MCQs on Capital Budgeting

Capital Budgeting is the process of making financial decisions regarding investing in long-term assets for a business. It involves conducting a thorough evaluation of risks and returns before approving or rejecting a prospective investment decision. This process is also known as investment appraisal. Capital budgeting decisions are a part of the overall financial management process for a firm. Decisions like constructing a new factory, purchasing heavy machinery for production or making a significant investment in an outside business entity are examples of Capital Budgeting.

Below is a list of multiple-choice questions and answers on Capital Budgeting to help students understand the importance of this process in a company’s overall decision making.

1. Which of the following is not true about Capital Budgeting?
   1. Capital Budgeting decisions have an influence on the future stability of an organisation
   2. Capital Budgeting decisions include investments to expand the business
   3. Capital Budgeting decisions are of an irreversible nature
   4. Sunk cost is a part of Capital Budgeting

Answer: d

2. Why is evaluating Capital Budgeting decisions based on cash flows?
   1. Cash is more important for an organisation than profits
   2. Cash flows are much easier to calculate compared to profits
   3. Both a and b are incorrect
   4. Both a and b are correct

Answer: c

3. _______ is a project whose cash flows are not affected by the acceptance or rejection of other projects.
   1. Risk-free project
   2. Low-cost project
   3. Independent project
   4. None of the above

Answer: c

4. Which of the following would be the result of including flotation costs in the analysis of a project?
   1. It will increase the initial outflow of cash for the project
   2. It will increase the rate of return for the project
   3. It will increase the Net Present Value (NPV) of the project
   4. It will have zero effect on the current value of the project

Answer: a

5. What should be the criteria of selection when choosing among mutually exclusive projects?
   1. Selecting a project with a lower cost of capital
   2. Selecting a project with the quickest payback
   3. Selecting a project with the longest payback
   4. Selecting a project with the highest net present value

Answer: b

6. Which of the following is true for a project with a shorter payback period?
   1. The project will have more Net Present Value
   2. The project will have less Net Present Value
   3. The project carries a greater amount of risk
   4. The project carries a lesser amount of risk

Answer: d

7. Which of the following is the term that describes the amount of time taken for a capital budgeting project to recover its initial investment?
   1. Investment period
   2. Redemption period
   3. Payback period
   4. Maturity period

Answer: c

8. Which of the following can be a criterion for the acceptance of a project?
   1. The Profitability Index should be greater than unity
   2. The Internal Rate of Return should be greater than the cost of capital
   3. The Net Present Value should be greater than zero
   4. All of the above

Answer: d

9. Which of the following is true for a project with a shorter payback period?
   1. The project will have a lesser risk
   2. The project will have less Net Present Value
   3. The project will have more Net Present Value
   4. The project will have a greater risk

Answer: a

10. Capital Budgeting decisions are evaluated using the _________ and _______ is used for this purpose.
    1. Weighted average, cost of capital
    2. Weighted average, component cost
    3. Unweighted average, cost of capital
    4. None of the above

Answer: a

11. What is the main difference between accounting profit and economic profit?
    1. Economic profit is based on cash flows, while accounting profit is based on specific rules for accountancy
    2. Accounting profit includes the last accounting period, while economic profit includes the entire life of a firm’s existence
    3. Accounting profit has a small charge for debt, but economic profit has a small charge for the providers of capital
    4. All of the above

Answer: d

12. Which of the following is a disadvantage of using the payback period?
    1. It does not take into account the cost of capital and timing of return
    2. When compared to the accounting rate of return method, it is more difficult to calculate and understand
    3. It does not take the initial investment into account
    4. All of the above

Answer: a

13. What is the main reason behind the specific required rates of return for different projects?
    1. It does not take into account the cost of capital and timing of return
    2. If a firm is divided then the units will also have a separate rate of return
    3. Both a and b are correct
    4. None of the above

Answer: a

14. Which of the following decisions require the use of a decision-tree approach?
    1. It is used for projects with independent cash flows
    2. It is used for making a decision to either accept or reject a proposal
    3. It is used for sequential decisions
    4. None of the above

Answer: a

15. Which of the following is true for an investment proposal with the most significant relative risk?
    1. It will have the lowest opportunity loss
    2. It will have the highest expected net present value
    3. It will have the highest standard deviation of the net present value
    4. It will have the highest coefficient of variation of the net present value

Answer: d

16. Which of the following would be the best example of a capital budgeting decision?
    1. Purchasing new machinery to replace an existing one
    2. Transferring money to your creditor’s account
    3. Payment of electricity bill for your factory
    4. None of the above

Answer: a

17. Which of the following decisions affects the size of assets, the profitability and competitiveness of a firm?
    1. Dividend decision
    2. Working capital decision
    3. Capital Budgeting decision
    4. None of the above

Answer: c

18. Which of the following is not incorporated within the capital budgeting decision for a company?
    1. The rate of cash discount
    2. Time value of money
    3. The required rate of return
    4. None of the above

Answer: a

19. Which of the following principles is not considered within capital budgeting for a company?
    1. Post-tax principle
    2. Accrual principle
    3. Cash flows principle
    4. None of the above

Answer: b

20. Which of the following is not true for Capital Budgeting for a business?
    1. The timing of cash flows is relevant
    2. The existing investment within a project is not considered as the sunk cost
    3. The cost of capital is equal to the minimum required rate of return
    4. The capital budgeting is only related to the asset replacement decisions

Answer: b

Also See:

• Difference between Cost Accounting and Management Accounting
• Difference between Wholesale Price Index and Consumer Price Index
• Financial statements of a company