Planning for Capital Investments
ANSWERS TO QUESTIONS (2, 5, 11, 13)
The cash payback technique is relatively easy to compute and understand. However, it should
not ordinarily be the only basis for the capital budgeting decision because it ignores the
expected profitability of the investment and the time value of money.
The decision rule is: Accept the project when net present value is zero or positive; reject the
project when net present value is negative.
A post-audit is a thorough evaluation of how well a project’s actual performance matches the
original projections. Performing post-audits can be valuable because:
(1) managers are more likely to submit reasonable and accurate data if they know that their
estimates will be evaluated subsequently, (2) they provide a process for determining whether
projects should be continued, and (3) they improve the development of future investment
proposals because, by evaluating their past successes and failures, managers improve their
Under the internal rate of return method, the objective is to find the rate that will make the
present value of the expected net annual cash flows equal the present value of the proposed
expenditure. The decision rule under the internal rate of return method is: Accept the project
when the internal rate of return is equal to or greater than the required rate of return, and reject
the project when the internal rate of return is less than the required rate.
SOLUTIONS TO BRIEF EXERCISES (1, 3, 7, 8)
BRIEF EXERCISE 12-1
$450,000 ÷ $55,000 = 8.2 years
BRIEF EXERCISE 12-3
Present value of net annual cash flows
Present value of salvage value
Net present value
Since the net present value is positive, the project is acceptable.