Accumulated conversion factor 567 Annuity 567 Capital investments 564 Cost of capital 565 Incremental revenue 571 Internal rate of return 570 Minimum rate of return 565 Net present value 569 Ordinary annuity 568 Payback method 578 Postaudit 581 Present value index 574 Present value table 566 Recovery of investment 580 Single-payment (lump-sum) 566 Time value of money 564 Unadjusted rate of return 579 Working capital 571 KEY TERMS
Planning for Capital Investments 585 1. What is a capital investment? How does it differ from an investment in stocks or bonds?2. What are three reasons that cash is worth more today than cash to be received in the future?3. “A dollar today is worth more than a dollar in the future.” “The present value of a future dollar is worth less than one dollar.” Are these two statements synonymous? Explain.4. Define the term return on investment.How is the return normally expressed? Give an example of a capital invest-ment return.5. How does a company establish its minimum acceptable rate of return on investments?6. If you wanted to have $500,000 one year from today and desired to earn a 10 percent return, what amount would you need to invest today? Which amount has more value, the amount today or the $500,000 a year from today?7. Why are present value tables frequently used to convert future values to present values?8. Define the term annuity.What is one example of an annuity receipt?9. How can present value “what-if” analysis be enhanced by using software programs?10. Receiving $100,000 per year for five years is equivalent to investing what amount today at 14 percent? Provide a mathematical formula to solve this problem, assuming use of a present value annuity table to convert the future cash flows to their present value equivalents. Provide the expres-sion for the Excel spreadsheet function that would perform the present value conversion.11. Maria Espinosa borrowed $15,000 from the bank and agreed to repay the loan at 8 percent annual interest over four years, making payments of $4,529 per year. Because part of the bank’s payment from Ms. Espinosa is a recovery of the original investment, what assumption must the bank make to earn its desired 8 percent compounded annual return?12. Two investment opportunities have positive net present values. Investment A’s net present value amounts to $40,000 while B’s is only $30,000. Does this mean that A is the better investment opportunity? Explain.13. What criteria determine whether a project is acceptable under the net present value method?14. Does the net present value method provide a measure of the rate of return on capital investments?15. Which is the best capital investment evaluation technique for ranking investment opportunities?16. Paul Henderson is a manager for Spark Company. He tells you that his company always maximizes profitability by accepting the investment opportunity with the highest internal rate of return. Explain to Mr. Henderson how his company may improve profitability by sometimes select-ing investment opportunities with lower internal rates of return.17.
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