Master Project Evaluation: Payback Period and Profitability Index

Question 1

What is the main drawback of using the payback period method to evaluate projects?

Accepted Answer

It doesn't consider the value of money over time.

Answer

It assumes cash flows are spread evenly throughout the project.

Answer

It can only be used for projects with positive cash flows.

Question 2

Which of the following is NOT a limitation of the payback period method?

Accepted Answer

Provides insights into the profitability of the project

Answer

Ignores the time value of money

Answer

Can be misleading when comparing projects with different cash flow patterns

Question 3

A project has a PI of 1.25. What does this indicate?

Accepted Answer

The project is marginally profitable.

Answer

The project is not profitable.

Answer

The project is highly profitable.

Question 4

What is the primary objective of the payback period method?

Accepted Answer

To assess the liquidity of a project

Answer

To determine the profitability of a project

Answer

To identify the risk involved in a project

Question 5

Which of the following is an advantage of the Profitability Index over the Payback Period method?

Accepted Answer

Both of the above

Answer

Considers the time value of money

Answer

Takes into account the entire life of the project

Question 6

Which of the following is a key advantage of using the payback period as a project evaluation tool?

Accepted Answer

Straightforward calculation and ease of understanding

Answer

Comprehensive assessment of project profitability

Answer

Ability to account for the time value of money

Answer

Detailed evaluation of project risks and uncertainties

Question 7

A project has cash inflows and outflows as follows: Year 0: -$40,000; Year 1: $10,000; Year 2: $25,000; Year 3: $35,000. What is the payback period for this project?

Accepted Answer

2.5 years

Answer

2.0 years

Answer

3.0 years

Answer

3.5 years

Question 8

How would the payback period and profitability index be affected if the initial cost of a project were increased while the annual cash flows remained constant?

Accepted Answer

The payback period would lengthen, and the profitability index would decline.

Answer

The payback period would shorten, and the profitability index would improve.

Answer

Both the payback period and the profitability index would shorten.

Answer

Both the payback period and the profitability index would improve.

Question 9

Which capital budgeting technique is known for its simplicity and ease of calculation?

Accepted Answer

Payback period

Answer

Net present value

Answer

Internal rate of return

Answer

Profitability index

Question 10

Calculate the payback period of a project with an initial investment of $10,000 and annual cash inflows of $2,500.

Accepted Answer

2 years

Answer

4 years

Answer

6 years

Answer

8 years

Question 11

Select the project with a higher profitability index.

Accepted Answer

Project B: Initial investment of $15,000, Net present value of $9,000

Answer

Project A: Initial investment of $10,000, Net present value of $5,000

Answer

Project A and Project B have the same profitability index

Answer

Insufficient information to determine

Question 12

Describe the relationship between the payback period and profitability index.

Accepted Answer

They can be directly or inversely proportional depending on the project

Answer

They are always directly proportional

Answer

They are always inversely proportional

Answer

They are not related

Question 13

What is the primary limitation of the payback period method in project evaluation?

Accepted Answer

Ignores the time value of money

Answer

Assumes a risk-averse perspective

Answer

Can be challenging to calculate for projects with uneven cash flows

Answer

Unaffected by the project's overall size

Question 14

What is a key benefit of using the payback period method for project evaluation?

Accepted Answer

It is a simple and fast method, especially for projects with a short payback period.

Answer

It accounts for the time value of money.

Answer

It allows for the comparison of projects with varying cash flow patterns.

Question 15

In project evaluation, what is the definition of the payback period?

Accepted Answer

The period needed for an investment to generate enough cash flow to cover its initial cost.

Answer

The period that always matches the project's operational lifespan.

Answer

A comprehensive measure of a project's overall profitability.

Answer

A suitable metric for comparing projects with different cash flow patterns.

Question 16

Which of the following is NOT a limitation of the payback period method?

Accepted Answer

Simplicity of calculation

Answer

Ignores cash flows beyond the payback period

Answer

Does not consider the time value of money

Question 17

Which is NOT a limitation of the payback period method?

Accepted Answer

It is independent of the time value of money.

Answer

It fails to consider project profitability.

Answer

It assumes equal annual cash flows.

Answer

It ignores cash flows beyond the payback period.

Question 18

Which project should be selected if both have a payback period of 2 years but Project A has a PI of 1.3 and Project B has a PI of 1.1?

Accepted Answer

Project A

Answer

Both projects should be selected.

Answer

Project B

Answer

Neither project should be selected.

Question 19

Identify an advantage of using the payback period method.

Accepted Answer

Simplicity and ease of calculation

Answer

Consideration of time value of money

Answer

Analysis of project profitability

Answer

Accommodation of uneven cash flows

Question 20

Which project option offers a shorter payback period?

Accepted Answer

Project with higher initial cash inflows

Answer

Project with lower initial cash inflows

Answer

Project with higher total cash inflows

Answer

Project with lower total cash inflows

Question 21

Identify a potential disadvantage of utilizing the Profitability Index (PI) method.

Accepted Answer

It disregards the time value of money beyond the payback period.

Answer

It is unaffected by the time value of money.

Answer

It is simple to calculate and understand.

Question 22

Which of the following is not considered an advantage of using the payback period method?

Accepted Answer

It incorporates the time value of money.

Answer

It allows for comparisons between projects with varying investment costs.

Answer

It offers a quick estimate of project profitability.

Answer

It is straightforward to calculate.

Question 23

Select the scenario that will result in a shorter payback period.

Accepted Answer

Higher cash inflows during earlier years.

Answer

Lower cash inflows during earlier years.

Answer

Longer project duration.

Answer

Higher initial investment.

Question 24

Under which conditions is the payback period method most appropriate?

Accepted Answer

Uniform cash flows over a relatively short project life

Answer

Projects with high initial investments

Answer

Uneven cash flows over a long project life

Question 25

A project with a payback period of 4 years and a net present value (NPV) of $5,000 would have a profitability index (PI) of:

Accepted Answer

1.25

Answer

2.50

Answer

0.80

Answer

5.00

Question 26

Which of the following is a potential disadvantage of using the payback period method?

Accepted Answer

It disregards cash flows beyond the payback period.

Answer

It can be used to compare projects with different cash flow patterns.

Answer

It assesses project risk.

Answer

It is simple to calculate.

Question 27

The profitability index (PI) can be utilized to:

Accepted Answer

Rank projects based on their profitability.

Answer

Estimate the project's net present value (NPV).

Answer

Calculate the payback period.

Answer

Determine the internal rate of return (IRR).

Question 28

Which of the following is a quantitative factor that should be considered when using the payback period and profitability index methods to assess projects?

Accepted Answer

Cash flow

Answer

Market demand

Answer

Environmental impact

Answer

Project risk

Question 29

Which of the following is NOT an advantage of the payback period method?

Accepted Answer

It does not take into account the time value of money

Answer

It provides a quick assessment of project viability

Answer

It represents the period in which the initial investment is recovered

Answer

It is easy to calculate

Question 30

Which of the following projects has a higher profitability index?

Accepted Answer

Project A: $1.5

Answer

Project C: $1.0

Answer

Project B: $1.2

Answer

Project D: $0.8

Question 31

A project has an initial investment of $200,000 and generates equal annual cash inflows of $50,000 for 6 years. What is the discounted payback period if the required rate of return is 8%? (PV of $1 at 8% for 6 years = 4.6229)

Accepted Answer

4.2 years

Answer

6.0 years

Answer

5.2 years

Answer

3.0 years

Question 32

A project generates annual net cash flows of $20,000 and requires an initial investment of $80,000. What is its payback period?

Accepted Answer

4 years

Answer

5 years

Answer

6 years

Answer

3 years

Question 33

Which of the following is NOT considered a limitation of the payback period as a project evaluation technique?

Accepted Answer

It incorporates the time value of money

Answer

It provides a simplified assessment of project profitability

Answer

It disregards cash flows occurring after the payback period

Answer

It is straightforward to calculate

Question 34

A project has an annual net cash flow of $10,000 and an initial investment of $50,000. Calculate its profitability index.

Accepted Answer

1.2

Answer

1.6

Answer

1.4

Answer

0.8

Question 35

In project evaluation, which of the following is considered a qualitative factor that influences profitability assessment?

Accepted Answer

Market risk

Answer

Breakeven point

Answer

Profitability index

Answer

Initial investment

Question 36

Which of the following best describes the payback period?

Accepted Answer

The time it takes for a project's cumulative cash inflows to equal the initial investment.

Answer

The total time required for a project to generate a profit.

Answer

The time it takes for a project to reach its maximum return on investment.

Answer

The period where a project experiences the highest cash inflows.

Question 37

A project has an initial cost of $150,000 and generates annual cash flows of $30,000 for six years. If the company's required rate of return is 10%, what is the project's net present value (NPV)?

Accepted Answer

Approximately $19,637

Answer

Approximately $15,432

Answer

Approximately $10,345

Answer

Approximately $24,567

Question 38

You are presented with two projects, each with different NPV and profitability index (PI) values. Which project would you recommend based on these metrics?

Accepted Answer

The project with the higher NPV and PI.

Answer

The project with the higher PI, even if the NPV is lower.

Answer

The project with the shorter payback period, regardless of NPV or PI.

Answer

The project with the higher NPV, even if the PI is lower.

Question 39

What does the payback period primarily focus on?

Accepted Answer

The time it takes to recover the initial investment.

Answer

The long-term financial sustainability of a project.

Answer

The impact of a project on a company's market share.

Answer

The overall profitability of a project over its entire life.

Question 40

A profitability index (PI) greater than 1 indicates that:

Accepted Answer

The project's present value of future cash inflows exceeds its initial investment.

Answer

The project's payback period is less than one year.

Answer

The project is highly risky.

Answer

The project will generate a high rate of return.

Question 41

Project A has a payback period of 3 years and a profitability index of 1.1. Project B has a payback period of 4 years and a profitability index of 1.3. Which project is more desirable based on these metrics, assuming all other factors are equal?

Accepted Answer

Project B

Answer

Both projects are equally desirable.

Answer

Project A

Answer

It's impossible to determine without more information.

Question 42

How is the profitability index (PI) calculated?

Accepted Answer

Present value of future cash inflows divided by the initial investment.

Answer

Annual cash flow multiplied by the payback period.

Answer

Total cash inflows divided by the total cash outflows.

Answer

Initial investment minus the present value of future cash inflows.

Question 43

Which of the following significantly influences a project's payback period?

Accepted Answer

The timing and amount of cash inflows.

Answer

The company's tax rate.

Answer

The project's marketing budget.

Answer

The project's location.

Question 44

What is a major limitation of the payback period as a project evaluation technique?

Accepted Answer

It ignores cash flows that occur after the payback period.

Answer

It is difficult to calculate accurately.

Answer

It does not consider the time value of money.

Answer

It is not widely used in financial analysis.

Question 45

A project has a payback period of 2 years and a profitability index of 1.05. What does this indicate about the project?

Accepted Answer

The project is expected to generate a positive return on investment, but its profitability is relatively modest.

Answer

The project is too risky to invest in.

Answer

The project is highly profitable.

Answer

The project is not profitable.

Question 46

Which of the following statements accurately describes the relationship between the payback period and the profitability index?

Accepted Answer

A shorter payback period does not necessarily guarantee a higher profitability index.

Answer

A higher profitability index always implies a shorter payback period.

Answer

The payback period and profitability index are always inversely proportional.

Answer

A longer payback period always results in a lower profitability index.

Question 47

A project requires an initial investment of $10,000 and generates annual cash flows of $3,000. How many years will it take to recover the initial investment?

Accepted Answer

3.33 years

Answer

5 years

Answer

2.5 years

Answer

4.17 years

Question 48

A project with an initial investment of $50,000 is expected to generate annual cash flows of $15,000 for four years. What is the project's profitability index?

Accepted Answer

1.2

Answer

1.0

Answer

0.8

Answer

1.5

Question 49

What is a significant advantage of using the payback period as a project evaluation technique?

Accepted Answer

It's straightforward to calculate and understand.

Answer

It allows for comparing projects with different lifespans effectively.

Answer

It provides a comprehensive measure of project profitability.

Answer

It accounts for the time value of money.

Question 50

Which of these factors would NOT directly affect the payback period of a project?

Accepted Answer

Inflation rate

Answer

Initial investment

Answer

Annual cash flows

Answer

Project life

Question 51

A project costs $20,000 initially and generates cash flows of $10,000 in year one, $12,000 in year two, and $15,000 in year three. Using a 10% discount rate, what is the project's discounted payback period (rounded to the nearest tenth of a year)?

Accepted Answer

2.9 years

Answer

4.0 years

Answer

2.5 years

Answer

3.3 years

Question 52

What does a profitability index greater than 1.0 indicate about a project?

Accepted Answer

The project is expected to generate a positive net present value.

Answer

The project has a very short payback period.

Answer

The project is expected to break even.

Answer

The project is not financially viable.

Question 53

A project has an initial cost of $30,000 and is expected to produce annual cash flows of $10,000 for six years. Using a 5% discount rate, what is the project's payback period calculated using the discounted cash flow method (rounded to the nearest tenth of a year)?

Accepted Answer

4.5 years

Answer

5.0 years

Answer

4.0 years

Answer

6.0 years

Question 54

Which of these is NOT a limitation of the profitability index?

Accepted Answer

It is not affected by the assumed discount rate.

Answer

It can be misleading if project cash flows are uneven.

Answer

It doesn't provide a measure of the project's overall profitability.

Answer

It does not consider the time value of money.