CPA Quiz: Perform Capital Budgeting Analysis
20 questions · exam conditions
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Perform Capital Budgeting AnalysisQuestion 1 of 20

A project requires an initial investment of $500,000 and generates after-tax cash flows of $150,000 per year for 5 years. The discount rate is 10% and the PV annuity factor for 5 years at 10% is 3.791. What is the NPV?

$250,000
$68,650
$150,000
-$68,650
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CPA Quiz: Perform Capital Budgeting Analysis

Practice Perform Capital Budgeting Analysis in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

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This quiz focuses on Perform Capital Budgeting Analysis, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

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Question 1

A project requires an initial investment of $500,000 and generates after-tax cash flows of $150,000 per year for 5 years. The discount rate is 10% and the PV annuity factor for 5 years at 10% is 3.791. What is the NPV?

  1. $250,000
  2. $68,650 (correct answer)
  3. $150,000
  4. -$68,650
Explanation: PV of cash flows = $150,000 x 3.791 = $568,650. NPV = $568,650 - $500,000 = $68,650. A positive NPV indicates the project creates value above the cost of capital. Option A sums undiscounted cash flows and subtracts the investment. Option C reports only one year's cash flow. Option D applies the correct formula but labels the sign incorrectly.

Question 2

A capital project uses straight-line depreciation of $80,000 per year. The tax rate is 25%. What is the annual depreciation tax shield?

  1. $80,000
  2. $60,000
  3. $40,000
  4. $20,000 (correct answer)
Explanation: Depreciation tax shield = Depreciation x Tax rate = $80,000 x 25% = 20,000.Depreciationisanon−cashexpensethatreducestaxableincome;thetaxsavingsfromthisreductionequalsthedepreciationamountmultipliedbythetaxrate.OptionAisthefulldepreciationamountbeforethetaxeffect.OptionBistheafter−taxoperatingincomeeffectofdepreciation(20,000. Depreciation is a non-cash expense that reduces taxable income; the tax savings from this reduction equals the depreciation amount multiplied by the tax rate. Option A is the full depreciation amount before the tax effect. Option B is the after-tax operating income effect of depreciation (80,000 x 75%). Option C uses a 50% tax rate.

Question 3

A company is replacing equipment. The old machine has a book value of $50,000 and a current market value of $30,000. The tax rate is 30%. What are the after-tax proceeds from selling the old equipment?

  1. $36,000 (correct answer)
  2. $30,000
  3. $44,000
  4. $50,000
Explanation: Loss on sale = Book value - Market value = $50,000 - $30,000 = $20,000. Tax benefit from loss = $20,000 x 30% = $6,000. After-tax proceeds = Market value + Tax benefit = $30,000 + $6,000 = $36,000. Selling at below book value creates a tax-deductible loss that increases the after-tax proceeds above the market value. Option B ignores the tax benefit. Option C applies the tax rate to the market value rather than the loss. Option D uses book value instead of market value.

Question 4

A $300,000 equipment purchase will generate pre-tax cost savings of $90,000 per year for 5 years. The tax rate is 25% and straight-line depreciation produces $60,000 per year. The PV annuity factor at 10% for 5 years is 3.791. What is the NPV?

  1. $12,000
  2. $12,758 (correct answer)
  3. $55,650
  4. $42,892
Explanation: After-tax annual cash flow = After-tax savings + Depreciation tax shield = (90,000x0.75)+(90,000 x 0.75) + (60,000 x 0.25) = $67,500 + $15,000 = $82,500. PV of cash flows = $82,500 x 3.791 = $312,758. NPV = $312,758 - $300,000 = $12,758. Option A uses an incorrect after-tax rate. Option C uses the full pre-tax savings as the cash flow base. Option D applies only the after-tax savings without the depreciation tax shield.

Question 5

Project L has a payback of 4.5 years and NPV of $420,000. Project S has a payback of 1.8 years and NPV of $95,000. A risk-averse CFO proposes selecting Project S for its faster payback. Which concern is most analytically relevant?

  1. Payback period is always the appropriate criterion for risk-averse decision makers
  2. Shorter payback always indicates lower investment risk
  3. Selecting Project S sacrifices $325,000 of value; payback ignores cash flows beyond the recovery point and does not discount for time value of money (correct answer)
  4. Both projects carry equivalent risk because they operate in the same industry
Explanation: Choosing Project S over Project L gives up 325,000ofNPV(325,000 of NPV (420,000 - $95,000). The payback period has two known limitations: it ignores all cash flows after the payback point (which is where much of Project L's value may be generated) and it does not apply time value discounting. While faster payback does reduce some forms of liquidity risk, it is an incomplete metric for value creation. A risk-averse investor should consider a risk-adjusted NPV or scenario analysis rather than relying on payback as a proxy for risk. Options A and B overstate the reliability of payback as a risk measure. Option D is an unsupported assumption.

Question 6

A project has positive NPV of 45,000atthecompany′sWACCof1245,000 at the company's WACC of 12%. The project involves a new market with no prior company experience. The CFO adds a 3% risk premium, reducing NPV to -28,000 at 15%. Which analytical conclusion is most appropriate?

  1. The project should be accepted because the base-case NPV is positive at WACC
  2. The project's viability depends critically on whether 12% or 15% appropriately reflects the risk of this specific investment; management should validate the risk premium before deciding (correct answer)
  3. The 3% risk premium is excessive and should be ignored in the analysis
  4. Any project with positive NPV at WACC should always be accepted regardless of risk adjustments
Explanation: When a modest change in the discount rate flips NPV from positive to negative, the investment's acceptance hinges on the accuracy of the risk adjustment. The WACC reflects the average risk of the company's existing operations; a new-market project may legitimately warrant a higher rate. The analytical imperative is to validate whether 3% is the right incremental risk premium based on the specific characteristics of this project - market risk, execution uncertainty, competitive dynamics - rather than accepting or dismissing it arbitrarily. Options A and D ignore the risk signal. Option C dismisses the risk premium without analytical basis.

Question 7

Equipment costs $200,000 to purchase or can be leased with annual payments of $44,000 for 5 years paid at year beginning (annuity due). The tax rate is 25% and the PV annuity due factor for 5 years at 8% is 4.312. What is the present value of the after-tax lease payments?

  1. $165,000
  2. $192,024
  3. $158,500
  4. $142,296 (correct answer)
Explanation: After-tax annual lease payment = $44,000 x (1 - 0.25) = $33,000. PV of after-tax lease payments (annuity due) = $33,000 x 4.312 = $142,296. Option A uses the pre-tax payment without the tax reduction. Option B applies the pre-tax payment to the annuity due factor. Option C uses a different annuity factor.

Question 8

A company consistently approves capital projects with positive total NPV, yet company-wide ROIC has declined for three consecutive years. Which analytical concern does this pattern raise?

  1. NPV analysis must be incorrect if ROIC is declining simultaneously
  2. ROIC and NPV measure fundamentally different things and cannot be compared
  3. Individual project NPVs are the only relevant measure and company-wide ROIC should be ignored
  4. Projects may be approved based on optimistic projections that are not achieved in practice; the gap between expected and actual project performance suggests biased forecasting, poor project selection, or inadequate post-implementation review of capital allocations (correct answer)
Explanation: A persistent ROIC decline despite an apparently sound capital approval process signals a disconnect between projected and actual project performance. This can result from: overly optimistic forecasts in project proposals (benefits overstated, costs understated), selection bias toward projects that look good on paper, or failure to track and learn from post-implementation performance. A rigorous capital allocation process should include systematic comparison of project outcomes against original forecasts to detect and correct persistent biases. Option A incorrectly attributes the problem to the NPV method itself. Option B incorrectly claims they are unrelated. Option C prioritizes a forecast metric over an outcome metric.

Question 9

A project requires an initial investment of $240,000 and generates cash flows of $60,000 (Year 1), $90,000 (Year 2), $80,000 (Year 3), and $70,000 (Year 4). What is the payback period?

  1. 3.0 years
  2. 2.7 years
  3. 3.14 years (correct answer)
  4. 4.0 years
Explanation: Cumulative cash flows: End of Year 1 $60,000; Year 2 $150,000; Year 3 $230,000. Remaining after Year 3 = $240,000 - $230,000 = $10,000. Year 4 fraction = $10,000 / $70,000 = 0.143. Payback = 3 + 0.143 = 3.14 years. Option A assumes the full investment is recovered exactly at Year 3. Option B calculates an earlier payback based on incorrect cumulative totals. Option D assumes recovery requires the full Year 4 cash flow.

Question 10

A company has a capital budget of $1,000,000 and three independent projects: Project A (investment $400,000, NPV $120,000, PI 1.30), Project B (investment $600,000, NPV $180,000, PI 1.30), Project C (investment $500,000, NPV $100,000, PI 1.20). Under capital rationing, which combination maximizes total NPV within the budget?

  1. Project B only; total NPV $180,000
  2. Project A only; total NPV $120,000
  3. All three projects; total NPV $400,000
  4. Projects A and C; total NPV $220,000 (correct answer)
Explanation: Feasible combinations within $1,000,000: A+C = $900,000 (NPV $220,000); B only = $600,000 (NPV $180,000); A only = $400,000 (NPV $120,000); A+B exceeds $1M. Projects A and C together generate the highest total NPV of $220,000. Although both A and B have the same PI (1.30), B alone generates only $180,000, while A+C generates $220,000. All three projects combined would require $1,500,000, exceeding the budget. The PI ranking confirms A and C should be selected over B alone.

Question 11

A project has an NPV of 85,000ata1285,000 at a 12% discount rate and an NPV of -20,000 at an 18% discount rate. Using linear interpolation, what is the approximate IRR?

  1. 15.0%
  2. 16.0%
  3. 16.9% (correct answer)
  4. 18.0%
Explanation: IRR = Lower rate + [NPV at lower rate / (NPV at lower rate + |NPV at upper rate|)] x (Upper rate - Lower rate) = 12% + [85,000/(85,000 / (85,000 + $20,000)] x (18% - 12%) = 12% + (0.810 x 6%) = 12% + 4.86% = 16.86%, approximately 16.9%. Option A uses an equal split between the two rates. Option B underestimates the interpolation result. Option D is the upper bound where NPV is negative.

Question 12

A project requires a $750,000 initial investment including $50,000 of net working capital. It generates after-tax cash flows of $160,000 per year for 6 years. At Year 6, salvage value is $80,000 (after-tax) and working capital is fully recovered. PV annuity factor at 10% for 6 years is 4.355; PV factor at Year 6 is 0.564. What is the NPV?

  1. $20,120 (correct answer)
  2. -$20,120
  3. $73,320
  4. $696,800
Explanation: PV of operating cash flows = $160,000 x 4.355 = $696,800. Terminal cash flows = Salvage $80,000 + NWC recovery $50,000 = $130,000. PV of terminal cash flows = $130,000 x 0.564 = $73,320. Total PV = $696,800 + $73,320 = $770,120. NPV = $770,120 - $750,000 = $20,120. Option B labels the sign incorrectly. Option C reports only the PV of terminal cash flows. Option D reports only the PV of operating cash flows.

Question 13

A $5,000,000 factory expansion generates positive NPV at the base-case demand forecast. Sensitivity analysis shows NPV turns negative if annual demand grows below 3%. Current industry demand growth is 2.1%. Which conclusion is most analytically sound?

  1. The project should be accepted because base-case NPV is positive
  2. The 3% threshold is close enough to the 2.1% rate that the risk is acceptable
  3. The project requires demand growth exceeding the current industry rate to be NPV-positive; the break-even demand assumption is above the observable market trend, making this a high-risk investment requiring additional scrutiny before approval (correct answer)
  4. NPV analysis is not appropriate for capacity expansion decisions
Explanation: The sensitivity analysis reveals that this project is viable only if demand outpaces current market conditions. The break-even threshold (3%) is above the observable industry growth rate (2.1%), meaning the base-case forecast implicitly assumes either above-market company performance or a market acceleration. This is a significant analytical concern: if demand follows industry trends, the project destroys value. The decision should involve rigorous assessment of what competitive advantages justify the above-market demand assumption, or consideration of a phased or smaller investment. Option A accepts the base case without acknowledging the sensitivity finding. Option B dismisses a meaningful 0.9-percentage-point gap relative to an NPV threshold. Option D incorrectly rejects NPV methodology.

Question 14

A project requires an initial investment of $600,000 and generates after-tax operating cash flows of $120,000 per year for 8 years, plus a $60,000 after-tax salvage value at the end of Year 8. The PV annuity factor at 10% for 8 years is 5.335 and the Year 8 PV factor is 0.467. What is the NPV?

  1. $40,200
  2. $68,220 (correct answer)
  3. $128,220
  4. -$68,220
Explanation: PV of operating cash flows = $120,000 x 5.335 = $640,200. PV of salvage = $60,000 x 0.467 = $28,020. Total PV = $640,200 + $28,020 = $668,220. NPV = $668,220 - $600,000 = $68,220. Option A omits the salvage value from the calculation. Option C adds the undiscounted salvage to the PV of operating cash flows. Option D applies the correct formula but labels the sign incorrectly.

Question 15

Two mutually exclusive projects use a cost of capital of 8% (PV annuity factor 3.993 for 5 years). Project X: initial investment $200,000, annual cash flows $58,000 for 5 years. Project Y: initial investment $350,000, annual cash flows $92,000 for 5 years. Which project should be selected?

  1. Project Y; NPV $17,356
  2. Project X; NPV $63,188
  3. Project X; NPV $31,594 (correct answer)
  4. Project Y; NPV $35,612
Explanation: Project X NPV = ($58,000 x 3.993) - $200,000 = $231,594 - $200,000 = 31,594.ProjectYNPV=(31,594. Project Y NPV = (92,000 x 3.993) - $350,000 = $367,356 - $350,000 = 17,356.ProjectXhasthehigherNPV(17,356. Project X has the higher NPV (31,594 vs. $17,356) and should be selected for mutually exclusive projects. Option A selects the lower-NPV project. Options B and D use incorrect cash flow or investment amounts.

Question 16

A project requires an initial investment of $400,000 and generates after-tax cash flows of $100,000 (Year 1), $120,000 (Year 2), $130,000 (Year 3), $110,000 (Year 4), and $80,000 (Year 5). What is the payback period?

  1. 3.0 years
  2. 2.75 years
  3. 4.0 years
  4. 3.45 years (correct answer)
Explanation: Cumulative cash flows: Year 1 $100,000; Year 2 $220,000; Year 3 $350,000. Remaining after Year 3 = $400,000 - $350,000 = $50,000. Year 4 fraction = $50,000 / $110,000 = 0.455. Payback = 3 + 0.455 = 3.45 years. Option A assumes Year 3 cumulative equals the investment. Option B produces a payback during Year 3 based on incorrect calculations. Option C assumes the investment is not recovered until all of Year 4's cash flow is received.

Question 17

Equipment purchased three years ago for $600,000 has a current book value of $200,000. A new machine costing $500,000 would save $90,000 per year in operating costs over 7 years. A manager opposes replacement because of the $200,000 book value write-off. Which capital budgeting principle best addresses this argument?

  1. The $200,000 book value should be included because it represents real economic value
  2. The book value write-off confirms the original investment was poor and the new machine should be rejected
  3. The $200,000 is a real cash outflow that must be included in the replacement NPV analysis
  4. The $200,000 book value is a sunk cost; the replacement decision should be based on whether the PV of $90,000 annual savings justifies the $500,000 investment net of after-tax disposal proceeds from the old machine (correct answer)
Explanation: The 200,000bookvaluerepresentsapastcostthatcannotberecovered−whethertheequipmentiskeptorsold,thisvaluedoesnotre−enterascash.Theaccountinglossfromwritingitoffisanon−cashchargethataffectsreportedincomebutnottheeconomicanalysis.Thecorrectanalysiscomparesthecostofreplacement(200,000 book value represents a past cost that cannot be recovered - whether the equipment is kept or sold, this value does not re-enter as cash. The accounting loss from writing it off is a non-cash charge that affects reported income but not the economic analysis. The correct analysis compares the cost of replacement (500,000 minus after-tax proceeds from selling the old machine) to the PV of future savings ($90,000 per year for 7 years). Option A treats an accounting figure as an economic cost. Option B conflates a reporting loss with investment merit. Option C incorrectly treats book value as a future cash outflow.

Question 18

A company's NPV analysis of a new product launch includes 800,000 of R&D completed last year. With R&D included, NPV is -120,000; without R&D, NPV is $680,000. Management argues R&D must be included to evaluate whether the total investment was worthwhile. Which concern does this raise?

  1. Management is correct that all project costs must be included in NPV analysis
  2. The $800,000 R&D is a sunk cost; including it leads to rejecting a project that would create $680,000 of future value; only incremental future cash flows are relevant (correct answer)
  3. Sunk costs should be included when they exceed $500,000
  4. The NPV should include R&D to assess the overall program ROI for the innovation portfolio
Explanation: The R&D was completed last year and cannot be recovered regardless of the current decision. Including it is a sunk cost fallacy - allowing a past expenditure to distort a forward-looking decision. The decision should be: 'Given where we are now, does launching this product create future value?' The answer is yes ($680,000 NPV). Rejecting the launch would forgo $680,000 of value while not recovering a single dollar of the R&D. Management's desire to assess whether the total investment was worthwhile is understandable but represents a different analytical question from the current decision. Options A, C, and D either endorse or rationalize the inclusion of sunk costs.

Question 19

A project has a present value of future cash flows of $720,000 and requires an initial investment of $600,000. What is the profitability index?

  1. 0.83
  2. 1.00
  3. 1.20 (correct answer)
  4. 1.50
Explanation: PI = PV of future cash flows / Initial investment = $720,000 / $600,000 = 1.20. A PI of 1.20 means each dollar invested generates $1.20 of present value - $0.20 of net value per dollar deployed. Option A inverts the formula. Option B would imply NPV of zero (break-even). Option D applies an incorrect denominator of $480,000.

Question 20

The profitability index (PI) is calculated as which of the following?

  1. Net present value divided by the IRR
  2. Present value of future cash flows divided by the initial investment (correct answer)
  3. Total undiscounted cash flows divided by the payback period
  4. IRR divided by the weighted average cost of capital
Explanation: PI = PV of future cash flows / Initial investment. A PI greater than 1.0 indicates the project creates value (equivalent to a positive NPV). PI is particularly useful for capital rationing because it measures value created per dollar invested, allowing comparison of projects with different investment amounts. Option A is not a standard capital budgeting ratio. Option C describes an undiscounted return metric, not PI. Option D is a ratio used to assess whether an IRR-based hurdle is met, not the PI formula.