Chapter 15

Tilly's Travel purchased a new tour bus at a cost of $320,000. The bus is expected to increase cash inflows over the next 5 years as follows: $98,000 in year 1, $87,000 in year 2, $74,500 in year 3, $60,000 in year 4, and $59,000 in year 5. The payback period for the new bus is in years.

4

What assumption underlies net present value analysis?

All cash flows generate by an investment project are immediately reinvested at a rate of return equal to the discount rate.

Identify each working capital situation with the appropriate treatment.

Cash Inflow-Working capital is released for use elsewhere within the company Cash outflow-Working capital is tied up for project needs.

Which of the following are appropriately classified as capital budgeting decisions?

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

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

Discounting

Match the following approaches used to compare competing investment projects with the appropriate explanation of the approach.

Incremental-cost approach-all cash flows that are included in calculating the net present value for each alternative. Incremental-cost approach-only those cash flows that differ between the two alternatives are included in the analysis.

What is the equation used to calculate the payback period when annual net cash inflows are the same every year

Investment required/ Annual net cash inflow

The incremental-cost approach:

Is preferable to the total-cost approach when only two alternatives are being considered. Only includes costs and revenues that differ between the alternatives being considered.

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.

When considering an equipment purchase, discounting is necessary because future cost savings are worth today than when they actually occur in the future.

Less

The required rate of return is the rate of return a project must yield to be acceptable.

Minimum

The concept of the time value of money is based on the notion that a dollar today is worth than a dollar a year from now

More

The period does not focus on a project's profitability, but rather on a project's ability to earn a quick return.

Payback

If a company's minimum required rate of return is used as the discount rate, a project with a:

Positive net present value will have a rate of return that exceeds the minimum required rate of return. Negative net present value is unacceptable.

Match the following Categories of capital budgeting decisions with their description.

Preference Decisions- Relate to selecting from among several acceptable alternatives. Screening Decisions- Relate to whether a proposed project is acceptable.

Preference decisions:

Relates to selecting from acceptable alternatives.

The net present value of a project is:

The difference between present value of cash inflows and present value of cash outflows for a project. Used in determining whether or no a project is an acceptable capital investment.

A capital investment project's payback period is the:

The length of time is takes for the project to recover its initial cost from net cash inflows generated.

Which of the following characteristics of the simple rate of return method for evaluating capital investment proposals?

The simple rate of return ignores the time value of money. The simple rate of return fluctuates from year to year along with fluctuations in revenue and expense.

True or False: When calculating the payback period, the annual net operating income should be increased by any depreciation the results from the investment.

True

A company is considering an investment that costs $30,000 and has a 5-year life. Net operating income will be $4,000 per year, which includes an annual depreciation deduction of $6,000 per year. at the end of 5 years the scrap value will be $2,000. Calculate the payback period.

2.8 years 30,000-2,000/4,000+6,000

An investment of $2,000 at 7% compound interest will be worth $ at the end of 3 years.

2450

What is annuity?

A stream of equal payments

Capital budgeting decisions place an emphasis on project cash flows because:

Accounting net income ignores when cash flows occur. The timing of cash inflows and outflows is critical in the success and profitability of capital projects.

Synonyms for the simple rate of return are the rate of return and the rate of return

Accounting; uadjusted

Place the following items in the appropriate order to create the equation used to calculate the simple rate of return.

Annual Incremental Net Operating Income/ Initial Investment

Another term for the minimum required rate of return is the cost of .

Capital

The term is used to describe how managers plan significant investments in projects that have long term implications

Capital Budgeting

True or False: When 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: The project with the shortest payback period will earn its investment back more quickly, but not necessarily the most desirable project between the alternatives.

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

The payback period is the length of time that it takes for a project to recover its costs from the net cash inflows that it generates.

Initial

The discount rate:

Is the rate used to find the present value of future cash flows

Which of the following are benefits of conducting postaudit?

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

In a situation where the capital project will create no additional revenue for the company, the most desirable alternative is the one with the:

Least total cost from the present value perspective.

Comparing a projects rate of return to its cost of capital is a decision

Screening

The two broad categories into which capital budgeting decisions fall are:

Screening decisions Preference decisions

Which of the following are tools that can help managers to make capital budgeting decisions that do not involve present value?

Simple rate of return Payback period

When a company plans to sell a piece of equipment for $15,000 five years from now, to find its present value you must discount a(n)

Single sum

What is the 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.

Which of the following statements regarding net present value and income taxes are true?

The cost of capital should be based upon after-tax costs. Income taxes on both revenues and expense should be considered in net present value analysis.

The rule used when comparing investments is:

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

Shortcomings of the payback period when making a capital investment decision include:

The payback period does not consider the time value of money. The payback period ignores all cash flows that occur after the payback period.

Match the net present value analysis with the appropriate reasoning.

Unacceptable project with a negative net present value- The project promises a return less than the required rate of return. 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.

Match each capital investment cash flow with the appropriate category.

Working capital- inflow and outflow Initial Investment-outflow Salvage value-inflow

The internal rate of return method identifies the rate of return promised by an investment promised by an investment project over its useful life by finding the discount rate that results in a net present value of .

Zero

Working capital is current minus current .

assets; liabilities

Working Capital:

often increases when a company takes on a new project.

The payback method is a useful tool when making a decision.

screening