- CFA Exams
- CFA Level I Exam
- Topic 3. Corporate Issuers
- Learning Module 5. Capital Investments and Capital Allocation
- Subject 3. Capital Allocation Principles and Pitfalls
CFA Practice Question
Which of the following is most likely a common capital allocation pitfall resulting from stagnant or declining investment returns while increasing capital investments?
A. Inertia
B. Internal forecasting errors
C. Basing investment decisions on net income
Explanation: This is where a company's return on investments stay the same or decline despite an increase in capital investments. This could be due to a lack of investment opportunities.
B is incorrect. Internal forecasting errors involve internal mistakes made by companies when evaluating investment opportunities. This is difficult to spot by external analysts and may lead to investment failure.
C is incorrect. Investment decisions should not be based on EPS, net income, or ROE but NPV. Additionally, managers may pick projects that aren't beneficial to a company in the long run.
User Contributed Comments 3
| User | Comment |
|---|---|
| abod2 | The Key Risk Considerations for investing in alternative investments can be remembered through: "FOCaL" i.e. Financial, Operational, Counterparty, and Liquidity risks! |
| murphynan | @abod2 I like this one !! |
| nmech1984 | CFA L1... THE END!!! |