Week 13 Capital Budgeting

Question 1

is the process of planning and evaluating investments in plant assets (equipment and machinery)

Answer 1

capital budgeting

Question 2

1. equipment purchase decision
2. equipment replacement decisions
3. lease v. buy decisions
4. plant expansion decisions

Answer 2

typical capital budgeting decisions

Question 3

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

Answer 3

four capital budgeting techniques

Question 4

if the Net present value is positive then the project is

Answer 4

acceptable, since it promises a return greater than the minimum required rate of return (cost of capital)

Question 5

if the Net present value is zero, then the project is

Answer 5

acceptable, since it promises a return equal to the minimum required rate of return (cost of capital)

Question 6

if the Net present value is negative, then the project is

Answer 6

not acceptable, since it promises a return less than the minimum required rate of return (cost of capital)

Question 7

represents the smallest rate of return the company is willing to accept on its investment projects

Answer 7

cost of capital
- use the cost of capital to find the present values of the cash flows

Question 8

• minimum required rate of return
• discount rate
• hurdle rate

Answer 8

cost of capital can be referred to as

Question 9

1. initial investment
2. working capital investment
3. increase in variable costs
4. repairs, maintenance, and overhauls

Answer 9

typical cash outflows

Question 10

1. increase in revenues
2. reduction of costs
3. salvage value
4. release of working capital

Answer 10

typical cash inflows

Question 11

is not included in calculating the net present value of a project because IT IS NOT A CASH OUTFLOW

Answer 11

depreciation

Question 12

represents the actual or real rate of return generated by an investment project

Answer 12

internal rate of return (IRR)

Question 13

if the Internal rate of return is equal to or greater than the minimum required rate of return (cost of capital), therefore the NPV > 0 or = 0, then the project is

Answer 13

acceptable

Question 14

if the Internal rate of return is less than the minimum required rate of return (cost of capital), therefore the NPV < 0 then the project is

Answer 14

rejected

Question 15

represents the length of time it will take for a project to pay for itself

Answer 15

payback period

Question 16

• The payback period formula is the same as what formula
• So the payback period is the same as

Answer 16

• IRR factor formula
• IRR factor

Question 17

1. it ignores the time value of money
2. it ignores all information that occurs after the payback period has been reached

Answer 17

disadvantages of payback method

Question 18

• ignores the time value of money
• should not be the basis on which a decision is made
• Can be used as a way to narrow the choices down to a reasonable number

Answer 18

Payback period and
accounting rate of return

Question 19

when the cash flows associated with an investment project change from year to year, the payback formula introduced earlier cannot be used

Answer 19

the un-recovered investment must be tracked year by year

Question 20

does not focus on cash flows - rather it focuses on accounting net income

Answer 20

accounting rate of return (ARR)

Question 21

a cash flow Net of its income tax effect

Answer 21

after tax cash flow

Question 22

What cash outlflows after tax are the exact same and you just multiple by 1

Answer 22

1. initial investment
2. working capital needed now

Question 23

What cash outflows after tax value is the outflow multiplies by (1 - tax rate)

Answer 23

1. increase in costs
2. repairs, maintenance, overhauls

Question 24

why is there no tax effect on the initial investment

Answer 24

the initial investment does not effect revenues or expenses thus it does not effect the taxes owed by a company. the intitla investment is simply giving up cash (an asset) to purchase another asset (equipment; machinery)
- the same logic can be applied to the working capital which is why there is no tax effect on it as well

Question 25

What cash inflows after tax value will be the inflow multiplied by (1 - tax rate)

Answer 25

1. increase in revenues
2. reduction in costs
3. salvage value

Question 26

what cash inflows after tax value will be the exact same so you will only multiply the inflow by 1

Answer 26

1. release of working capital

Question 27

becomes a cash inflow when we incorporate the effect of taxes

Answer 27

depreciation

Question 28

while _____ is not a cash flow, it is an expense and thus does reduce the income taxes that must be paid. thus, the tax savings from ____ is considered a cash inflow

Answer 28

depreciation