Managerial Accounting Test #3

The net present value of a proposed investment is negative. Therefore, the discount rate (cost of capital or minimum rate of return) used must be:  ? 

  Greater than the project’s internal rate of return

The net present value of a proposed investment is positive. Therefore, the discount rate (cost of capital or minimum rate of return) used must be:    

  Less than the project’s internal rate of return

The net present value of a proposed investment is zero. Therefore, the internal rate of return on the investment and the discount rate (cost of capital or minimum rate of return) used must be:  ? 

   Equal

What is the best capital budgeting method for ranking investment projects of different dollar amounts? 

   Project profitability index

What makes the NPV and IRR capital budgeting techniques superior to the payback and accrual accounting rate of return capital budgeting techniques? 

Time value of money 

How is the IRR determined? (step 1)

Set NPV at $0 

How is the IRR determined? (step 2)

Determine PV of cash outflows

How is the IRR determined? (step 3)

Determine PV of cash inflows and related rate of return (IRR) required

A differential cost

is also referred to as a relevant cost or an incremental cost.

Relevant cost –

cost that differs among alternatives; future cost; avoidable cost. An historical cost is not a relevant cost. 

Sunk cost

not a relevant cost but a cost already incurred; unavoidable cost. 

Opportunity cost-

loss from taking one course of action instead of another. These are relevant in decision-making.

Fixed costs

may be relevant or not relevant depending on the circumstances. 

Joint processes

production processes in which the creation of one product also creates other products. It is a process in which one input yields multiple outputs.

Joint cost

a cost incurred in a joint process (such as the crude oil example above) before separate products “split-off”. Joint costs may include direct material, direct labor, and overhead costs incurred during a joint production process. A joint process is a production process in which one input yields multiple outputs. 

Joint products

two or more products produced from a common input (such as described above, crude oil yielding gas, oil, and kerosene). 

Variable costs

may be relevant or not relevant depending on the circumstances.