Chapter 14

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.

True or false: When calculating the payback period, the depreciation on the investment is excluded in the calculation of net cash flow.

True

Which of the following statements are true?

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

Capital budgeting decisions include ______.

acquiring a new facility to increase capacity purchasing new equipment to reduce cost choosing to lease or buy new equipment deciding to replace old equipment determining which equipment to purchase among available alternatives

A postaudit is a valuable process because ______.

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

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

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

True or false: 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

When analyzing an investment project, uncertain future cash flows ______.

may be estimated using computer simulations

A dollar today is worth (more/less) than a dollar earned a year from now.

more

One dollar earned today is worth ______.

more than one dollar earned at a future point in time

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

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.

2.6 Reason: After two years $44,600 ($21,500 + $23,100) will have been paid back leaving $11,400 ($56,000 - $44,600). $11,400 ÷ $19,000 = .6, so the total payback period is 2.6 years.

Capri Industries is considering an investment that has an initial cost of $26,500 and the following expected cash inflows: Year Cash Inflow 1: $6,000 2: $8,000 3: $10,000 4: $5,000 5: $3,000 The expected payback period is _________ years.

3.5

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 $.

42000

Identify each working capital situation with the appropriate treatment.

Cash inflow: Working capital is released for use elsewhere within the company Working capital is released for use elsewhere within the company Cash outflow: Working capital is tied up for project needs Working capital is tied up for project needs

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

Simple rate of return

Choose whether each of the following would be acceptable or unacceptable: A project with a positive net present value is __________ and a project with a negative net present value __________ is .

acceptable, unacceptable

The simple rate of return is also referred to as the _______ or _______ 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

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

A postaudit involves ______.

checking whether expected results are actually realized

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

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

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

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

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

internal rate of return

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

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

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 Eye Clinic of Dr. Christensen is investing in some equipment to perform corrective eye surgery. It is expected that the equipment purchase will generate an internal rate of return of 24%. This equipment was chosen over equipment to perform cataract eye surgery. Thus, the internal rate of return of the cataract eye surgery equipment must have been ______.

less than the internal rate of return of the corrective eye surgery equipment

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

long-term

Working capital ______.

often increases when a company takes on a new project

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

If the net present value is ______, the original investment in a capital project has been recovered.

positive or zero

Conducting a postaudit ______.

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

Preference decisions are also called ______ decisions.

ranking rationing

Preference decisions are also called _____ or ____ decisions.

rationing, ranking

Capital budgeting decisions ______.

require a great deal of analysis prior to acceptance involve an immediate cash outlay in order to obtain a future return

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 Reason: In order for a project to be acceptable, the internal rate of return must equal or exceed the required rate of return.

The net present value of a project is ______.

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

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

The internal rate of return is ______.

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

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

total cost

Working capital is ______.

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

True or false: The net present value can be used to determine whether a project should be accepted.

true

Current assets minus current liabilities is called .

working capital