ch15 - Chapter 15 Capital Budgeting Questions 1. Capital...

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Chapter 15 Capital Budgeting Questions 1. Capital assets are the long-lived assets that are acquired by a firm. Capital assets provide the essential production and distributional capabilities required by all organizations. 2. Cash flows are the final objective of capital budgeting investments just as cash flows are the final objective of any investment. Accounting income ultimately becomes cash flow but is reported based on accruals and other accounting assumptions and conventions. These accounting practices and assumptions detract from the purity of cash flows and, therefore, are not used in capital budgeting. 3. Time lines provide clear visual models of the expected cash inflows and outflows for each point in time for a project. They provide an efficient and effective means to help organize the information needed to perform capital budgeting analyses. 4. The payback method measures the time expected for the firm to recover its investment. The method ignores the receipts expected to occur after the investment is recovered and ignores the time value of money. 5. Return of capital means the investor is receiving the principal that was originally invested. Return on capital means the investor is receiving an amount earned on the investment. 6. The NPV of a project is the present value of all cash inflows less the present values of all outflows associated with a project. If the NPV is zero, it is acceptable because, in that case, the project will exactly earn the required cost of capital rate of return. Also, when NPV equals zero, the project’s internal rate of return equals the cost of capital. 7. It is highly unlikely that the estimated NPV will exactly equal the actual NPV achieved because of the number of estimates necessary in the original computation. These estimates include the project life, the discount rate chosen and the timing and amounts of cash inflows and outflows. The original investment may also include an estimate of the amount of working capital that is needed at the beginning of the project life. 8. The NPV method subtracts the initial investment from the discounted net cash inflows to arrive at the net present value. The profitability index is calculated by dividing the discounted cash inflows by the initial investment. Thus, each computation uses the same set of amounts in different ways. The PI model attempts to measure the planned efficiency of the use of the money (i.e., output/input) in that it reflects the expected dollars of discounted cash inflows per dollar of investment in the project. A PI equal to or greater than 1.00 is equivalent to a NPV equal to or greater than zero and indicates that the investment will provide an acceptable return 55
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Chapter 15 on capital. 9. The IRR is the rate that would cause the NPV of a project to equal zero. A project is
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This note was uploaded on 12/12/2008 for the course ACCT 310 taught by Professor Nacemagner during the Fall '08 term at Western Kentucky University.

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ch15 - Chapter 15 Capital Budgeting Questions 1. Capital...

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