Q.1 Which of the following is the primary objective of capital budgeting?
To reduce costs
To evaluate long-term investments
To record day-to-day expenses
To maintain liquidity
Explanation - Capital budgeting is mainly concerned with evaluating and selecting long-term investment projects that will yield benefits over time.
Correct answer is: To evaluate long-term investments
Q.2 Which method of capital budgeting considers the time value of money?
Payback Period
Accounting Rate of Return
Net Present Value
Average Rate of Return
Explanation - The Net Present Value (NPV) method discounts future cash flows to their present value, considering the time value of money.
Correct answer is: Net Present Value
Q.3 The internal rate of return (IRR) is the rate at which:
Future cash inflows equal future cash outflows
Present value of cash inflows equals present value of cash outflows
Net Present Value is maximized
Payback Period is minimized
Explanation - IRR is the discount rate that equates the present value of inflows and outflows, making NPV equal to zero.
Correct answer is: Present value of cash inflows equals present value of cash outflows
Q.4 Which of the following ignores the time value of money?
Net Present Value
Internal Rate of Return
Payback Period
Profitability Index
Explanation - The Payback Period method calculates how quickly an investment recovers its cost but does not consider the time value of money.
Correct answer is: Payback Period
Q.5 Which metric is defined as the ratio of present value of cash inflows to initial investment?
Net Present Value
Payback Period
Profitability Index
Internal Rate of Return
Explanation - Profitability Index (PI) measures the benefit per unit of cost, calculated as PV of inflows divided by initial investment.
Correct answer is: Profitability Index
Q.6 What is the discount factor used in Net Present Value calculations?
Accounting rate
Cost of capital
Payback period
Return on investment
Explanation - NPV discounts future cash inflows using the cost of capital as the discount factor.
Correct answer is: Cost of capital
Q.7 In capital budgeting, which technique is considered the most theoretically sound?
Payback Period
Accounting Rate of Return
Net Present Value
Internal Rate of Return
Explanation - NPV is considered the most reliable method because it considers cash flows, time value of money, and risk.
Correct answer is: Net Present Value
Q.8 Which capital budgeting method gives multiple IRRs under unconventional cash flows?
Net Present Value
Internal Rate of Return
Profitability Index
Payback Period
Explanation - When cash flows change sign multiple times, IRR can yield multiple values, making NPV a better choice in such cases.
Correct answer is: Internal Rate of Return
Q.9 What does a positive NPV indicate?
The project should be rejected
The project increases firm value
The payback period is shorter
The IRR is lower than the cost of capital
Explanation - A positive NPV means the present value of inflows exceeds the outflows, adding value to the firm.
Correct answer is: The project increases firm value
Q.10 Which of the following is a non-discounting technique?
Net Present Value
Payback Period
Profitability Index
Discounted Payback Period
Explanation - The Payback Period is a non-discounting method since it doesn’t account for the time value of money.
Correct answer is: Payback Period
Q.11 What does the Accounting Rate of Return (ARR) measure?
Return based on cash flows
Return based on accounting profits
Discounted value of returns
Capital structure returns
Explanation - ARR evaluates returns using accounting profits instead of cash flows, ignoring the time value of money.
Correct answer is: Return based on accounting profits
Q.12 Which decision rule is consistent with maximizing shareholder wealth?
Net Present Value
Payback Period
Accounting Rate of Return
Simple Average Return
Explanation - NPV directly measures the increase in shareholder wealth and aligns with financial management objectives.
Correct answer is: Net Present Value
Q.13 If a project's IRR is greater than the cost of capital, then:
NPV will be negative
The project should be accepted
The project reduces value
The payback period will increase
Explanation - If IRR exceeds the cost of capital, the project earns more than its financing cost, so it should be accepted.
Correct answer is: The project should be accepted
Q.14 Which method measures the time taken to recover the initial investment in present value terms?
Discounted Payback Period
Net Present Value
Profitability Index
Accounting Rate of Return
Explanation - Discounted Payback Period considers the time value of money while calculating recovery time for investments.
Correct answer is: Discounted Payback Period
Q.15 Which of the following is a limitation of the Payback Period method?
It considers time value of money
It ignores cash flows after recovery
It always gives correct results
It is difficult to compute
Explanation - Payback period ignores cash flows beyond the recovery period, making it less accurate for long-term profitability.
Correct answer is: It ignores cash flows after recovery
Q.16 Which technique is also called the benefit-cost ratio?
Payback Period
Profitability Index
Internal Rate of Return
Accounting Rate of Return
Explanation - Profitability Index is the ratio of PV of inflows to investment, also known as benefit-cost ratio.
Correct answer is: Profitability Index
Q.17 Which factor primarily affects capital budgeting decisions?
Short-term liabilities
Shareholder meetings
Expected cash inflows
Depreciation method
Explanation - Capital budgeting decisions depend on the estimation of future cash inflows from projects.
Correct answer is: Expected cash inflows
Q.18 A project with a zero NPV means:
The project should always be rejected
The project neither adds nor reduces value
The IRR is less than cost of capital
The project increases shareholder wealth
Explanation - Zero NPV means inflows are just enough to recover the investment and cost of capital.
Correct answer is: The project neither adds nor reduces value
Q.19 Which capital budgeting method is most suitable when capital is rationed?
Net Present Value
Profitability Index
Internal Rate of Return
Payback Period
Explanation - Profitability Index helps rank projects based on benefits per unit of cost, useful under capital rationing.
Correct answer is: Profitability Index
Q.20 What type of decision is capital budgeting?
Short-term
Operational
Long-term
Day-to-day
Explanation - Capital budgeting involves evaluating long-term investments like plant, machinery, and expansion projects.
Correct answer is: Long-term
Q.21 Which is a discounted cash flow technique?
Net Present Value
Payback Period
Accounting Rate of Return
Simple Rate of Return
Explanation - NPV is a discounted cash flow technique that accounts for the time value of money.
Correct answer is: Net Present Value
Q.22 Which of the following is not a capital budgeting technique?
Net Present Value
Payback Period
Break-even Analysis
Profitability Index
Explanation - Break-even analysis is a cost-volume-profit tool, not a capital budgeting technique.
Correct answer is: Break-even Analysis
Q.23 Which of the following best represents mutually exclusive projects?
Projects independent of each other
Projects with identical cash flows
Projects where acceptance of one excludes the other
Projects with equal NPV
Explanation - Mutually exclusive projects mean that only one project can be undertaken out of the available choices.
Correct answer is: Projects where acceptance of one excludes the other
Q.24 If the cost of capital increases, what happens to NPV?
It increases
It decreases
It remains constant
It turns positive
Explanation - Higher cost of capital increases the discount rate, reducing the present value of future inflows, thus lowering NPV.
Correct answer is: It decreases
Q.25 Which method uses average annual accounting income as a basis?
Accounting Rate of Return
Net Present Value
Internal Rate of Return
Profitability Index
Explanation - ARR evaluates performance based on accounting profits rather than cash flows or time value of money.
Correct answer is: Accounting Rate of Return