C
HAPTER
11
M
ANAGING
L
ONG
L
IVED
R
ESOURCES
: C
APITAL
B
UDGETING
SOLUTIONS
R
EVIEW
Q
UESTIONS
11.1
Capital budgeting refers to the set of tools companies use to evaluate large expenditures
on longlived resources.
11.2
The time value of money arises because a dollar today is worth more than a dollar tomor
row. Time value of money is important for project evaluation as cash inflows and out
flows occur at different points in time – thus, we need to put these different cash flows on
equal footing to compare them.
11.3
A lumpy resource is one where it is difficult to match the demand for capacity with the
supply. As the text discusses, we cannot buy threefourths of an MRI machine – capital
budgeting techniques recognize this and account for the timing and magnitude of all cash
inflows and outflows associated with resource acquisition, use, and disposal.
11.4
Capital budgets link strategic and operating budgets. Operating budgets allocate the firm
’s productive capacity among products, whereas capital budgets allocate scarce capital
among available investment opportunities.
11.5
(1) Initial outlay, (2) estimated life and salvage value, (3) timing and amounts of operat
ing cash flows, and (4) cost of capital.
11.6
Net present value is the total present value of all cash inflows and outflows. We compute
net present value by discounting future cash inflows and outflows (using present value
tables for our selected discount rate) back into today’s dollars.
11.7
The internal rate of return (IRR) is the discount rate at which a project has zero net
present value. We can compute the IRR using the appropriate formula in Excel or a finan
cial calculator
11.8
(1) The initial cash outflow takes place at the beginning of the period; (2) Subsequent
cash inflows and outflows occur at the end of the relevant period; (3) the firm reinvests
future cash inflows in projects that yield a return that equals the cost of capital.
11.9
The payback method is easy to use and understand (e.g., we do not need to determine the
opportunity cost of capital). The payback method also focuses on a project’s downside
risk.
11.10
The modified payback method computes the payback period using discounted cash flows,
meaning that the method accounts for the time value of money.
11.11
The accounting rate of return equals the average annual income from a project divided by
the average annual investment in the project.
11.12
Taxes are important because they affect both the amount and timing of cash flows.
Balakrishnan, Managerial Accounting 1e
FOR INSTRUCTOR USE ONLY
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A depreciation tax shield for any given year equals the depreciation deduction for the
year multiplied by the tax rate. We can view the tax shield as a cash inflow or as a reduc
tion in cash outflows.
11.14
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 Spring '08
 KEENAN
 Net Present Value

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