Accounting 231 - Ch. 11 LearnSmart

When making a preference decision, the net present value of one project cannot be directly compared to the net present value of another project unless the initial investments are ___.

Equal

A manager with a current ROI of 22% has been offered a project with a positive net present value and a simple rate of return of 17%. Which of the following statements are true?

If the manager is evaluated based on ROI he will probably reject the project; The company will want the manager to accept the project

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

Committing funds today with the expectation of earning a return on those funds in the future in the form of additional cash flows is required when a company makes a(n) ___.

Investment

(Use the following items to create the equation used to calculate the payback period when annual net cash inflow is the SAME EVERY YEAR)

Investment Required/(divided by) Annual Net Cash Inflow

It is important to know the present value of an investment because a dollar:

Is worth more today than it will be worth a year from today

Which of the following are benefits of conducting a postaudit?

It provides an opportunity to cut losses on floundering projects; It provides an opportunity to reinforce and possibly expand successful projects; It will flag any manager's attempts to inflate benefits or downplay costs in a project proposal

In a situation where the capital project will create no additional revenue for the company, the most desirable alternative is the one with the:

Least total cost from the present value perspective

A capital investment project's payback period is the:

Length of time it takes for the project to recover its initial cost from the net cash inflows generated

The term capital budgeting is used to describe how managers plan significant investments in projects that have ___ implications.

Long-term

The required rate of return is the ___ rate of return a project must yield to be acceptable.

Minimum

The concept of the time value of money is based on the notion that a dollar today is worth ___ than a dollar a year from now.

More

A dollar today is ___ a dollar received a year from today.

More valuable than

Unlike other capital budgeting methods, the simple rare of return method focuses on ___, rather than ___.

Net Operating Income; Cash Flows

When a conflict between capital budgeting method exists, the most reliable method to use for making preference decisions is:

Net Present Value

The term discounting cash flows refers to the process of calculating the ___ value of those cash flows.

Present

The basic premise of the payback method is that the more ___ the cost of an investment can be recovered, the more desirable the investment is.

Quickly

(Select the terms that are interchangeable with the term PREFERENCE DECISION)

Ranking Decision and Rationing Decision

The discount rate can also be referred to as the minimum required ___ of ___.

Rate of Return

The investment value used in the payback period calculation when new equipment is being considered should be the cost of the new equipment net of any ___ value from the old equipment being replaced.

Salvage

When using the simple rate of return, the initial investment should be reduced by the ___ value of old equipment.

Salvage

(Match each capital investment cash flow with the appropriate category)

Salvage Value - Inflow Initial Investment - Outflow Working Capital - Inflow and Outflow

Which of the following are NOT typical capital budgeting cash outflows?

Salvage value of old equipment; Cost reduction

Comparing a project's rate of return to its cost of capital is a ___ decision.

Screening

One of the two broad categories of capital budgeting decisions, a ___ decision, relates to whether a proposed project is acceptable based on a present criterion.

Screening

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

Screening and Preference

Shortcomings of the payback method when making a capital investment decision include:

The payback method does not consider the time value of money; The payback method ignores all cash flows that occur after the payback period

Acceptable project with a net present value of zero

The project promises a return equal to the required rate of return

Acceptable project with a positive net present value

The project promises a return greater than the required rate of return

Unacceptable project with a negative net present value

The project promises a return less than the required rate of return

If $1,000 is invested at 7% interest, the total value of the investment at the end of one year will be $___.

$1,070

An investment of $2,000 at 7% compound interest will be worth $___ at the end of 3 years.

$2,450 (2,000*(1+.07)^3)

Given an interest rate of 8% compounded annually, $5,000 to be received four years from today is equal to:

$3,675 today

Calculate the present value of a 10-year, 6% loan with annual payments of $7,500 made at the end of each year.

$55,200 ($7,500*7.360)

Calderon Kitchen Supplies is planning to invest $210,000 in a new product. The product is expected to generate a net present value of $56,700. The project profitability index is:

0.27

(Place the following steps used to calculate net present value in the correct order)

1) Determine the discount rate using the minimum required return 2) Find the PV factors using the discount rate and timing of each cash flow 3) Multiply all project cash flows by the present value factor 4) Find the difference between the PV of cash inflows and cash outflows

(Select all correct statements regarding net present value)

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

A postaudit is a valuable process because:

Actual values can be used to determine if the project is performing as expected

What assumption underlies net present value analysis?

All cash flows generated by an investment project are immediately reinvested at a rate of return equal to the discount rate

(Place the following items in the appropriate order to create the equation used to calculate the SIMPLE RATE OF RETURN)

Annual Incremental Net Operating Income/(divided by) Initial Investment

A series of equal cash flows is a(n) ___.

Annuity

When making a capital budgeting decision, it is most useful to calculate the payback period:

As part of the screening process; If a company is "cash poor"

Cost of Capital:

Average rate of return that must be paid to long-term creditors and shareholders for use of their funds

Which of the following are true regarding the time value of money?

By collecting a project's return quickly, the investor has the opportunity to re-invest that money to earn even more; Projects that provide earlier returns are preferable to those that promise later returns

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

When discussing capital investments, the term out-of-pocket costs refer to:

Cash outlays for salaries, advertising, and other operating expenses

A postaudit involves:

Checking whether expected results are actually realized

Working Capital:

Current assets minus current liabilities

Finding the present value of a future cash flow is called ___.

Discounting

Salvage Value:

Funds gained from the sale of a capital asset

Initial Investment:

Funds needed to purchase a capital asset or begin a capital investment project

When using the project profitability index to rank competing investments, the ___ the project profitability index, the more desirable the project.

Higher

The ___ rate of return focuses on cash flows, while the ___ rate of return focuses on revenue and expense.

Internal; Simple

Capital budgeting decisions:

Involve an immediate cash outlay in order to obtain a future return; Require a great deal of analysis prior to acceptance

The internal rate of return:

Is an alternative to the net present value method; Is the rate of return promised by an investment over its useful life; May be used for preference or screening decisions

Actual cash outlays for operating expenses are:

Out-of-pocket Costs

The ___ period does not focus on a project's profitability, but rather on a project's ability to earn a quick return.

Payback

What is the cost of capital?

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

The net present value of a project is:

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

An investment requires committing funds today with:

The expectations of earning a return on those funds in the future

Which of the following statements are true?

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

Which of the following are characteristics of the simple rate of return method for evaluating capital investment proposals?

The simple rate of return fluctuates from year to year along with fluctuations in revenue and expense; The simple rate of return ignores the time value of money

When computing net present value after tax, income tax expense is:

Treated like every other cash flow

Current assets minus current liabilities is called ___ ___.

Working Capital

Cash Inflow:

Working capital is released for use elsewhere within the company

Cash Outflow:

Working capital is tied up for project needs