Chapter 14: Capital Budgeting Decisions

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.

Capital budgeting decisions include ______.

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

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

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 ______.

-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

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.

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.

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.

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. True false question.

False

One dollar earned today is worth ______.

More than one dollar earned at a future point in time

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

True. Depreciation is a non-cash expense, and therefore, should not be included in the calculation of the net cash inflows of a capital investment. Thus it must be added back to determine the annual net cash flow.

Cash inflow in a working capital situation:

Working capital is released for use elsewhere within the company

Cash outflow in a working capital situation:

Working capital is tied up for project needs

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

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

To determine if a project is acceptable compare the internal rate of return to the company's ______.

hurdle rate

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

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

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

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

more

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

Working capital ______.

often increases when a company takes on a new project

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

payback

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

positive or zero

Current assets minus current liabilities is called _______ _______.

working capital