MHA 702 Chapter 10-12 Questions and ANSWERs 100% Correct and Verified
1. What is the primary goal of capital budgeting in healthcare organizations?
ANSWER: To evaluate and select long-term investments that are expected to provide returns over a
period longer than one year, aligning with the organization's strategic goals.
2. What distinguishes a capital expenditure from an operational expenditure?
ANSWER: A capital expenditure (CapEx) is for acquiring or upgrading long-term assets, while an
operational expenditure (OpEx) is for day-to-day running costs.
3. What are the four main steps in the capital budgeting process?
ANSWER: 1. Proposal Generation, 2. Review and Analysis, 3. Decision Making, 4. Implementation and
Follow-up.
4. What is the payback period?
ANSWER: The amount of time required for an investment to generate cash flows sufficient to recover its
initial cost.
5. A project has an initial cost of $150,000 and is expected to generate $50,000 in annual cash flows.
What is its payback period?
ANSWER: 3 years ($150,000 / $50,000 = 3).
6. What is the major weakness of the payback period method?
ANSWER: It ignores the time value of money and all cash flows beyond the payback period.
7. What does the Net Present Value (NPV) of a project represent?
ANSWER: The dollar value of the project's expected profit, calculated by discounting all expected cash
inflows and outflows to the present using the firm's cost of capital.
8. According to the NPV decision rule, when should a project be accepted?
ANSWER: If the NPV is positive (NPV > $0).
,9. What is the discount rate often used in NPV calculations for healthcare projects?
ANSWER: The organization's corporate cost of capital.
10. If a project's NPV is $0, what does that imply?
ANSWER: The project's cash flows are just sufficient to return the invested capital and provide the
required rate of return; it is economically breakeven.
11. What is the Internal Rate of Return (IRR)?
ANSWER: The discount rate that forces the NPV of a project to equal zero.
12. According to the IRR decision rule, when should a project be accepted?
ANSWER: If the IRR is greater than the project's cost of capital (IRR > r).
13. What is a potential problem with using IRR when evaluating mutually exclusive projects?
ANSWER: The scale problem (a small project may have a high IRR but a low NPV) and the timing problem
(IRR may favor projects with early high returns over those with higher total value).
14. What is the profitability index (PI)?
ANSWER: The ratio of the present value of a project's future cash flows to its initial investment. It shows
the value created per dollar invested.
15. According to the profitability index rule, when is a project acceptable?
ANSWER: If the PI is greater than 1.0 (PI > 1.0).
16. Why is post-audit an important part of the capital budgeting process?
ANSWER: It helps to see if projects met their financial forecasts, improves future forecasts, and identifies
projects that need to be terminated.
17. What are "relevant cash flows" in capital budgeting analysis?
, ANSWER: The specific set of cash flows that should be considered in the analysis, which are incremental,
after-tax cash flows directly resulting from the project.
18. What is an incremental cash flow?
ANSWER: The change in a firm's overall cash flow that occurs as a direct result of taking on a project.
19. Why are sunk costs not considered in a capital budgeting analysis?
ANSWER: Because they are costs that have already been incurred and cannot be recovered, regardless of
whether the project is accepted or rejected.
20. What is an opportunity cost in the context of capital budgeting?
ANSWER: The return that could be earned on an asset if it is used for its next-best alternative purpose. It
is a relevant cash flow and should be included in the analysis.
21. How does inflation impact capital budgeting decisions?
ANSWER: It must be accounted for consistently, either by using nominal cash flows with a nominal
discount rate or real cash flows with a real discount rate.
22. What is capital rationing?
ANSWER: The situation where a business places a limit on the total amount of capital expenditures it will
make during a period, forcing it to choose among profitable projects.
23. What is the primary advantage of NPV over IRR?
ANSWER: NPV directly measures the expected dollar increase in firm value, and it does not suffer from
the multiple IRR problem or reinvestment rate assumption flaw.
24. What is the reinvestment rate assumption?
ANSWER: The assumption that a project's cash inflows can be reinvested at the project's rate of return.
NPV assumes reinvestment at the cost of capital, while IRR assumes reinvestment at the IRR itself.
25. What is scenario analysis in capital budgeting?
1. What is the primary goal of capital budgeting in healthcare organizations?
ANSWER: To evaluate and select long-term investments that are expected to provide returns over a
period longer than one year, aligning with the organization's strategic goals.
2. What distinguishes a capital expenditure from an operational expenditure?
ANSWER: A capital expenditure (CapEx) is for acquiring or upgrading long-term assets, while an
operational expenditure (OpEx) is for day-to-day running costs.
3. What are the four main steps in the capital budgeting process?
ANSWER: 1. Proposal Generation, 2. Review and Analysis, 3. Decision Making, 4. Implementation and
Follow-up.
4. What is the payback period?
ANSWER: The amount of time required for an investment to generate cash flows sufficient to recover its
initial cost.
5. A project has an initial cost of $150,000 and is expected to generate $50,000 in annual cash flows.
What is its payback period?
ANSWER: 3 years ($150,000 / $50,000 = 3).
6. What is the major weakness of the payback period method?
ANSWER: It ignores the time value of money and all cash flows beyond the payback period.
7. What does the Net Present Value (NPV) of a project represent?
ANSWER: The dollar value of the project's expected profit, calculated by discounting all expected cash
inflows and outflows to the present using the firm's cost of capital.
8. According to the NPV decision rule, when should a project be accepted?
ANSWER: If the NPV is positive (NPV > $0).
,9. What is the discount rate often used in NPV calculations for healthcare projects?
ANSWER: The organization's corporate cost of capital.
10. If a project's NPV is $0, what does that imply?
ANSWER: The project's cash flows are just sufficient to return the invested capital and provide the
required rate of return; it is economically breakeven.
11. What is the Internal Rate of Return (IRR)?
ANSWER: The discount rate that forces the NPV of a project to equal zero.
12. According to the IRR decision rule, when should a project be accepted?
ANSWER: If the IRR is greater than the project's cost of capital (IRR > r).
13. What is a potential problem with using IRR when evaluating mutually exclusive projects?
ANSWER: The scale problem (a small project may have a high IRR but a low NPV) and the timing problem
(IRR may favor projects with early high returns over those with higher total value).
14. What is the profitability index (PI)?
ANSWER: The ratio of the present value of a project's future cash flows to its initial investment. It shows
the value created per dollar invested.
15. According to the profitability index rule, when is a project acceptable?
ANSWER: If the PI is greater than 1.0 (PI > 1.0).
16. Why is post-audit an important part of the capital budgeting process?
ANSWER: It helps to see if projects met their financial forecasts, improves future forecasts, and identifies
projects that need to be terminated.
17. What are "relevant cash flows" in capital budgeting analysis?
, ANSWER: The specific set of cash flows that should be considered in the analysis, which are incremental,
after-tax cash flows directly resulting from the project.
18. What is an incremental cash flow?
ANSWER: The change in a firm's overall cash flow that occurs as a direct result of taking on a project.
19. Why are sunk costs not considered in a capital budgeting analysis?
ANSWER: Because they are costs that have already been incurred and cannot be recovered, regardless of
whether the project is accepted or rejected.
20. What is an opportunity cost in the context of capital budgeting?
ANSWER: The return that could be earned on an asset if it is used for its next-best alternative purpose. It
is a relevant cash flow and should be included in the analysis.
21. How does inflation impact capital budgeting decisions?
ANSWER: It must be accounted for consistently, either by using nominal cash flows with a nominal
discount rate or real cash flows with a real discount rate.
22. What is capital rationing?
ANSWER: The situation where a business places a limit on the total amount of capital expenditures it will
make during a period, forcing it to choose among profitable projects.
23. What is the primary advantage of NPV over IRR?
ANSWER: NPV directly measures the expected dollar increase in firm value, and it does not suffer from
the multiple IRR problem or reinvestment rate assumption flaw.
24. What is the reinvestment rate assumption?
ANSWER: The assumption that a project's cash inflows can be reinvested at the project's rate of return.
NPV assumes reinvestment at the cost of capital, while IRR assumes reinvestment at the IRR itself.
25. What is scenario analysis in capital budgeting?
