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Unformatted text preview: Chapter 11 Capital Budgeting QUESTIONS 11-1 A long-term or capital asset is one that is expected to provide benefits to the organization for two or more years. 11-2 Capital budgeting is a systematic approach to evaluating an investment in a long-term or capital asset. 11.3 Long-term assets usually commit large sums of money over long periods of time. This imposes financial and technological risks on organizations. They reduce an organizations flexibility and create the potential for either excess capacity or scarce capacity. Capital budgeting is a systematic process of evaluation that is intended to mitigate the risk of selecting poor investments. 11-4 The fundamental evaluation issue in dealing with a long-term asset is whether its future benefits justify its initial cost. The future benefits are evaluated by considering cash inflows and outflows associated with the long-term asset. The net present value of cash flows is compared to the investment in the long-term asset. 11-5 An investment is the total monetary value of assets sacrificed to acquire a long- term or capital asset. The investment usually, but not always, takes place at time zero. 11-6 Return is the increased cash flows in the future attributable to an investment. 11-7 Since money can be invested to earn a return, the earlier money is received, the earlier it can be invested to earn a return. Therefore, money has a time value in the sense that the value of money depends on when it is received. The earlier it is received the more valuable it is. 225 Atkinson, Solutions Manual t/a Management Accounting, 5E 11-8 Within the limits of the discussion of this chapter, because of the time value of money, money received now is always worth more than money received in the future. 11-9 Future value is the amount, given a specified rate of interest, to which a current amount (todays investment) will accumulate at some point in the future. In capital budgeting, cash flows from the investment occur in the future, and represent future values. 11-10 Future value is used when the decision maker wishes to compute the future amount to which an investment made today will accumulate. 11-11 The compounding effect refers to the situation where interest is earned on interest that was earned during a prior period. 11-12 Present value is the current value (at time zero), given a specified rate of interest, of an amount that is to be received at some point in the future. 11-13 Because of the time value of money and because cash flows take place at many times during a projects life, all money flows must be converted to an equivalent value at a single point in time to be comparable. By convention, this common time period is time zero, the time at which a project is initiated....
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- Spring '12