Capital Budgeting

Question 1

Managerial Accounting technique used to evaluate different investment options

Helps management make decisions

Uses both accounting and non-accounting information

Internal focus

GAAP is not mandatory

Answer 1

Capital Budgeting

Question 2

Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

Answer 2

Capital Budgeting

Question 3

For ONE payment- ONE time.

Answer 3

Capital Budgeting

Question 4

Multiple payments made over time- where the payments are made at the START of the period.

Answer 4

Capital Budgeting

Question 5

Multiple payments over time- where payments are made at the END of the period.

Think A for Arrears.

Answer 5

Capital Budgeting

Question 6

1 / (( 1+i )^n)

i : interest rate
n : number of periods

Answer 6

Capital Budgeting

Question 7

A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money
: PV of Future Cash Flows - Investment

Answer 7

Capital Budgeting

Question 8

NPV : PV Future Cash Flows - Investment

If NPV is Negative- Cost is greater than benefits (bad investment)

If NPV is Positive- Cost is less than benefit (good investment)

If NPV : 0- Cost : Benefit (Management is indifferent)

Answer 8

Capital Budgeting

Question 9

The Discount Rate.

Answer 9

Capital Budgeting

Question 10

The rate of return on an investment used.

It represents the minimum rate of return required.

Answer 10

Capital Budgeting

Question 11

Uses the Time Value of Money

Uses all cash flows- not just the cash flows to arrive at Payback

Takes risks into consideration

Answer 11

Capital Budgeting

Question 12

Not as simple as the Accounting Rate of Return.

Answer 12

Capital Budgeting

Question 13

NPV includes Salvage Value because it is a future cash inflow.

NPV does NOT include depreciation because it is non-cash.

Exception - If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.

Answer 13

Capital Budgeting

Question 14

The minimum rate of return is used.

Answer 14

Capital Budgeting

Question 15

It calculates a project’s actual rate of return through the project’s expected cash flows.

IRR is the rate of return required for PV of future cash flows to EQUAL the investment.

Investment / After Tax Annual Cash Inflow : PV Factor

Answer 15

Capital Budgeting

Question 16

Cash flows are re-invested at the rate of return earned by the original investment.

Answer 16

Capital Budgeting

Question 17

Rate of return for IRR is the rate earned by the investment.

Rate of return for NPV is the minimum rate.

Answer 17

Capital Budgeting

Question 18

Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR

Answer 18

Capital Budgeting

Question 19

When the benefits are greater than the costs.

IRR is greater than the Discount Rate

Answer 19

Capital Budgeting

Question 20

When Costs are greater than Benefits

IRR is less than the Discount Rate

Answer 20

Capital Budgeting

Question 21

When benefits equal the Costs

IRR : Discount Rate

Answer 21

Capital Budgeting

Question 22

It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow

Investment / Annual Cash Inflow : Payback Method

Compare to a targeted timeframe; if payback is shorter than target- it’s a good investment. If payback is longer than target- it’s a bad investment.

Answer 22

Capital Budgeting

Question 23

Takes risk into consideration

2 year payback is less risky than a 5 year payback

Answer 23

Capital Budgeting

Question 24

Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back

Answer 24

Capital Budgeting

Question 25

An approximate rate of return on assets

ARR : Net Income / Average Investment

Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.

Answer 25

Capital Budgeting

Question 26

Simple to use

People understand easily

Answer 26

Capital Budgeting

Question 27

Can be skewed based on Depreciation method that is used.

Ignores the Time Value of Money.

Answer 27

Capital Budgeting

Question 28

An approximate rate of return on assets.

Answer 28

Capital Budgeting