Chapter 13: Capital Budgeting Decisions

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

$1,070 ($1,000 x (1 + .07))

State bank is implementing a new marketing campaign that requires an initial investment of $35,000. If the project profitability index is 0.2, the net present value of the campaign's future cash flow is $____.

$7,000 ($35,000 x 0.2)

Which of the following statements are true?

- 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.

Typical capital budgeting decisions include:

- Cost reduction decisions - Lease or buy decisions - Equipment selection decisions

Capital budgeting systems include:

- Deciding to replace old equipment - Determining which equipment to purchase among available alternatives - Acquiring a new facility to increase capacity - Purchasing new equipment to reduce cost - Choosing to lease or buy new equipment

The payback method:

- Does not consider the time value of money - Ignores all cash flows that occur after the payback period - Is not a true measure of investment profitability

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

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

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

Select the capital budgeting approaches that use discounted cash flows.

- Internal rate of return method - Net present value method

Capital budgeting decisions:

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

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

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

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

- Screening - Preference

Which of the following statements is true?

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

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 for a project

Which of the following statements are true?

- 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 a hurdle rate. - The cost of capital may be used to screen out undesirable projects.

Bo's Baseball Equipment is planning to invest in some new equipment that has a purchase price of $30,000. The new equipment will save Bo $7,500 in operating expenses annually. The factor of the internal rat of return for this project is:

4 ($30,000/$7,500)

Positive or zero value range:

Acceptable

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

Cost of Capital:

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

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

Both the net present value and the internal rate of return methods

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

An investor deposits $100 and earns $6 of interest in the first year and $6.36 of interest in the second year. This means the investment is earning 6% _______ interest.

Compound

Working Capital:

Current assets - current liabilities

Net present value is the:

Difference between the present value of a project's cash inflows and the present value of the project's cash outflows

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

Committing funds today with the exception 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

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

Spending the money on opening a new location, purchasing new equipment, implementing new programs, expanding to new product lines, and conducting research are all examples of:

Investments

The concept of 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

Stephan Photography has an 18% required rate of return and is analyzing competing investments in new camera equipment. Option A has a project profitability index of 0.16, and Option B has a project profitability index of 0.13. The best choice for Stephan Photography would be:

Option A

Instead of focusing on a project's profitability, the _______ period focuses on the time it takes for an investment to pay for itself.

Payback

Investment required/Annual net cash flow is the formula for the:

Payback period

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 ________ ________.

Payback period

One of the two broad categories of capital budgeting decisions, a _____ decision, relates to selecting from among several acceptable alternatives.

Preference

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

Present

Preference decisions are also called _____ decisions.

Ranking and Rationing

The internal rate of return is compared against the minimum ____ rate of return when analyzing the acceptability of an investment project.

Required

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.

Which of the following statements is FALSE?

The net present value method assumes that cash flows are not invested.

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

Negative value range:

Unacceptable

Cash inflow:

Working capital is released for use somewhere within the company

Cash outflow:

Working capital is tied up for project needs

The internal rate of return is the discount rate that results in a net present value of __________ for the investment.

Zero

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

cash outlays for salaries, advertising, and other operating expenses.