Chapter 12

Pam's Pet Palace is considering an investment in dog grooming equipment that would increase cash receipts by $12,000 annually. The initial cost of the equipment is $50,000. The equipment has an estimated 10 year life and will have a $5,000 salvage value. Using a discount rate of 8%, what is the net present value of this equipment?

$32,835

the difference between the present value of cash inflows and present value of cash outflows used in determining whether or not a project is an acceptable capital investment

-76,510

Which of the following statements are true?

-Compound interest means that interest is paid on interest. -The more frequently interest is compounded, the faster the balance grows.

Identify capital budgeting decisions.

-Expansion decisions -Equipment replacement decisions

Select the capital budgeting approaches that use discounted cash flows.

-Internal rate of return method -Net present value method

Which of the following statements are true?

-The cost of capital may be used to screen out undesirable projects. -When the net present value method is used, the discount rate equals the hurdle rate. -When using the internal rate of return method, the cost of capital is used as the hurdle rate.

Typical capital budgeting decisions include ______ decisions.

-cost reduction -equipment selection -lease or buy

Calderon Kitchen Supplies is planning to invest $210,000 in a new product. If the present value of the cash inflows is $266,700, the project profitability index is

1.27

State Bank is implementing a new marketing campaign that requires an initial investment of $35,000. If the project profitability index is 1.2, the present value of the campaign's future cash flows is $ _____

42,000

Match the following net present value ranges with the acceptability of the proposed project. Positive or zero Negative

Acceptable Unacceptable

Another term for the minimum required rate of return is the cost of

capital

The term _____ _____ is used to describe how managers plan significant investments in projects that have long-term implications such as the purchase of new equipment or the introduction of new products

capital budgeting

When using the internal rate of return method to rank competing investment projects

the higher the internal rate of return, the more desirable the project

All cash flows are included, and a net present value is computed for each alternative when using the _____-_____ approach.

total cost

Current assets minus current liabilities is called

working capital

Which of the following statements are true?

-The net present value method automatically provides for return of the original investment. -A project with a positive NPV will recover the original cost of the investment plus sufficient cash inflows to compensate for tying up funds.

Capital budgeting decisions include

-acquiring a new facility to increase capacity -choosing to lease or buy new equipment -deciding to replace old equipment -purchasing new equipment to reduce cost

The payback method

-does not consider the time value of money -is not a true measure of investment profitability -ignores all cash flows that occur after the payback period

If the internal rate of return is

-greater than the hurdle rate the project is acceptable -less than the hurdle rate the project should be rejected

When using net present value to compare projects, the total cost approach

-includes all cash inflows and outflows under each alternative -is the most flexible method available to compare projects

The capital budgeting methods that focus on cash flows rather than incremental operating income are

-net present value -payback -internal rate of return

The two broad categories into which capital budgeting decisions fall are ______ and ______ decisions.

-screening -preference

Working capital is

-treated as a cash inflow when released at the end of a project. -treated as a cash outflow when required at the beginning of a project.

The net present value of a project is

-used in determining whether or not a project is an acceptable capital investment -the difference between the present value of cash inflows and present value of cash outflows

Sandy's Soda Co. is planning to purchase new equipment that costs $56,000 and will save on operating costs for the next 5 years as follows: $21,500 in year 1; $23,100 in year 2; $19,000 in year 3; $13,900 in year 4; and $15,200 in year 5. The payback period for the cooling equipment is ______ years.

3

When a capital investment decision is being made between two or more alternatives, the project with the shortest payback period is always the most desirable investment.

False

Which of the following capital budgeting decision tools focuses on net operating income rather than cash flows?

Simple rate of return

True or false: When calculating the payback period, any depreciation deducted in arriving at the project's net operating income must be added back to obtain the project's expected annual net cash inflow.

True

Identify each working capital situation with the appropriate treatment. Cash Inflow Cash Outflow

Working capital is released for use elsewhere within the company Working capital is tied up for project needs

Synonyms for the simple rate of return are the ______ rate of return and the _____ rate of return.

accounting, unadjusted

When a project with a negative NPV has significant intangible benefits, the

annual intangible benefit necessary to make the investment worthwhile should be calculated

A series of equal cash flows is a(n)

annuity

An investment that pays the investor $1,000 per year for the next 10 years is an example of a(n) _____

annuity

The cost of capital is the

average rate of return a company must pay its long-term creditors and shareholders for the use of their funds

When computing the simple rate of return, the annual incremental net operating income in the numerator should ______ the investment's depreciation charges.

be reduced by

To screen out undesirable investments, ______ use(s) the cost of capital.

both the net present value and internal rate of return methods

When the cash flows associated with an investment project change from year to year, the payback period must be calculated

by tracking the unrecovered investment year by year

Future cash flows expected from investment projects

can be difficult to estimate

How managers plan significant investments in projects that have long term implications such as purchasing new equipment or introducing new products is called

capital budgeting

A postaudit involves

checking whether expected results are actually realized

An investor deposits $100.00 and earns $6.00 of interest in the first year and $6.36 of interest in the second year. This means the investment is earning 6% _____ interest.

compound

When computing the payback period for a new piece of equipment, the salvage value of the equipment being replaced is

deducted from the cost of the new equipment

The net present value of a project is the

difference between the present value of cash inflows and the present value of cash outflows the difference between the present value of cash inflows and present value of cash outflows used in determining whether or not a project is an acceptable capital investment

Suppose a project with a negative net present value would provide intangible benefits. To estimate the annual value of intangible benefits needed to accept the project, ______ the negative net present value excluding intangible benefits by the ______

divide, present value factor for an annuity

To determine if a project is acceptable compare the internal rate of return to the company's

hurdle rate

Investment required ÷ Annual net cash inflow is the formula to find the factor that needed to calculate the

internal rate of return

In an equipment capital budgeting decision, recovering the original investment means that the

investment has generated enough cash inflows to completely cover the cost of the equipment

When net cash inflow is the same every year, the equation used to calculate the factor of the internal rate of return is

investment required ÷ annual net cash inflow

The internal rate of return

is the discount rate that makes NPV equal zero for a project

It is important to know the present value of an investment because a dollar ______ it will be worth a year from today.

is worth more today than

A net present value decision that does not involve any revenues is known as a(n) _____ _____ decision

least cost

When a capital budgeting decision does not involve any revenues, the most desirable alternative is the one with the

least total cost from a present value perspective

When analyzing an investment project, uncertain future cash flows

may be estimated using computer simulations

The concept of the time value of money is based on the notion that a dollar today is worth (more/less) _____ than a dollar a year from now

more

A dollar received today is ______ a dollar received a year from now.

more valuable than

Two capital budgeting approaches that use discounted cash flows are the _____ value method and the _____ _____of return method.

net present internal rate

Working capital

often increases when a company takes on a new project

Reggie's Refrigerators is considering the purchase of some new equipment. The company has limited its purchase options to two alternatives. Option A has an internal rate of return of 10%, and option B has an internal rate of return of 13%. If the required rate of return on the project is 9.5%

option B is the preferred choice

The length of time that it takes for a project to recover its initial cost from the net cash inflows that it generates is the _____ period

payback

If the original investment in a capital project has been recovered, the net present value will be

positive or zero

The purpose of a(n)_____ is to see if capital budgeting expectations were actually realized

postaudit

Preference decisions are also called ______ decisions.

rationing ranking

Preference decisions are sometimes called _____ decisions or _____ decisions.

rationing ranking

A screening decision

relates to whether a proposed project is acceptable

When computing the simple rate of return, the initial investment should be reduced by any ______ value realized from the sale of the old equipment.

salvage

Little Tots Gym has a required rate of return of 13%. The gym is considering the purchase of $12,500 of new equipment. The internal rate of return on the project has been calculated to be 11%. This project

should be rejected

The capital budgeting method that focus on incremental operating income rather than cash flows is

simple rate of return

The internal rate of return is

the rate of return of an investment project over its useful life

The concept that a dollar today is worth more than a dollar a year from now is called the _____ _____ of money

time value