ACCA MA · Chapter 11
Capital budgeting MCQs with Answers
10 multiple-choice questions on Capital budgeting for ACCA MA Management Accounting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following is capital expenditure?
- A) Purchase of a new delivery vehicle
- B) Repairs to an existing delivery vehicle
- C) Fuel for delivery vehicles
- D) Annual insurance of delivery vehicles
Show answer & explanation
Answer: A) Purchase of a new delivery vehicle
Capital expenditure buys or improves non-current assets that will be used over several periods. Buying a vehicle is capital expenditure. Repairs, fuel and insurance keep existing assets running and are revenue expenditure.
Question 2
A project costs $120,000 now and is expected to generate cash inflows of $30,000 in Year 1, $40,000 in Year 2, $45,000 in Year 3 and $50,000 in Year 4. Assuming cash flows arise evenly through each year, what is the payback period?
- A) 3.0 years
- B) 2.9 years
- C) 3.1 years
- D) 2.4 years
Show answer & explanation
Answer: C) 3.1 years
Cumulative inflows: Year 1 30,000; Year 2 70,000; Year 3 115,000. After 3 years, 120,000 - 115,000 = $5,000 is still to be recovered. This takes 5,000 / 50,000 = 0.1 of Year 4. Payback = 3.1 years. Dividing by average annual inflows (120,000 / 41,250 = 2.9) is only valid when inflows are constant.
Question 3
$5,000 is invested at 6% per year, compounded annually. What will the investment be worth at the end of 4 years (to the nearest $)?
- A) $6,200
- B) $6,691
- C) $3,960
- D) $6,312
Show answer & explanation
Answer: D) $6,312
Future value = 5,000 x (1.06) to the power 4 = 5,000 x 1.262477 = $6,312. Simple interest would give 5,000 + (4 x 300) = $6,200. Compounding for 5 years gives $6,691, and $3,960 is the present value of $5,000 received in 4 years.
Question 4
A loan charges interest of 1.5% per month, compounded monthly. What is the equivalent annual interest rate (to two decimal places)?
- A) 18.00%
- B) 18.56%
- C) 19.56%
- D) 16.08%
Show answer & explanation
Answer: C) 19.56%
Effective annual rate = (1 + monthly rate) to the power 12 - 1 = (1.015) to the power 12 - 1 = 1.1956 - 1 = 19.56%. Simply multiplying 1.5% by 12 gives the nominal rate of 18.00%, which ignores compounding.
Question 5
A project costs $100,000 now and will generate cash inflows of $35,000 a year for 4 years, starting one year from now. The cost of capital is 10%, and the 4-year annuity factor at 10% is 3.170. What is the net present value?
- A) $10,950
- B) $40,000
- C) $(12,955)
- D) $32,685
Show answer & explanation
Answer: A) $10,950
PV of inflows = 35,000 x 3.170 = $110,950. NPV = 110,950 - 100,000 = $10,950, which is positive, so the project should be accepted. $40,000 is the undiscounted surplus, and the other figures use annuity factors for 3 or 5 years instead of 4.
Question 6
A project has an NPV of $10,950 at a discount rate of 10% and an NPV of $(5,850) at 18%. Using linear interpolation, what is the estimated internal rate of return (to one decimal place)?
- A) 15.2%
- B) 14.0%
- C) 12.8%
- D) 27.2%
Show answer & explanation
Answer: A) 15.2%
IRR = L + [NL / (NL - NH)] x (H - L) = 10% + [10,950 / (10,950 + 5,850)] x (18% - 10%) = 10% + (10,950 / 16,800) x 8% = 10% + 5.2% = 15.2%. Because the NPV at 18% is negative, the two NPVs are added in the denominator. 14.0% is simply the midpoint of the two rates.
Question 7
An investment will pay $12,000 a year in perpetuity, with the first receipt in one year's time. The discount rate is 8%. What is the present value of the perpetuity?
- A) $162,000
- B) $138,889
- C) $150,000
- D) $96,000
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Answer: C) $150,000
PV of a perpetuity starting in one year = annual cash flow / discount rate = 12,000 / 0.08 = $150,000. If the first payment were received immediately, the PV would be 150,000 + 12,000 = $162,000.
Question 8
A project will generate $20,000 a year at the end of Years 3 to 6 inclusive. The discount rate is 10%. Annuity factors at 10% (to 3 decimal places) are 1.736 for Years 1-2 and 4.355 for Years 1-6. Using these annuity factors, what is the present value of these cash flows?
- A) $63,400
- B) $87,100
- C) $47,613
- D) $52,380
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Answer: D) $52,380
The annuity factor for Years 3-6 = factor for Years 1-6 - factor for Years 1-2 = 4.355 - 1.736 = 2.619. PV = 20,000 x 2.619 = $52,380 (using the 3-decimal factors given). Using the 4-year factor at 10% (3.170) ignores the delay and gives $63,400. Discounting the 4-year annuity back 3 years instead of 2 (3.170 x 0.751 = 2.381) gives $47,613.
Question 9
Which of the following is an advantage of net present value (NPV) compared with the payback method?
- A) NPV takes account of all cash flows over the project's life and the time value of money
- B) NPV is quicker and simpler to calculate
- C) NPV does not require an estimate of the cost of capital
- D) NPV focuses only on the early cash flows, which are the least uncertain
Show answer & explanation
Answer: A) NPV takes account of all cash flows over the project's life and the time value of money
NPV discounts all relevant cash flows over the whole life of the project at the cost of capital, so it allows for the time value of money and measures the increase in shareholder wealth. Payback ignores cash flows after the payback point and, in its basic form, the time value of money.
Question 10
Which of the following should be excluded from the cash flows in an NPV appraisal of a new machine?
- A) Extra working capital needed at the start of the project
- B) Depreciation charged on the new machine
- C) Scrap proceeds from selling the machine at the end of its life
- D) Extra fixed overheads incurred only because of the project
Show answer & explanation
Answer: B) Depreciation charged on the new machine
NPV uses relevant future cash flows only. Depreciation is a non-cash accounting charge; the cash cost of the machine is already included as the initial outlay. Working capital, scrap proceeds and extra (incremental) fixed costs are all relevant cash flows.