of the following are the three first stages of the investment process?

A) Screening
B) Development and classification
C) Generation of ideas
D) Auditing

Question 20

Which three of the following are drawbacks of payback?

A) Cash flows beyond the payback cut- off are ignored.
B) The cut- off point is arbitrarily selected: it has no theoretical base.
C) It is difficult to calculate and interpret.
D) It fails to allow for the time value of money.

Question 21

The payback period of a project that costs €1,000 initially and promises after- tax cash inflows of
€3,000 each year for the next three years is 0.333 years.

Question 22

The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximisation goal.

Question 23

Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost of capital and are therefore often acceptable at higher discount rates compared to projects with higher cash inflows that occur in the later years.

Question 24

The measures the amount of time it takes the firm to recover its initial investment.

A) internal rate of return
B) net present value
C) average rate of return
D) payback period

Question 25

A firm is evaluating a proposal which has an initial investment of €35,000 and has cash flows of €10,000 in year 1, €20,000 in year 2, and €10,000 in year 3. The payback period of the project is

A) between two and three years.
B) one year.
C) two years.
D) between one and two years.

Question 26

The payback period of a project that costs £10,000 initially and promises after- tax cash inflows of
£3,000 each year for the next three years is 3.33 years.

Question 27

Which three of the following are the main attractions of using payback as an appraisal tool?

A) It makes allowance for the time value of money.
B) It complements more sophisticated methods.
C) It is simple and easy to use.
D) It makes allowance for increased risk of more distance cash flows.

Question 28

For conventional projects, both NPV and IRR techniques will always generate the same accept- reject decision, but differences in their underlying assumptions can cause them to rank mutually exclusive projects differently.

Question 29

Which of the following is the most popular method of project appraisal

A) ARR
B) Payback
C) NPV
D) Discounted payback