CAPITAL BUDGETING 3 Flashcards
What type of decision involves deciding if an investment meets a predetermined standard?
Screening decisions
If a payback period for a project is greater than its expected useful life, the
entire initial investment will not be recovered.
An analysis of a proposal by the net present value method indicated that the present value of future cash inflows exceeded the amount to be invested. Which of the following statements best describes the results of this analysis?
The proposal is desirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis
NPV indicates a project is deemed desirable (acceptable) when the NPV is
greater than or equal to zero
If Arbitrary Company wants to use IRR to evaluate long-term decisions and to establish a cutoff rate of return, it must be sure that the cutoff rate is
at least equal to its cost of capital.
The NPV and IRR methods give
the same decision (accept or reject) for any single investment.
Mutually exclusive projects are those that:
if accepted, preclude the acceptance of competing projects.
In choosing from among mutually exclusive investments the manager should normally select the one with the highest
NPV
Why do the NPV method and the IRR method sometimes produce different rankings of mutually
exclusive investment projects?
The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method assumes a reinvestment rate equal to the internal rate of return
Post-audit of capital projects
provides a formal mechanism by which the company can determine whether existing projects should be supported or terminated.
A thorough evaluation of how well a project’s actual performance matches the projections made
when the project was proposed is called a
post-audit.
A follow-up evaluation of a capital project is performed to see that investment expenditures are
proceeding on time and on budget, to compare actual cash flows with those originally predicted, and to evaluate continuation of the project. This follow-up is called a
post-audit
Companies use post audits to:
provide feedback that enables managers to improve the accuracy of the projections of future
cash flows, thereby maximizing the quality of the firm’s capital investments.
