Acct ch 11 q3

Steps used to Calculate net present value in the correct order.

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

Annuity

A series of identical cash flows.

The term out- of-pocket costs refers to:

Actual cash outlays for salaries, adverting, and other operating expenses

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

By tracking the unrecovered investment year by year.

Finding the present value of a future cash flow is called :

Discounting

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.

Because of the time value of money, projects that promise _______ returns are preferable to those that promise the opposite

Earlier

Conducting a Postaudit :

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

Internal Rate of Return

Focuses on cash flows

Simple Rate of Return

Focuses on revenue and expenses.

initial investment

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

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 & outflows under each alternative. Is the most flexible method available to compare projects.

Working capital

Inflow & outflow Current assets - current liabilities

Internal rate of return

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

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.

Initial investment

Outflow

Match the following net present value ranges with the acceptability of the proposed project.

Positive or Zero - Acceptable. Negative - Unacceptable

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.

Net present value

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. Determines whether or not a project is an acceptable investment.

The rule used when comparing investments is:

The higher the project profitability index, the more desirable the project

Payback period

The length of time that it takes for a project to fully recover its initial cost out of the net cash inflows that it generates.

The required rate of return is :

The minimum rate of return a project must yield to be acceptable.

Discount Rate can also be referred to as:

The minimum required rate of return

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

Treated like every other cash flow

Capital Budgeting

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.

Cash inflow

Working capital is released for use elsewhere within the company

Cash outflow

Working capital is tied up for project needs

Simple Rate of Return Formula

annual incremental net operating income / initial investment

Working Capital

current assets - current liabilities

Calculating the present value of money is referred to as:

discounting cash flows

The simple rate of Return

ignored the time value of money. fluctuates from year to year along with fluctuations in revenue & expense.

Salvage value

inflow

payback period formula

investment required/annual net cash inflow

Postaudit

involves checking whether or not expected results are actually realized

project profitability index equation

net present value of the project / investment required

Preference decisions

relate to selecting from among several acceptable alternatives. Sometimes called rationing decisions, or ranking decisions.

Screening decisions

relate to whether a proposed project is acceptable - whether it passes a preset hurdle

The basic premise of the payback method is:

the more quickly the cost of an investment can be recovered, the more desirable the investment is.