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Principles of Accounting - Managerial > Chapter 13 - Capital Budgeting Decisions & The Concept of Present Value > Flashcards

Chapter 13 - Capital Budgeting Decisions & The Concept of Present Value Flashcards

1
Q

List 5 typical capital budgeting decisions

A
  1. Plant expansion
  2. Equipment selection
  3. Lease or buy
  4. Equipment replacement
  5. Cost reduction
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2
Q

What are the two broad categories that capital budgeting tends to fall into?

A
  1. Screening decisions

2. Preference decisions

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3
Q

What 3 methods focus on analyzing the cash flows associated with capital investment projects?

A
  1. Payback method
  2. Net present value
  3. Internal rate of return
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4
Q

Which method focuses on incrementing net operating income?

A

The simple rate of return method

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5
Q

List 4 types of typical cash outflows

A
  1. Repairs and maintenance
  2. Working capital required
  3. Incremental operating costs
  4. Initial investment
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6
Q

List 4 types of typical cash inflows

A
  1. Salvage value
  2. Working capital released
  3. Incremental revenues
  4. Reduction of costs
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7
Q

What is repairs and maintenance an example of?

A

Periodic outlays

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8
Q

Are capital investments that promise earlier returns or later returns preferred?

A

Capital investments that promise earlier returns are preferred

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9
Q

What do capital budgeting techniques that best recognize the time value of money involve?

A

Discounted cash flows

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10
Q

What does the payback method focus on?

A

The payback period

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11
Q

What is the length of time that it takes for a project to recoup its initial cost out of the cash receipts that it generates?

A

The payback period

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12
Q

What does the payback method analyze?

A

Cash flows

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13
Q

What is the payback period expressed in?

A

Years

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14
Q

What is the formula to find the payback period?

A

Investment / Annual net cash inflow

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15
Q

Management at the Daily Grind wants to install an espresso bar in its restaurant that:

  1. Costs $140,000 and has a 10-year life.
  2. Will generate annual net cash inflows of $35,000.

Management requires a payback period of 5 years or less on all investments.

What is the payback period for the espresso bar?

A 
PP = Investment / Annual net cash inflow
PP =  $140,000 / $35,000
PP = 4 years
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16
Q

When should someone invest in a company?

A

Company payback period < required payback period

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17
Q

What does the net present value method focus on?

A

Cash flows

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18
Q

Fill in the Blanks:

The net present value method compares the present value of a project’s _________ with the present value of its _________.

A
  1. Cash inflows

2. Cash outflows

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19
Q

What is the difference between the streams of cash inflows and cash outflows?

A

The net present value

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20
Q

What is the formula to find the annual net cash inflow?

A

Net operating income + depreciation

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21
Q

Fill in the Blank:

You should accept a contract when the project has a ______ net present value

A

Positive

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22
Q

Is investment on equipment a cash inflow or cash outflow?

A

Cash outflow

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23
Q

Is working capital required a cash inflow or cash outflow?

A

Cash outflow

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24
Q

Is the salvage value of equipment a cash inflow or cash outflow?

A

Cash inflow

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25
Is working capital released a cash inflow or cash outflow?
Cash inflow
26
# Fill in the Blanks: A cash inflow has a _______ net present value whereas a cash outflow has a _______ net present value
1. Positive | 2. Negative
27
What is the formula used in the net present value method to find the future cash flow's present value?
Total cash flows x discount factor
28
What does a positive net present value indicate?
The project’s return > the discount rate
29
What does a negative net present value indicate?
The project’s return < the discount rate
30
What is the discounted rate also known as?
The required rate of return
31
Is the project acceptable if the net present value is zero?
Yes
32
What does a net present value of 0 indicate?
The project return = the discount rate
33
What is the company’s cost of capital usually regarded as?
The minimum required rate of return
34
What is the average return the company must pay to its long-term creditors and stockholders?
The cost of capital
35
What does the net present value method automatically provide for?
Return of the original investment
36
What are the 2 methods for computing the net present value method?
1. The present value of a dollar | 2. The present value of an annuity
37
# Fill in the Blank: Greatest/Least In decisions where revenues are not directly involved, managers should choose the alternative that has the ____ total cost from a present value perspective
Least
38
What is the formula to find the salvage value?
Net present value / Present value
39
Do screening decisions or preference decisions come first?
Screening decisions come first
40
What attempts to rank acceptable alternatives from the most to least appealing?
Preference decisions
41
What pertains to whether or not some proposed investment is acceptable?
Screening decisions
42
When can the net present value of one project be directly compared to the net present value of another project?
When their investments are equal
43
What is the formula to find the profit profitability index?
Net present value / Investment
44
Is a project more desirable when the profit profitability index is lower or higher?
Higher
45
What does the simple rate of return method focus on?
Operating income
46
What is the formula to find the simple rate of return?
Net operating income / (Investment - salvage value on old equipment)
47
Management of the Daily Grind wants to install an espresso bar in its restaurant that: Cost $140,000 and has a 10-year life. Will generate incremental revenues of $100,000 and incremental expenses of $65,000 including depreciation. What is the simple rate of return on the investment project?
``` SRoR = (Net operating income - Depreciation) / Investment SRoR = ($100,000 - $65,000) / $140,000 SRoR = $35,000 / $140,000 SRoR = 25% ```
48
What is the simple rate of return's annual incremental net operating income reduced by?
Depreciation
49
What is the formula to find depreciation?
(Original cost - Salvage value) / Usable Life
50
True or False: The payback method doesn't include depreciation while the simple rate of return does
True
51
What are 2 disadvantages of the simple rate of return method?
1. It ignores the time value of money | 2. The same project may appear desirable in some years and undesirable in other years
52
What might a project's simple rate of return motivate investment center managers to do when they are evaluated using return on investment?
To bypass investment opportunities that earn positive net present values
53
What is a follow-up after the project has been completed to see whether or not expected results were actually realized?
A postaudit
54
What is the formula to find the working capital?
Current assets - current liabilities
55
What is the layout of the rows in the net present value method?
Years Cash Flows % Factor Present Value
56
When should you use the present value of a $ chart?
When it is a 1 time event
57
When should you use the present value of an annuity chart?
When it is an annual event
58
Which chart do you use to find the present value of annual net cash inflows?
The present value of an annuity chart
59
When you have an annual event which year should you look at to find the present value % factor?
The last year
60
True or False: When you are calculating the net present value you have to include working capital released at the end of the period if there is a working capital required
True
61
What is working capital released equal to?
A positive working capital required
62
What is the formula to find the balance at the end of the period?
(Money x %) + Money
63
Assume a bank pays 8% interest on a $100 deposit made today. How much will the $100 be worth in one year?
(100 x 8%) + 100 = 108
64
What is the interest that is paid in the second year on the interest earned in the first year?
Compound interest
65
What if the $108 was left in the bank for a second year? How much would the original $100 be worth at the end of the second year?
(108 x 8%) + 108 = 116.64
66
List 2 ways an investment can be viewed
1. It's future value | 2. It's present value
67
What is the interest rate used to find the present investment amount?
The discount rate
68
What is it called when you use an interest rate to find the present invested amount?
Discounting
69
What is an investment that involves a series of identical cash flows at the end of each year?
An annuity
70
List 3 disadvantages of the payback method
1. It ignores the time value of money 2. It ignores cash flows after the payback period 3. A shorter payback period does not always mean a more desirable investment
71
List 3 advantages of the payback method
1. It serves as screening tool 2. It identifies products that recoup initial investment quickly 3. It identifies investments that recoup cash investments quickly

Principles of Accounting - Managerial (11 decks)

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