Chapter 13 Capital Budgeting Decisions Flashcards
Compound interest?
Earning interest on interest
What is the discount rate?
Interest rate used to find the present value
What is an annuity?
An investment that involves a series of identical cash flows at the end of each year
Which table do you use for a series of identical cash flows?
Annuity table
Who makes capital budgeting decisions?
Investment center. Upper level management
5 typical capital budgeting decisions?
Plant expansion Equipment selection Equipment replacement Lease or buy Cost reduction
Screening decisions?
Does a proposed project meet the standard of acceptance?
Preference decisions?
Selecting from among several competing courses of action
Capital budgeting methods that focus on cash flows? (3)
Payback method
Net present value
Internal rate of return
The only method that focuses on incremental net operating income?
Simple rate of return
What is the payback period?
The amount of time it takes to recoup the initial investment of a project
Equation for payback period?
= investment required/annual net cash inflow
- only if have the same cash inflow every year
Shortcomings of payback method? (2)
Shorter payback period does not always mean a more desirable investment.
Ignores cash flows after the payback period.
Net present value method?
Calculate present value of the future cash flows of an investment to determine whether a good investment.
2 assumptions of net present value method?
All cash flows other than the initial investment occur at the end of periods.
All cash flows generated by an investment project are immediately reinvested at a rate of return equal to the discount rate.
