Chapter_5_Solutions - 5-1 Instructors Manual for Financial...

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5-1 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Chapter 5 CAPITAL BUDGETING , QUESTIONS FOR DISCUSSION 5-1. No. Operating budgets charge the entire cost of acquisitions into the current year. Because benefits of an acquisition may extend well beyond the current year, we may incorrectly believe that an acquisition is not worthwhile if the capital budget is made part of the operating budget. A capital budget is needed because it considers costs and benefits of an acquisition over its entire useful lifetime. 5-2. Yes. Approved items from the capital budget are depreciated over their useful lifetimes. The annual depreciation expense becomes a cost included in the operating budget. 5-3. False. In theory, a capital asset is any resource that will provide benefits to the organization in more than one fiscal year. To simplify bookkeeping, however, most organizations only consider items that are expensive and have a lifetime of more than one year to be capital assets. 5-4. Some reasons that capital assets warrant special attention are that (1) the initial cost is large, (2) the items are generally kept a long time, (3) we can only understand the financial impact if we evaluate the entire lifetime of the assets, and (4) because we often pay for the asset early and receive payments as we use it later, the time value of money (or interest cost) related to the acquisition must be considered. Mistakes can be particularly costly because of the long-term commitment. Further, interest costs may not be obvious and may need to be explicitly considered. 5-5. A dollar today is not worth the same amount as a dollar at some future time. If you have the money today, you can invest it and earn a positive return during the time period you would otherwise be waiting to receive the money. Money has an opportunity cost. 5-6. Compound interest simply refers to the fact that when money is invested going forward in time, at some point the interest earned on the money starts to earn interest itself. Discounting is just the reversal of this process as we go backward in time. 5-7. The quarterly interest rate for 3% annually is .75%. The table does not have a column for a .75% interest rate. You could take the average of the .5% and 1% columns to get an approximation of the correct answer. Alternatively, you could solve the exercise using a calculator or a computer that can solve for any interest rate.
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Chapter 5: Capital Budgeting 5-2 5-8. The net present cost method is very helpful for comparing projects that have identical lifetimes. If projects have differing lifetimes, you are not comparing equal benefits unless you equalize the lifetimes. We could use the lowest common denominator of the lifetimes, extending both alternatives until their lifetimes are equal. However, the uncertainties in replacement and operating costs going forward in time may be substantial. The annualized cost method overcomes these problems. In that approach, one first finds the Net Present Cost for each alternative. Then, that
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