Chapter 25: Capital Investment Decisions/Term Loans (JAIIB – Paper 3)
1. Which of the following is a non-discounted cash flow method used for investment appraisal?
A. Net Present Value (NPV)
B. Internal Rate of Return (IRR)
C. Payback Period
D. Discounted Payback Period
Payback Period is a non-discounted cash flow method as it does not consider the time value of money while calculating the recovery period of investment.
2. In the Net Present Value (NPV) method, an investment is considered acceptable if:
A. NPV = 0
B. NPV > 0
C. NPV < 0
D. NPV = Investment cost
Positive NPV indicates that the present value of expected cash inflows exceeds the investment outlay, making the project profitable.
3. Which of the following statements about the Internal Rate of Return (IRR) method is correct?
A. IRR ignores the time value of money
B. IRR is always equal to the cost of capital
C. IRR cannot be used for mutually exclusive projects
D. IRR is the discount rate at which NPV = 0
IRR is the rate at which the present value of future cash inflows equals the initial investment, making NPV zero.
4. Which of the following is a limitation of the Payback Period method?
A. It ignores cash flows beyond the payback period
B. It always considers the time value of money
C. It requires complex calculations
D. It is suitable only for large projects
The Payback Period method considers only the time required to recover investment and ignores cash flows received after that period.
5. A project with NPV = 0 at a discount rate of 10% means:
A. The project is unprofitable
B. The project’s return is less than 10%
C. The project’s return equals 10%
D. The project has no cash inflows
When NPV is zero at a given discount rate, it indicates that the project’s internal rate of return equals that discount rate.
6. What is a term loan?
A. A short-term loan repayable within 3 months
B. A loan provided for a fixed period, typically more than one year
C. A loan without any repayment schedule
D. A revolving credit facility
Term loans are loans provided for a fixed period, usually exceeding one year, with a structured repayment schedule.
7. Which of the following is NOT a typical feature of term loans?
A. Fixed or floating interest rates
B. Structured repayment schedule
C. Immediate withdrawal without approval
D. Purpose-specific utilization
Term loans are granted for a specific purpose and cannot be withdrawn immediately like an overdraft; they follow a structured repayment schedule.
8. What determines the repayment tenure of a term loan?
A. Nature of the project and cash flow generation
B. Borrower’s preference alone
C. RBI directives only
D. Interest rate fluctuations
The repayment tenure is usually linked to the project’s cash flow and ability to generate returns, ensuring that the borrower can repay without stress.
9. Which type of term loan is generally provided to finance the purchase of machinery or equipment?
A. Working capital loan
B. Overdraft facility
C. Cash credit
D. Equipment loan / Capital expenditure loan
Equipment or capital expenditure loans are a type of term loan provided specifically for purchasing machinery, plant, or equipment.
10. In banking, term loans are generally sanctioned after which of the following assessments?
A. Interest rate analysis only
B. RBI inspection only
C. Project viability, cash flows, and creditworthiness of the borrower
D. Collateral valuation alone
Term loans are sanctioned after analyzing project feasibility, expected cash flows, and the borrower’s ability to repay the loan.
11. What is a Deferred Payment Guarantee (DPG)?
A. A guarantee for immediate payment on delivery of goods
B. A guarantee that waives repayment obligations
C. A guarantee provided by the borrower to the bank
D. A bank guarantee ensuring payment to the seller at a future date
A Deferred Payment Guarantee is issued by a bank to ensure that the seller receives payment at a future agreed date, even if the buyer defaults.
12. Which of the following is a key purpose of Deferred Payment Guarantees?
A. To reduce interest rates on term loans
B. To provide assurance of future payment to exporters or sellers
C. To extend the repayment period of a borrower
D. To waive the need for collateral
DPGs are primarily used to assure the seller or exporter that payment will be made on the deferred date, reducing commercial risk.
13. Who is the primary obligor under a Deferred Payment Guarantee?
A. The beneficiary
B. The issuing bank
C. The buyer/importer
D. The regulatory authority
Under a DPG, the buyer (importer) is the primary obligor, while the bank acts as a guarantor ensuring payment if the buyer defaults.
14. Deferred Payment Guarantees are commonly used in which type of transactions?
A. International trade and export-import transactions
B. Personal loans
C. Retail banking deposits
D. Domestic cash credit limits
DPGs are widely used in international trade to protect exporters by guaranteeing deferred payments from importers.
15. Which of the following is an important risk a bank covers by issuing a Deferred Payment Guarantee?
A. Currency exchange fluctuation
B. Buyer default risk
C. Operational risk of the seller
D. Political risk in the seller’s country
By issuing a DPG, the bank guarantees payment in case the buyer defaults, transferring default risk from the seller to the bank.
16. What is project financing primarily concerned with?
A. Short-term working capital loans
B. Personal loans for entrepreneurs
C. Funding a specific project using its projected cash flows and assets
D. Deposits collection from retail customers
Project financing involves lending for a specific project where the repayment depends primarily on the project’s cash flows and assets, rather than the borrower’s balance sheet.
17. Which of the following is a key characteristic of project financing?
A. Repayment depends entirely on the borrower's net worth
B. Repayment depends on future cash flows of the project
C. No collateral is required
D. Only short-term lending is allowed
In project financing, repayment is primarily linked to the cash flows generated by the project, making the project’s success critical for loan recovery.
18. Which of the following is a major difference between term loan appraisal and project appraisal?
A. Term loan appraisal considers only project viability
B. Project appraisal ignores financial analysis
C. Both are identical in methodology
D. Term loan appraisal focuses on borrower’s repayment capacity, while project appraisal evaluates technical, financial, and economic feasibility of the project
Term loan appraisal mainly analyzes the borrower’s ability to repay, whereas project appraisal is broader and assesses technical, financial, and economic feasibility.
19. In project financing, what role do cash flows play in loan approval?
A. Cash flows determine the project’s ability to service debt
B. Cash flows are irrelevant for approval
C. Only past cash flows are considered
D. Cash flows are considered only for collateral valuation
Future projected cash flows of the project are critical in determining whether the loan can be repaid as per schedule.
20. Which of the following is typically included in project appraisal but not emphasized in term loan appraisal?
A. Borrower’s credit history
B. Collateral analysis
C. Technical feasibility and economic viability of the project
D. Borrower’s repayment history
Project appraisal evaluates technical and economic aspects to ensure the project can generate adequate returns to meet loan obligations, which is not the main focus in term loan appraisal.
21. Which financial ratio is commonly used to assess a project’s ability to meet its debt obligations?
A. Current ratio
B. Debt Service Coverage Ratio (DSCR)
C. Return on Equity (ROE)
D. Inventory turnover ratio
DSCR measures the project’s ability to generate enough cash flow to cover its debt obligations, which is critical in project financing.
22. What does a DSCR of less than 1 indicate?
A. The project generates surplus cash for expansion
B. The project is highly profitable
C. The project’s cash flows are insufficient to meet debt obligations
D. Debt has been fully repaid
A DSCR below 1 indicates that the project cannot generate enough cash flow to cover its debt, implying a higher risk for lenders.
23. Why is the debt-equity ratio important in project appraisal?
A. It indicates the proportion of debt and equity financing, affecting financial risk
B. It determines tax rates applicable to the project
C. It shows operational efficiency
D. It calculates interest on term loans
The debt-equity ratio reflects how much of the project is funded by debt versus equity, affecting the financial leverage and risk profile.
24. Which of the following is considered a major risk in project financing?
A. Currency risk for domestic projects only
B. Operational risk unrelated to cash flows
C. Customer satisfaction risk
D. Cash flow and repayment risk due to project delays or cost overruns
Cash flow risk arises if the project faces delays, cost overruns, or lower revenues, affecting its ability to service debt.
25. What is the primary focus of project risk analysis?
A. Evaluating borrower’s personal assets
B. Assessing potential threats to the project’s cash flows and financial viability
C. Estimating short-term working capital needs only
D. Monitoring regulatory compliance exclusively
Project risk analysis identifies potential threats—financial, operational, or technical—that could affect the project’s ability to generate adequate cash flows.
