Capital Investment Decisions

Question 1

How do capital expenditures differ from ordinary expenditures?

Answer 1

• usually involve large sums of $$
• are not as regularly recurring as are expenditures for payroll and inventory
• commit a firm to a long-term course of action which cannot be easily reversed
• involve large cash inflows and outflows over a number of years

Question 2

External pressures

Answer 2

include the effects of competition, demand, and technology

Question 3

Internal pressures

Answer 3

include a firm’s cost structure and managements’ expectations

Question 4

Types of investments

Answer 4

1. replacement
2. cost reduction
3. expansion
4. new products

Question 5

Capital budgeting process

Answer 5

develop ideas –> projects classified into type of investment –> estimate future cash inflows/ outflows –> appraise risk –> analyze financial value of project –> post-audit (compare actual results with predicted results)

Question 6

What is the interest rate received by the lender determined by?

Answer 6

i. ) receipt of $$ is preferred sooner rather than later
ii. ) risk of the capital sum not being repaid
iii. ) inflation

Question 7

future value

Answer 7

dollar in hand today is worth more than a dollar to be received in the future b/c if you had it now, you could invest it and earn interest
the amt to be received at the end of one period

Question 8

present value

Answer 8

the current value of a specified amt to be received at some future date

Question 9

PVIF

Answer 9

present value interest factor (number you will find on the table)

Question 10

Net present value (NPV)

Answer 10

method of adjusting cash inflows and outflows for the time value of money so that they are comparable
difference b/w the PV of the inflows and the PV of the outflows

Question 11

Required Rate of Return (RRR)

Answer 11

rate of return that an investment must earn to be financially attractive
as RRR increases, present value of cash flows in future years decreases
RRR for a business should be equal to its cost of capital (cost of capital is the cost of both debt and equity to the firm)

Question 12

cost of debt

Answer 12

interest rate at which the business can borrow money

should be tax adjusted

Question 13

cost of equity

Answer 13

interest that investors require to invest in the business

Question 14

cost of capital

Answer 14

weighted average of the relative proportions of debt and equity on the business’ balance sheet

Question 15

Risk and RRR

Answer 15

higher the risk of a project, the higher the RRR

lower RRR is used for projects that are critical to the company’s strategy or mission

Question 16

Internal Rate of Return (IRR)

Answer 16

Calculated by finding the interest rate at which the PV of the inflows from the investment is equal to the PV of the outflows
at this point, the NPV is 0