Capital Budgeting Basics: Project Evaluation, Payback, NPV and IRR (Intro Level) Questions

Q: Write steps in capital budgeting/project evaluation using a flowchart (brief).

Steps (flow): Identify project → Estimate **cash flows** → Choose method (Payback/NPV/IRR) → Apply decision rule → Select project → Implement & review (concept)

Q: Differentiate cash flows and accounting profit using a table (any three points).

Cash flow vs accounting profit: | Basis | **Cash flow** | Accounting profit | |---|---|---| | Meaning | actual cash inflow/outflow | profit as per accounting rules | | Includes | cash receipts/payments | includes non-cash items (depreciation) | | Use | used for **NPV/IRR** | not directly used | Thus, project appraisal is based on cash flows.

Q: Compute payback period: Investment ₹100,000; annual inflow ₹25,000. Interpret (brief).

Payback = 100,000 / 25,000 = **4 years**. Interpretation: the project recovers the initial investment in 4 years; cash inflows after 4 years are surplus (concept).

Q: Explain NPV and its decision rule (brief) using a small table.

NPV (concept): NPV = PV(inflows) − PV(outflows). | NPV result | Decision | |---|---| | **NPV > 0** | accept | | NPV = 0 | indifferent | | NPV < 0 | reject | Thus, NPV measures value addition at the discount rate.

Question 1

What is payback period?

Accepted Answer

Payback period is the time required to **recover the initial investment** from project cash inflows.

Question 2

NPV stands for and means what?

Accepted Answer

NPV stands for **Net Present Value** and it is PV(inflows) minus PV(outflows) at a discount rate (concept).

Question 3

Define capital budgeting.

Accepted Answer

Capital budgeting is the process of evaluating **long-term investment** projects based on expected cash flows and risk (concept).

Question 4

IRR is the rate at which NPV becomes zero. (True/False)

Accepted Answer

True. **IRR** is the discount rate where PV of inflows equals PV of outflows (NPV = 0) (concept).

Question 5

Project evaluation is based on cash flows, not accounting profit. (True/False)

Accepted Answer

True. Capital budgeting uses **cash flows** because they represent actual money available (concept).

Question 6

State one decision rule for NPV.

Accepted Answer

Accept the project if **NPV > 0**; reject if NPV < 0 (concept).

Question 7

Write steps in capital budgeting/project evaluation using a flowchart (brief).

Accepted Answer

Steps (flow):

Identify project → Estimate **cash flows** → Choose method (Payback/NPV/IRR) → Apply decision rule → Select project → Implement & review (concept)

Question 8

Differentiate cash flows and accounting profit using a table (any three points).

Accepted Answer

Cash flow vs accounting profit:

| Basis | **Cash flow** | Accounting profit |
|---|---|---|
| Meaning | actual cash inflow/outflow | profit as per accounting rules |
| Includes | cash receipts/payments | includes non-cash items (depreciation) |
| Use | used for **NPV/IRR** | not directly used |

Thus, project appraisal is based on cash flows.

Question 9

Compute payback period: Investment ₹100,000; annual inflow ₹25,000. Interpret (brief).

Accepted Answer

Payback = 100,000 / 25,000 = **4 years**.

Interpretation: the project recovers the initial investment in 4 years; cash inflows after 4 years are surplus (concept).

Question 10

Explain NPV and its decision rule (brief) using a small table.

Accepted Answer

NPV (concept): NPV = PV(inflows) − PV(outflows).

| NPV result | Decision |
|---|---|
| **NPV > 0** | accept |
| NPV = 0 | indifferent |
| NPV < 0 | reject |

Thus, NPV measures value addition at the discount rate.

Question 11

Compute NPV (single-year): Initial outflow ₹1,000; inflow after 1 year ₹1,100; discount rate 10%. Interpret (brief).

Accepted Answer

PV of inflow = 1,100 / 1.10 = ₹1,000.

NPV = PV(inflows) − outflow = 1,000 − 1,000 = **₹0**.

Interpretation: at 10% discount rate, the project is **break-even** in present value terms (concept).

Question 12

Explain IRR and its decision rule (brief) using points/table.

Accepted Answer

IRR (concept): the discount rate where **NPV = 0**.

Decision rule:
- accept if **IRR > required rate** (cost of capital)
- reject if IRR < required rate

Thus, IRR is the project’s percentage return measure.

Question 13

Write an exam-style answer on payback method: meaning, merits and limitations (include a table and conclusion).

Accepted Answer

### Meaning
**Payback period** is the time needed to recover the initial investment from cash inflows.

| Aspect | Points |
|---|---|
| Merits | simple, focuses on **liquidity**, easy to communicate |
| Limitations | ignores **time value of money**; ignores cash flows after payback (concept) |

### Conclusion
Payback is useful as a quick screening tool, but for value-based decisions firms prefer NPV/IRR (concept).

Question 14

Write an exam-style answer explaining NPV (meaning, steps, decision) with a flowchart/table and conclude.

Accepted Answer

### Meaning
**NPV** is PV(inflows) minus PV(outflows) discounted at required rate.

### Steps (flow)
Estimate cash flows → Choose discount rate → Discount each cash flow → Sum PVs → Compute **NPV** → Decision (accept if NPV > 0)

| Rule | Decision |
|---|---|
| **NPV > 0** | accept |
| NPV < 0 | reject |

### Conclusion
NPV directly shows value addition and therefore is a strong method for project selection (concept).

Question 15

Differentiate NPV and IRR (exam-style) using a table and give a short conclusion.

Accepted Answer

### Comparison

| Basis | **NPV** | **IRR** |
|---|---|---|
| Output | value in ₹ | percentage rate |
| Decision | **NPV > 0** accept | **IRR > required rate** accept |
| Interpretation | measures value addition | measures % return |

### Conclusion
NPV directly measures wealth/value addition, while IRR is easier to understand as a rate; both consider TVM (concept).

Capital Budgeting Basics: Project Evaluation, Payback, NPV and IRR (Intro Level)

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