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CHAPTER 13
CAPITAL INVESTMENT DECISIONS
QUESTIONS FOR WRITING AND DISCUSSION
1.
Independent projects are such that the ac
ceptance of one does not preclude the ac
ceptance of another. With mutually exclus
ive projects, acceptance of one precludes
the acceptance of others.
2.
The timing and quantity of cash flows de
termine the present value of a project. The
present value is critical for assessing wheth
er a project is acceptable or not.
3.
By ignoring the time value of money, good
projects can be rejected and bad projects
accepted.
4.
The payback period is the time required to
recover the initial investment. Payback =
$80,000/$30,000 = 2.67 years
5.
(a) A measure of risk. Roughly, projects with
shorter paybacks are less risky. (b) Obsol
escence. If the risk of obsolescence is high,
firms will want to recover funds quickly. (c)
Selfinterest. Managers want quick pay
backs so that shortrun performance meas
ures are affected positively, enhancing
chances for bonuses and promotion.
Also,
this method is easy to calculate.
6.
The accounting rate of return is the average
income divided by original or average invest
ment. ARR = $100,000/$300,000 = 33.33%
7.
Agree. Essentially, net present value is a
measure of the return in excess of the in
vestment and its cost of capital.
8.
NPV measures the increase in firm value
from a project.
9.
The cost of capital is the cost of investment
funds and is usually viewed as the weighted
average of the costs of funds from all
sources. It should serve as the discount rate
for calculating net present value or the
benchmark for IRR analysis.
10.
For NPV, the required rate of return is the
discount rate. For IRR, the required rate of
return is the benchmark against which the
IRR is compared to determine whether an
investment is acceptable or not.
11.
If NPV > 0, then the investment is accept
able. If NPV < 0, then the investment should
be rejected.
12.
Disagree. Only if the funds received each
period from the investment are reinvested to
earn the IRR will the IRR be the actual rate
of return.
13.
Postaudits help managers determine if re
sources are being used wisely. Additional
resources or corrective action may be
needed. Postaudits also serve to encourage
managers to make good capital investment
decisions. They also provide feedback that
may help improve future decisions.
14.
NPV signals which investment maximizes
firm value; IRR may provide misleading sig
nals. IRR may be popular because it
provides the correct signal most of the time
and managers are accustomed to working
with rates of return.
15.
Often, investments must be made in assets
that do not directly produce revenues. In this
case, choosing the asset with the least cost
(as measured by NPV) makes sense.
16.
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 Spring '09
 unauth
 Managerial Accounting

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