ACCTG 231 - Ch12 McGrawHill
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
What is the term used to describe the discount rate at which the present value of a project's cash inflows will equal the present value of its cash outflows?
Internal Rate of Return
Which are the two broad categories of capital budgeting decisions?
Screening decisions Preference decisions
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, the depreciation on the investment is excluded in the calculation of net cash flow.
True
Which of the following statements are true? (select all that apply) a) When the net present value method is used, the discount rate equals the hurdle rate. b) When using the internal rate of return method, the cost of capital is used as the hurdle rate. c) The cost of capital may be used to screen out undesirable projects. d) In order for a project to be acceptable, the discount rate must be higher than the minimum acceptable rate of return.
a) When the net present value method is used, the discount rate equals the hurdle rate. b) When using the internal rate of return method, the cost of capital is used as the hurdle rate. c) The cost of capital may be used to screen out undesirable projects.
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
One dollar earned today is worth ______.
more than one dollar earned at a future point in time
The internal rate of return is the discount rate that results in a net present value of ___________ for the investment.
zero
Project Marvel is a five-year project. The project has a total cash inflow of $350,000. The present value of such inflows is $275,000. The project requires an initial investment of $200,000 and additional working capital of $25,000. What is the net present value of the project?
$50,000 Net present value of cash flows= present value of cash inflows- present value of cash outflows(inflows -outflows) Net present value of cash flows= $275,000- (200,000+25,000)= 50,000
Identify the simplifying assumptions usually made in net present value analysis.
- all cash flows other than the initial investment occur at the end of periods - all cash flows generated by the investment project are immediately reinvested at a rate of return equal to the discount rate
Typical capital budgeting decisions include ______ decisions.
- cost reduction - equipment selection - lease or buy
The payback method ______.
- is not a true investment profitability - does not consider the time value of money - ignores all cash flows that occur after the payback period
When using net present value to compare projects, the total cost approach ______.
- is the most flexible method available to compare projects -includes all cash inflows and outflows under each alternative
Capital budgeting decisions ______.
- require a great deal of analysis prior to acceptance -involve an immediate cash outlay in order to obtain a future return
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
Addison Corporation is considering the purchase of equipment that would increase sales revenues by $250,000 per year and cash operating expenses by $100,000 per year. The equipment would cost $400,000 and have a 5-year life with no salvage value. The simple rate of return on the investment is closest to ________.
17.5% Annual depreciation= (cost of $400,000- salvage value of $0)/ 5 year life= $80,000 Annual incremental net operating income= annual incremental revenue of $250,000- annual depreciation of $80,000- annual incremental cash operating expense of $100,000= $70,000 Simple rate of return= annual incremental net operating income of $70,000/initial investment of $400,000= 17.5%
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 $________
42,000
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 35000*1.2
An investment proposal with an initial investment of $100,000 generates annual net cash inflow of $20,000 for a period of 10 years. The project has a net present value of $10,000. What is this investment proposal's payback period?
5 years (100,000/20,000)
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 Reason:Both options are acceptable because they each have an internal rate or return greater than the required rate of return, but Option B is preferred because it has a higher internal rate of return.
What terms are used to describe preference decision making?
Ratio decisions Ranking decisions
When a project with a negative NPV has significant intangible benefits, the ______.
annual intangible benefit necessary to make the investment worthwhile should be calculated
The simple rate of return is also called ________ and _________.
annual rate of return
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
The managers plan for significant investments in projects that have long term implications such as purchasing new equipment or introducing new products is called __________ ___________.
capital budgeting
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 flow 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 basic premise of the payback method is the ______, the more desirable the investment.
faster the cost of the investment is recovered
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
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 net present value decision that does not involve any revenues is known as a(n) ________ - _________ decision.
least-cost
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
When analyzing an investment project, uncertain future cash flows ______.
may be estimated using computer simulations
The simple rate of return method focuses on ______, rather than ______.
net operating income cash flows
Working capital ______.
often increases when a company takes on a new project
The basic premise of the __________ method is that the more quickly the cost of an investment can be recovered, the more desirable the investment is.
payback
The length of time that it takes for a project to recover its initial cost from the net cash inflows that it generates is then ___________ _________.
payback period
If the original investment in a capital project has been recovered, the net present value will be ______.
positive or zero
Preference decisions are also called _________ or _________ decisions.
rationing or ranking
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