CTP Long-Term Capital Investments 5 — Questions and Answers
Question 1: When evaluating an international capital investment, the treasury professional must account for an additional risk factor known as:
- Default risk premium
- Country risk premium (Correct answer)
- Liquidity risk premium
- Duration risk
Correct answer: Country risk premium
International projects require a country risk premium added to the discount rate to reflect political, regulatory, and sovereign risks.
Question 2: The weighted average cost of capital (WACC) used as a discount rate implicitly assumes that the project:
- Has the same risk as the firm's existing asset portfolio (Correct answer)
- Is financed entirely with equity
- Will generate cash flows only in the domestic currency
- Has a shorter life than the firm's average investment
Correct answer: Has the same risk as the firm's existing asset portfolio
Using the firm's WACC is only appropriate when the project has similar risk and capital structure characteristics as the firm's existing operations.
Question 3: Monte Carlo simulation in capital budgeting generates:
- A single best-estimate NPV
- A probability distribution of NPV outcomes across thousands of scenarios (Correct answer)
- The exact IRR for the most likely scenario
- Break-even units required for the project to succeed
Correct answer: A probability distribution of NPV outcomes across thousands of scenarios
Monte Carlo simulation randomly samples input variable distributions thousands of times to build a probability distribution of possible NPV outcomes.
Question 4: A firm sells an old machine for $80,000. The machine has a book value of $50,000 and the tax rate is 25%. What is the after-tax salvage value?
- $80,000
- $72,500 (Correct answer)
- $57,500
- $50,000
Correct answer: $72,500
Tax on gain = ($80,000 − $50,000) × 25% = $7,500; after-tax salvage = $80,000 − $7,500 = $72,500.
Question 5: Which of the following is a limitation of the payback period method?
- It is difficult to compute for projects with even cash flows
- It ignores the time value of money and cash flows beyond the payback period (Correct answer)
- It requires estimating a discount rate
- It always conflicts with NPV rankings
Correct answer: It ignores the time value of money and cash flows beyond the payback period
The payback period ignores both the time value of money and all cash flows occurring after the payback cutoff date, potentially favoring inferior projects.
Question 6: A project generates the following undiscounted cash flows: Year 0: −$200,000; Years 1−5: $50,000/yr. Which statement is TRUE regarding its discounted payback period versus simple payback period?
- They are always identical
- The discounted payback period is shorter than the simple payback period
- The discounted payback period is longer than the simple payback period (Correct answer)
- The discounted payback period cannot be calculated without the IRR
Correct answer: The discounted payback period is longer than the simple payback period
Discounting reduces the present value of future cash flows, so more periods are needed to recover the investment, making the discounted payback always longer.
Question 7: An expansion project requires an increase in net working capital (NWC) of $40,000 at inception. This NWC investment should be treated as:
- A tax-deductible operating expense in Year 0
- A cash outflow at inception, recovered as a cash inflow at project termination (Correct answer)
- An increase to the project's annual depreciation expense
- Irrelevant to the capital budgeting analysis
Correct answer: A cash outflow at inception, recovered as a cash inflow at project termination
NWC invested at project start is a cash outflow that is recovered (as a cash inflow) at the project's end when working capital needs wind down.
CTP Long-Term Capital Investments 5
When evaluating an international capital investment, the treasury professional must account for an additional risk factor known as: