Question 1

Which of the following statements best describes the Net Present Value (NPV) method in capital budgeting?

Accepted Answer

NPV is the sum of all future cash flows, discounted at the project's cost of capital, minus the initial investment.

Question 2

A project has the following cash flows: Year 0: $$-100, Year 1: 10$$, Year 2: $$60, Year 3: 80. If $$the WACC is 10%, what is the project's NPV? (Round to two decimal places)

Accepted Answer

$18.78

Question 3

Which of the following is NOT a limitation of the payback period method?

Accepted Answer

It properly ranks projects across various sizes and time horizons.

Question 4

If two projects are mutually exclusive, which project should be accepted according to the NPV rule?

Accepted Answer

The project with the highest positive NPV.

Question 5

The Internal Rate of Return (IRR) is defined as:

Accepted Answer

The discount rate that makes the NPV of a project equal to zero.

Question 6

A firm is considering a new product that will reduce sales of its existing product by 15%. What is this effect called, and how should it be treated in project analysis?

Accepted Answer

It is called an erosion cost and should be subtracted from the incremental cash flows.

Question 7

Which of the following costs should NOT be included in the calculation of incremental cash flows for a new project?

Accepted Answer

Sunk costs incurred before the project decision.

Question 8

A company is evaluating a project with the following cash flows: Initial investment: $$20,000; Year 1: 20$$,000; Year 2: $$2,000; Year 3: 2$$,000. If the cost of capital is 8.75%, what is the NPV of the project? (Use the formula $$NPV = \sum_{t=0}^{n} \frac{CF_t}{(1+r)^t})$$

Accepted Answer

$4,000

Question 9

Which formula correctly calculates the Profitability Index (PI) for a project with standard cash flows?

Accepted Answer

$$PI = \frac{NPV + |cost|}{|cost|}$$

Question 10

A firm’s Weighted Average Cost of Capital (WACC) is best described as:

Accepted Answer

The minimum acceptable rate of return the firm should earn on its investments of average risk.

Question 11

Which of the following is the correct formula for the cost of equity using the Dividend Growth Model?

Accepted Answer

$$R_E = \frac{D_1$}{P_0$} + g$$

Question 12

A company issues preferred stock with a $$1.25 annual dividend and a current price of 25.85. $$What is the cost of preferred stock ($$R_P$$)?

Accepted Answer

$$R_P = \frac{1.25}{25.85} = 0.0484 or 4.84$$%

Question 13

Which of the following statements about the cost of debt is TRUE?

Accepted Answer

The cost of debt is the required return on a company's debt, often estimated by the yield to maturity on existing debt.

Question 14

A company sells an asset for $$15,000 at the end of year 2. The book value at that time is 16$$,800, and the marginal tax rate is 21%. What is the after-tax salvage value (ATSV)? Use the formula $$ATSV = SV - T_c(SV - BV).$$

Accepted Answer

$$15,378$$

Question 15

Which of the following is a correct statement about sunk costs?

Accepted Answer

Sunk costs are expenses that have already been incurred and should not be considered in project evaluation.

Question 16

Which of the following best describes the difference between arithmetic and geometric average returns?

Accepted Answer

Geometric average return accounts for compounding over multiple periods, while arithmetic average does not.

Question 17

Which of the following is the correct formula for the cost of equity using the Security Market Line (SML) approach?

Accepted Answer

$$R_E = R_f + \beta_E (E(R_M) - R_f)$$

Question 18

A project requires an initial investment of $$100,000 and is expected to generate cash inflows of 40$$,000 per year for 3 years. If the WACC is 10%, what is the NPV of the project? (Use $$NPV = \sum_{t=0}^{n} \frac{CF_t}{(1+r)^t})$$

Accepted Answer

$$NPV = -100,000 + \frac{40,000}{1.1} + \frac{40,000}{1.1^2} + \frac{40,000}{1.1^3} = -100,000 + 36,364 + 33,058 + 30,053 = -$536$$

Question 19

Which of the following statements about the Efficient Market Hypothesis (EMH) is correct?

Accepted Answer

In a strong-form efficient market, all public and private information is reflected in stock prices.

Capital Budgeting, Cash Flow Analysis, and Financial Decision Models – FINA3001 Exam 3 Review

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