Chapter 4 - Capital Budgeting

Question 1

what are the 4 types of capital budget decisions?

Answer 1

1. OSHA requirement
2. Acquiring equipment to reduce the operating cost
3. acquiring equipment to increase sales
4. replacing existing equipment

Question 2

what is the future value factors?

Answer 2

it shows how much my $1 worth in future (FV of 1) , number always should be more than 1

Question 3

what is the present value factors?

Answer 3

it shows how much my future $1 worth today - always less than 1

Question 4

what is present value factors for annuity?

Answer 4

it shows how much I need to invest now to receive $X in future

Question 5

what is future value factors for annuity?

Answer 5

it shows how much I will receive annually in future

Question 6

what are the 4 capital budgeting models?

Answer 6

1. accounting rate of return (ARR)
2. payback
3. Net present value (NPV)
4. internal rate of return (IRR)

Question 7

what is the formula for accounting rate of return (ARR)?

Answer 7

ARR = Average Annual project income / Average Investment

Question 8

what is the formula for average annual project income?

Answer 8

total project income over its life / number of years

Question 9

what is the formula for average investment?

Answer 9

Project cost + Salvage / # of investment

Question 10

what is advantage and disadvantage of ARR?

Answer 10

simplicity, easy to calculate but fails to consider cash flows or the time value of money

Question 11

what is formula for payback?

Answer 11

payback period = project cost / annual cash flow

Question 12

what is advantage and disadvantage of payback?

Answer 12

simple, easy to calculate, but fails to consider time value of money and cash flow of future payback period

Question 13

what is advantage and disadvantage of Net Present Value model?

Answer 13

consider the time value of money over the projected life of the capital project. The project is acceptable if NVP is greater than zero. disadvantage is complex.

Question 14

what is internal rate of return?

Answer 14

The IRR model is a capital budgeting approach that considers cash flows and the time value of money and determines the rate of return earned by a proposed project. Net present value of cash flows is set at zero and the discount rate is determined. Using IRR model, a project is accepted if the IRR is equal to, or greater than, the established minimum IRR.

Question 15

what is hurdle rate?

Answer 15

minimum IRR established by hospitality managers

Question 16

what is capital rationing?

Answer 16

limiting funds for capital purpose regardless of the expected profitability of the projects. The combination of projects with the highest net present value should be selected under capital rationing.