Capital Budgeting Decisions

Question 1

The Payback Method

Answer 1

Incremental Investment / Annual Net Cash Inflow

Investment Required:
-deduct salvage value of the old machines from the cost of the new machines

Annual Net Cash Inflow:
-Add depreciation back to Net Income

Question 2

Net Present Value

Answer 2

Initial flows multiplied by 1

Annual and one time cash flows by present value factor

Question 3

Simple Rate of Return

Answer 3

Net Operating Income / Initial Investment

Net Operating Income:

• Deduct Depreciation from Total Operating Expenses to find Net Income
• Deduct salvage value of old machines from initial cost of new machines

Question 4

Annual Net Cash Inflows

Answer 4

Expected Inflows - Outflows [Not Discounted]

Question 5

Uncertain Cash Flows

Answer 5

Negative Net Present Value to be Offset / Present Value Factor = Needed (Uncertain) Cash Flow

Question 6

Project Profitability Index

Answer 6

PPI = Net Present Value / Investment Required

Investment Required:

• Includes all initial outflows of the project
• reduced by any salvage value recovered from the sell of old equipment

NPV = Present Value of Future Cash Flows - Investment Required

Question 7

Depreciation

Answer 7

(Initial Investment - Salvage Value of New Equipment) / Time

Question 8

Factor of the Internal Rate of Return

Answer 8

Investment Required / Annual Net cash Inflow