unit 5 module 12- capital budgeting

Question 1

capital budgeting

Answer 1

the decision making process that businesses use to decide whether to invest money in new assets, such as computer systems, equipment, buildings, or any assets that the company needs to expand and grow
- also used for determining if the business needs a new line of product

Question 2

why is capital budgeting important?

Answer 2

because large sums of money are involved and because it is difficult and expensive to reverse capital budgeting decision s

Question 3

statement of cash flows

Answer 3

financial statement required by the GAAP that is used in evaluating a companies past cash flows

Question 4

cash flows 3 sections

Answer 4

• operating
• investing
• financing

(OIF- oh if only we could remember)

Question 5

amortization

Answer 5

non-cash deductible expense for longterm “intangible asset” which are valuable but they cannot actually be seen or touched. ex. copyrights, trademarks, patents, etc.

Question 6

3 main capital budgeting methods

Answer 6

1. payback
2. net present value
3. Internal rate of Return

Question 7

payback

Answer 7

determines time needed to recover the original investment.

• it doesn’t factor TMV
• the answer is given to us in units of time such as years, etc.

Question 8

what is an ideal method to evaluate capital investment projects

Answer 8

the method must consider time value of money

Question 9

Net present Value

Answer 9

what is the real value of payment received in the future?

• used because the companies own discount rate with TMV math
• NVP is a preferred method to rank capital budgeting projects

Question 10

Internal Rate of Return

Answer 10

-what is the rate of return for this investment.
the discount rate that results in a net present value of 0
- considers TMV

Question 11

why is IRR used ?

Answer 11

it measures investment efficiency, The higher the IRR the better

Question 12

does the IRR represent the annual rate of return of a project ?

Answer 12

no, because projects usually have cash inflows that occurs over the course of multiple years

Question 13

other capital budgeting methods

Answer 13

• profitability index
  -reinvestment rate
  -equivalent annuity
  (besides PB, IRR,NPV)

Question 14

profitability index

Answer 14

useful tool for ranking projects, because it allows you to quantify the amount of value created per unit of investment

Question 15

reinvestment rate

Answer 15

used when trying to decide between alternative investments in order to maximize the value of the firm.

Question 16

Equivalent annuity

Answer 16

used when comparing investment projects of unequal lifespans