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Ch.

11 Capital Budgeting Decisions:


1. The term capital budgeting is used to describe how managers plan significant investments in projects that have
long-term implications.

2. The payback period does not focus on a projects profitability, but rather on a projects ability to earn a quick
return.

3. The net present value of a project is: used in determining whether or not a project is an acceptable capital
investment & the difference between the present value of cash inflows and present value of cash outflows for
a project.

4. Capital Budgeting:
Screening decisions: relate to whether a proposed project is acceptable
Preference decisions: relate to selecting from among several acceptable alternatives

5. Create the equation used to calculate the payback period when annual net cash inflows is the same every year:
Investment required___ DIVIDE
Annual net cash inflow

6. One dollar earn today is worth: more than one dollar earned at a future point in time

7. State Bank is implementing a new marketing campaign that requires an initial investment of $35,000. If the
project profitability index is 2, the net present value of the campaigns future cash flows is $7000.
35,000 * 0.2 = 7,000

8. Shortcomings of the payback method when making a capital investments decision include:
The pay back method does not consider the time value of money
The payback method ignores all cash flows that occur after the payback period.

9. Create the equation used to calculate the simple rate of return:
Annual increment net operating income DIVIDE
Initial investment

10. Net present value ranges with the acceptability of the proposed project:
Positive or zero -> Acceptable Negative -> Unacceptable

11. To calculate the net present value of a project: discount the projects cash inflows and outflows to present
value, then compare those values.

12. Unlike other capital budgeting methods, the simple rate of return method focuses on net operating income,
rather than cash flows.

13. A dollar today is worth more than a dollar earned a year from now.

14. Capital budgeting decisions place an emphasis on project cash flows bc:
Accounting net income ignores when cash flows occur
The timing of cash inflows and outflows is critical in the success and profitability of capital projects.

15. The 2 broad categories into which capital budgeting decisions fall are: preference decisions & screening
decisions

16. Another term for the minimum required rate of return is the cost of capital.

17. Print out

18. One of the two broad categories of capital budgeting decisions, a screening decisions, relates to whether a
proposed project is acceptable based on a preset criterion.

19. Print out

20. Identify each working capital situation with the appropriate treatment:
Cash inflow: working capital is released for use elsewhere within the company
Cash outflow: working capital is tied up for project needs

21. Total-cost approach all cash flows are included in calculating the net present value for each alternative.
Incremental-cost approach only those cash flows that differ between 2 alternatives are included in the
analysis.

22. The required rate of return is the minimum rate of return a project must yield to be acceptable.

23. Capital budgeting decisions: involve an immediate cash outlay in in order to obtain a future return and
required a great deal analysis prior to acceptance

24. Capital budgeting decisions focus on cash inflows and outflows rather than accounting income bc:
The present value of a cash flow depends on when it occurs & accounting net income is based in accruals

25. Using the minimum required rate return as the discount rate when calculating net present value ensures that
any project with a positive net present value is acceptable.

26. The equation used to calculate the project profitability index is net present value of the project divided by
investment required.

27. Salvage value- inflow initial investment- outflow working capital- inflow & outflow

28. When making a capital budgeting decision, it is most useful to calculate the payback period: if a company is
cash poor or as part of the screening process

29. The rule used when comparing competing investments is: the higher the project profitability index, the more
desirable the project.

30. An investment of $2,000 at 7% compound interest will be worth $2450 at the end of 3 years.



31. Which of the following are characteristics of the simple rate of return method for evaluating capital investment
proposals? The simple rate of return fluctuates from year along with fluctuations in revenue and expense. The
simple rate of return ignores the time value of money.

32. Working capital requires is cash outflow, but working capital released is a cash inflow.

33. Because of the time value of money, projects that promise early returns are preferable to those that promise
the opposite.

34. True statement about net present value and income taxes:
Income taxes on both revenues and expense should be considered in the net present value analysis.
The cost of capital should be based on upon after-Tax cost.

35. True statement: the more frequently interest is compounded, the faster the balance grows. & compound
interest means that interest is paid on interest.

36. The payback period and the simple rate of return are tools used to make capital budgeting decisions.

37. Benefits of conducting a postaudit: it provides an opportunity to reinforce and possibly expand successful
projects; it will flag any managers attempts to inflate benefits or downplay costs in a project proposal. It
provides an opportunity to cut losses on floundering projects.

38. When the cash flows associated with an investment project change from year to year, the payback period must
be calculated: by tracking the uncovered investment year by year.

39. A stream of equal amounts of money to be received or paid is a(n) annuity.

40. When using the simple rate of return, the initial investment should be reduced by the salvage value of old
equipment.

41. Given an interest rate of 8% compounded annually, $5,000 to be received four years from today is equal to 0
today.

= $3,675
42. When making a capital budgeting decision, it is most useful to calculate the payback period: .

43. The incremental-cost approach: only includes costs and revenues that differ between the alternatives being
considered. & is preferable to the total cost approach when only 2 alternatives are being considered.

44. It is important to know the present value of an investment bc a dollar: is worth more today than it will be worth
a year from now.

45. A (n) investment requires committing funds today with the expectation of earning a return on those funds in the
future in the form of additional cash flows.