Tag: analysis of financial statements

Questions Related to analysis of financial statements

Which of the following is not true for capital budgeting?

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  1. Sunk costs are ignored

  2. Opportunity costs are excluded

  3. Incremental cash flows are considered

  4. Relevant cash flows are considered

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Correct Option: B
Explanation:

Capital budgeting decisions involve huge funds and are long term decisions. As they involve huge costs one wrong decision would have a big effect on the business. They include all the potential expenses/costs. It includes opportunity cost, actual cost, incremental and relevant cash flows. It does not include sunk costs.

Capital Budgeting Decisions are __________.

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  1. Reversible

  2. Irreversible

  3. Unimportant

  4. All of the above

Show answer
Correct Option: B
Explanation:

Capital budgeting decisions involve huge funds and are long term decisions. As they involve huge costs one wrong decision would have a big effect on the business. Hence, capital budgeting decisions are irreversible as its difficult to take back the decision. 

Risk in Capital budgeting implies  _____________.

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  1. Uncertainty of Cash flows

  2. Probability of Cash flows

  3. Certainty of Cash flows

  4. Variability of Cash flows

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Correct Option: A
Explanation:

Risk is the probability of damage, loss or threat. Risk in capital budgeting implies that the decision maker knows the probability of cash flows. Therefore, risk in capital budgeting means uncertainty of cash flows. 

Feasibility Set Approach to Capital Rationing can be applied in ____________.

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  1. Accept-Reject situations

  2. Divisible projects

  3. Mutually Exclusive Projects

  4. None of the Above

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Correct Option: A
Explanation:

Feasibility Set Approach to capital Rationing can be applied in Accept-reject situations.  Accept-Reject situations are the situations which the company is not sure about, so conducting a feasibility test would ensure if the project is suitable or not for the company. 

In case of the indivisible projects, which of the following may not give the optimum result?

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  1. Internal Rate of Return

  2. Profitability Index

  3. Feasibility Set Approach

  4. All of the above

Show answer
Correct Option: C
Explanation:

Feasibility Set Approach to capital Rationing can be applied in divisible projects. Indivisible projects are the one which can be accepted or rejected wholly. So conducting a feasibility test would ensure if the project is suitable or not for the company. 

Real rate of return is equal to__________.

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  1. Nominal Rate x Inflation Rate

  2. Nominal Rate $\div$ Inflation Rate

  3. Nominal Rate - Inflation Rate

  4. Nominal Rate + Inflation Rate

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Correct Option: B
Explanation:

The real rate of return formula is the sum of one plus the nominal rate divided by the sum of one plus the inflation rate which then is subtracted by one. The formula for the real rate of return can be used to determine the effective return on an investment after adjusting for inflation.

Risk in capital budgeting implies that the decision-maker knows _______ of the cash flows.

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  1. Variability

  2. Probability

  3. Certainty

  4. None of the Above

Show answer
Correct Option: B
Explanation:

Risk is the probability of damage, loss or threat. Risk in capital budgeting implies that the decision maker knows the probability of cash flows. The decision maker after analysing the risk will have of fair idea of the cash flows that might arise from the decision that is made. 

A proposal is not a capital budgeting proposal if it____________.

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  1. Is related to fixed assets

  2. Brings long-term benefits

  3. Brings short-term benefits Only

  4. Has very large investment

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Correct Option: C
Explanation:

A proposal is not a capital budgeting proposal if it brings short-term benefits only. Capital budgeting decisions involve huge funds and are long term decisions, it benefits the firm in long term. As they involve huge costs one wrong decision would have a big effect on the business.

Profitability Index, when applied to Divisible Projects, impliedly assumes that_____________.

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  1. Project cannot be taken in parts

  2. NPV is linearly proportionate to part of the project taken up

  3. NPV is additive in nature

  4. Both B and C

Show answer
Correct Option: D
Explanation:

Profitability index is an index that identifies the relationship between cost and profitability of a project. Profitability Index. when applied to divisible projects impliedly assumes that project cannot be taken in parts has to be accepted fully, NPV is linearly proportionate to part of the project taken up and NPV is additive in nature. 

Evaluation of capital budgeting proposals is based on cash flows because_____________.

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  1. Cash rows are easy to calculate

  2. Cash flows are suggested by SEBI

  3. Cash is more important than profit

  4. None of the above

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Correct Option: C
Explanation:

Capital budgeting is based on cash flows because there is discounting and other factors used which can be done only on cash. Moreover, cash can be spent and not profit. Cash is more important than profit as the company has to focus on many costs. As in the long run the company will succeed if it focuses mote on cash flow statement.