FNAN 522 EXAM SCRIPT 2025/2026 QUESTIONS WITH
ANSWERS GRADED A+
✔✔what is the most important and difficult step in capital budgeting - ✔✔estimating
cash flows
✔✔change in cash flow attributable to a project - ✔✔incremental cash flow
✔✔expenses that have already occurred and will not change due to acceptance or
rejection of a project - ✔✔sunk costs
✔✔costs that require a sacrifice of a benefit - ✔✔opportunity costs
✔✔effects of outside forces that may impact the success of a project - ✔✔externalities
✔✔where cost may be understated or inflows overstated - ✔✔cash flow bias
✔✔a technique which indicates how much the NPV or IRR will change in response to a
given change in a single input variable, all else being equal - ✔✔sensitivity analysis
✔✔considers both the sensitivity of NPV to changes in Key inputs and also the range of
likely variables values - ✔✔scenario analysis
✔✔represent the percentage of estimated cash flow that investors would be satisfied to
receive for certain rather than the cash flows that may be possible for each year given a
proposed investment - ✔✔certainty equivalents (CE)
✔✔rate of return that must be earned on a given project to compensate the firm's
owners adequately - ✔✔Risk-adjusted discount rate
✔✔list the RADRs and risk classes - ✔✔I - below average risk - RADR 8%
II - average risk - RADR 12%
III - above-average risk - RADR 14%
IV - high risk - RADR 20%
✔✔Between CE and RADR, which is preferred in practice? - ✔✔CEs are preferred
because they separately adjust for risk and time
They first eliminate risk from the cash flows, then discount the certain cash flows at a
risk-free rate
✔✔an approach that allows the use of probability and abandonment - ✔✔decision tree
analysis
, ✔✔what is the project selection criteria using payback period - ✔✔if PBP is <= required
PBP, accept the project
✔✔what is the project selection criteria using NPV? - ✔✔if NPV >= 0, accept project
✔✔what is the project selection criteria using IRR? - ✔✔if IRR is larger than required
return (cost of capital), accept project
✔✔what is the project selection criteria using profitability index - ✔✔if PI >= required
return, accept project
✔✔what is the project selection criteria using modified IRR? - ✔✔if MIRR >= cost of
capital, accept project
✔✔what are the components of cost of capital for most firms? - ✔✔permanent financing
portion of short-term notes
all long-term debt
all preferred stock
all common stock
✔✔what is specifically excluded from cost of capital calculations? - ✔✔non interest-
bearing liabilities -- accounts payable and accruals
✔✔how is cost of capital measured with respect to taxes? - ✔✔it is measured on an
after-tax basis
✔✔what are the 2 ways a firm can raise common equity? - ✔✔retaining earnings
issuing new common stock
✔✔the risk everyone assumes when investing in a market - ✔✔systematic risk or
nondiversifiable risk
✔✔Company- or industry-specific hazard that is inherent in each investment -
✔✔unsystematic risk or diversifiable risk - can be reduced by diversification
✔✔a measure of the risk arising from exposure to general market movements as
opposed to idiosyncratic factors - ✔✔beta
✔✔A model that describes the relationship between risk and expected return and that is
used in the pricing of risky securities - ✔✔capital asset pricing model (CAPM)
ANSWERS GRADED A+
✔✔what is the most important and difficult step in capital budgeting - ✔✔estimating
cash flows
✔✔change in cash flow attributable to a project - ✔✔incremental cash flow
✔✔expenses that have already occurred and will not change due to acceptance or
rejection of a project - ✔✔sunk costs
✔✔costs that require a sacrifice of a benefit - ✔✔opportunity costs
✔✔effects of outside forces that may impact the success of a project - ✔✔externalities
✔✔where cost may be understated or inflows overstated - ✔✔cash flow bias
✔✔a technique which indicates how much the NPV or IRR will change in response to a
given change in a single input variable, all else being equal - ✔✔sensitivity analysis
✔✔considers both the sensitivity of NPV to changes in Key inputs and also the range of
likely variables values - ✔✔scenario analysis
✔✔represent the percentage of estimated cash flow that investors would be satisfied to
receive for certain rather than the cash flows that may be possible for each year given a
proposed investment - ✔✔certainty equivalents (CE)
✔✔rate of return that must be earned on a given project to compensate the firm's
owners adequately - ✔✔Risk-adjusted discount rate
✔✔list the RADRs and risk classes - ✔✔I - below average risk - RADR 8%
II - average risk - RADR 12%
III - above-average risk - RADR 14%
IV - high risk - RADR 20%
✔✔Between CE and RADR, which is preferred in practice? - ✔✔CEs are preferred
because they separately adjust for risk and time
They first eliminate risk from the cash flows, then discount the certain cash flows at a
risk-free rate
✔✔an approach that allows the use of probability and abandonment - ✔✔decision tree
analysis
, ✔✔what is the project selection criteria using payback period - ✔✔if PBP is <= required
PBP, accept the project
✔✔what is the project selection criteria using NPV? - ✔✔if NPV >= 0, accept project
✔✔what is the project selection criteria using IRR? - ✔✔if IRR is larger than required
return (cost of capital), accept project
✔✔what is the project selection criteria using profitability index - ✔✔if PI >= required
return, accept project
✔✔what is the project selection criteria using modified IRR? - ✔✔if MIRR >= cost of
capital, accept project
✔✔what are the components of cost of capital for most firms? - ✔✔permanent financing
portion of short-term notes
all long-term debt
all preferred stock
all common stock
✔✔what is specifically excluded from cost of capital calculations? - ✔✔non interest-
bearing liabilities -- accounts payable and accruals
✔✔how is cost of capital measured with respect to taxes? - ✔✔it is measured on an
after-tax basis
✔✔what are the 2 ways a firm can raise common equity? - ✔✔retaining earnings
issuing new common stock
✔✔the risk everyone assumes when investing in a market - ✔✔systematic risk or
nondiversifiable risk
✔✔Company- or industry-specific hazard that is inherent in each investment -
✔✔unsystematic risk or diversifiable risk - can be reduced by diversification
✔✔a measure of the risk arising from exposure to general market movements as
opposed to idiosyncratic factors - ✔✔beta
✔✔A model that describes the relationship between risk and expected return and that is
used in the pricing of risky securities - ✔✔capital asset pricing model (CAPM)
