Capital investment decisions one

Question 1

What is the definition of capital investment

Answer 1

And outlay at one point in time expected to yield economic benefits at another point in time

Question 2

List three reasons why capital investment decisions are very important

Answer 2

– Large outlays
– Once investment is made it is difficult to get out of
- Long timescales

Question 3

How must businesses invest

Answer 3

In a way which ties in with the long-term strategy

Question 4

What are four examples of capital investment

Answer 4

– Purchased fixed assets

• expand production facilities
• build new premises
• Move to a new location

Question 5

What are the different types of projects

Answer 5

– Independent – mutually exclusive – contingent

Question 6

What is the most important stage in capital investment decisions

Answer 6

Evaluate the proposed project

Question 7

What are the four investment appraisal methods

Answer 7

– Accounting rate of return – payback period – net present value – internal rate of return

Question 8

What does the accounting rate of return do

Answer 8

It takes the average accounting operating profit that the investment will generate and express it as a percentage of the average investment made over the life of the project

Question 9

How is ARR calculated

Answer 9

Average annual operating profit divided by average investment to earn that profit times by hundred percent

Question 10

Has depreciation been deducted on average annual operating profit

Answer 10

It needs to be

Question 11

How is average investment calculated

Answer 11

It’s the value of amount invested at the beginning plus value of amount invested at end divided by two

Question 12

To be accepted what must the project achieve

Answer 12

Target accounting rate of return

Question 13

If there is more than one competing project which exceeds the target what should they do

Answer 13

Choose the one with the highest ARR

Question 14

Two examples of accounting rate of return

Answer 14

It’s similar to other financial ratios and results expressed as a percentage so they’re easy to understand

Question 15

List three disadvantages for accounting rate return

Answer 15

– It ignores timing of cash flows – it uses accounting profit rather than cash – it’s difficult to compare investments of different sizes

Question 16

What is the definition of payback period

Answer 16

The time taken for an initial investment to be repaid out of the net cash inflows from a project

Question 17

To accept a project what must the payback period be

Answer 17

It must be shorter than the maximum payback period set by the business

Question 18

If more than one project meets the payback period target which product should be chosen

Answer 18

The one with the shortest payback period

Question 19

List four advantages of the payback period

Answer 19

– Quick and easy to calculate – easy to understand – takes timing of cash flows into account – uses cash flows rather than accounting profit

Question 20

List five disadvantages of the payback period

Answer 20

– Ignores cash flows beyond the payback period – favours speed of repayment over maximisation of wealth – difficult to set a target payback period – timing of the payments within the payback period is not considered – investment size is not Incorporated