Exam 10: Capital Budgeting Techniques

The following three projects would seem to compete with one another form the firm's resources and therefore would be examples of mutually exclusive projects. (1) installing air conditioning in the plant (2) acquiring a small supplier (3) purchasing a new computer system

The investment operating schedule is the difference between an investment's net operating profit after taxes and the cost of funds used to finance the investment, which is found by multiplying the dollar amount of the funds used to finance the investment by the firm's weighted average cost of capital.

Comparing net present value and internal rate of return

The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $143.51.

Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

One strength of payback period is that it fully accounts for the time value of money.

The purchase of additional physical facilities, such as additional property or a new factory, is an example of a capital expenditure.

If its IRR is greater than $0.00, a project should be accepted.

Table 10.4 A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent. -Using the internal rate of return approach to ranking projects, which projects should the firm accept? (See Table 10.4)

If a firm has unlimited funds to invest in capital assets, all independent projects that meet its minimum investment criteria should be implemented.

A conventional cash flow pattern associated with capital investment projects consists of an initial

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is

Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques, the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows cash inflows received prior to the termination of a project.

Which capital budgeting method is most useful for evaluating the following project? The project has an initial after tax cost of $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3 and $2,300,000 in year 4?

Table 10.2 -Given the information in Table 10.2 and 15 percent cost of capital, (a) compute the net present value. (b) should the project be accepted?

Net present value profiles are most useful when selecting among independent projects.

If net present value of a project is greater than zero, the firm will earn a return greater than its cost of capital. The acceptance of such a project would enhance the wealth of the firm's owners.

An internal rate of return greater than the cost of capital guarantees that the firm earns at least its required return. Investing in such an project would enhance the market value of the firm and therefore the wealth of its owners.

The primary motive for capital expenditures is to refurbish fixed assets.

By measuring how quickly the firm recovers its initial investment, the payback period gives implicit (though not explicit) consideration to the timing of cash flows and therefore to the time value of money.