Capital structure and budgeting decisions - One Line Questions
1.
What is a 'sunk cost' in the context of capital budgeting? —
A past cash outflow that cannot be recovered
2.
When evaluating independent projects in capital budgeting, a firm should generally accept all projects with: —
An NPV greater than zero
3.
In capital budgeting, what does the term 'cash flows' usually refer to? —
Incremental cash flows generated by the project
4.
Which of the following is a key assumption of the Net Present Value (NPV) method? —
Cash flows are received at the end of each period.
5.
Which of the following is NOT a source of long-term capital for a firm? —
Trade credit
6.
The Pecking Order Theory posits that firms prefer to finance new investments using: —
Internal financing (retained earnings) first, then debt, then equity
7.
Which of the following is a component of capital structure decisions? —
Financing mix of debt and equity
8.
The Modigliani-Miller theorem with taxes suggests that: —
Firm value increases with leverage due to tax benefits
9.
What is a disadvantage of having too much debt in the capital structure? —
Higher risk of financial distress and bankruptcy
10.
Which statement best describes the relationship between financial leverage and risk according to the Trade-off Theory? —
Increasing leverage increases financial risk, which can lead to bankruptcy costs.
11.
The concept of 'terminal value' in capital budgeting is used to account for: —
Cash flows beyond the explicit forecast period
12.
According to the Pecking Order Theory, why do firms prefer internal financing? —
It avoids signaling financial distress to the market.
13.
What is the main disadvantage of the IRR method when dealing with projects of unequal lives? —
It assumes reinvestment at the IRR
14.
A higher degree of financial leverage generally leads to: —
Higher risk for equity holders
15.
The optimal capital structure is the mix of debt and equity that: —
Maximizes the firm's value
16.
The concept of 'agency costs' is most relevant to which aspect of capital structure theory? —
Agency theory
17.
Which capital budgeting technique ignores the time value of money? —
Payback Period
18.
Which of the following is a measure of the risk associated with a capital budgeting project? —
Sensitivity Analysis
19.
Which capital budgeting technique is criticized for potentially ranking small projects higher than large, profitable ones? —
Profitability Index (PI)
20.
Which capital budgeting technique provides a measure of the project's profitability as a percentage of its investment? —
Accounting Rate of Return (ARR)
21.
The Internal Rate of Return (IRR) is the discount rate at which: —
NPV is zero
22.
A project is considered acceptable using the NPV method if: —
NPV is positive
23.
If a firm's WACC increases, what is the likely impact on the NPV of its projects? —
NPV will decrease
24.
Which of the following is a key component of a firm's capital structure? —
Debt
25.
Which capital budgeting technique measures the return generated by an investment relative to its cost? —
Profitability Index (PI)
26.
Which of the following capital budgeting methods is most theoretically sound for maximizing shareholder wealth? —
Net Present Value (NPV)
27.
The concept of 'reinvestment assumption' is critical for which capital budgeting technique? —
Internal Rate of Return (IRR)
28.
Which theory suggests that firms with higher debt ratios have lower taxes due to the tax deductibility of interest payments? —
Trade-off Theory
29.
The 'terminal value' in a DCF analysis for capital budgeting is often calculated using a: —
Perpetuity growth model
30.
The Profitability Index (PI) is calculated as: —
Present value of future cash flows / Initial investment
31.
When comparing mutually exclusive projects, the NPV rule is generally preferred over the IRR rule when: —
All of the above
32.
Which of the following is a potential benefit of using debt financing? —
Tax shield from interest deductibility
33.
Which type of capital budgeting decision involves choosing between alternative projects with different cash flow patterns? —
Mutually exclusive decisions
34.
The Net Present Value (NPV) method discounts future cash flows at the: —
Required rate of return (or cost of capital)
35.
What is the primary focus of capital budgeting decisions? —
Allocation of capital to long-term assets
36.
Opportunity cost in capital budgeting refers to: —
The return forgone from the next best alternative investment
37.
What is the Weighted Average Cost of Capital (WACC)? —
The average cost of all the capital components of a firm, weighted by their proportion
38.
The term 'financial distress costs' refers to: —
The direct and indirect costs associated with a firm nearing or entering bankruptcy
39.
The 'cost of equity' in WACC calculation is typically estimated using: —
The dividend growth model or CAPM
40.
The Modigliani-Miller (MM) theorem, in its original form, assumes: —
Perfect capital markets and no taxes
41.
In capital budgeting, the discount rate used typically reflects: —
The riskiness of the project and the firm's cost of capital
42.
What is the primary challenge in applying the Modigliani-Miller theorem in practice? —
The difficulty in achieving perfect capital markets
43.
Which of the following is considered a 'real' option in capital budgeting? —
The option to abandon a project
44.
When a firm has multiple IRRs for a project, it indicates: —
There is a change in the sign of cash flows more than once
45.
What is the cost of debt in the context of WACC calculation? —
The interest rate paid on new debt, adjusted for taxes
46.
What is the primary purpose of capital budgeting decisions for a firm? —
To evaluate and select long-term investment projects
47.
What is the primary purpose of capital budgeting? —
To make decisions about long-term investments
48.
What is the primary goal of capital structure decisions? —
To minimize the firm's total cost of capital
49.
The Trade-off Theory suggests that the optimal capital structure is achieved when the benefits of debt financing (like tax shields) are balanced against the costs of debt financing (like bankruptcy costs). —
True, this is the core idea of the Trade-off Theory.