cost test 3

Capital budgeting decisions focus on cash flows for projects requiring more than one year to complete.

True

Which of the following statements is true regarding the time value of money concept?

A dollar received today is worth more than a dollar received in the future.

The percent cost of capital is typically the company's percentage cost to obtain investment funds

True

The appropriate rate to be used for evaluating a long-term investment proposal can be referred to as all of the following except:

The cash flow rate

Which of the following is a benefit of using the payback method?

It determines how long it will take to recover the initial investment.

A direct labor budget is regarded as the starting point for the master budget.

False

All of the following items can appear on the cash collections and cash payments budget except:

Depreciation expense

If the majority of decisions within a company are made by top management at headquarters, which of the following terms best describes this company?

Centralized organization

When defining operating income for return on investment (ROI) purposes, many organizations do not include which of the following?

Allocated overhead

When selecting between mutually exclusive investment options, which method provides the most appropriate basis for choosing the better project?

Net present value

The payback method ignores the timing of cash flows beyond recovering the initial investment and therefore does not account for the time value of money

True

Assume two projects have identical total cash inflows. Project X receives its largest inflows later in the project life; Project Y receives its largest inflows early. If the discount rate is greater than zero, which project will generally report the higher NPV?

Project Y

Capital budgets typically cover multi-year planning for major long-term investments, while operating budgets usually cover activities for a single year

True

Including lower-level managers in the budgeting process often increases motivation and enhances acceptance of the final budget.

True

Two investments each cost $200,000 and generate the same total cash inflows over time. Investment A’s inflows are weighted toward years 3 and 4, while Investment B’s inflows are weighted toward years 1 and 2. Assuming a positive discount rate, which has the higher NPV?

Investment B

Two divisions within a company each report the same operating income. Division A uses fewer operating assets than Division B. The company evaluates managers using ROI. Which manager will appear to perform better under this system, assuming all other factors are equal?

The manager of Division A

Profit margin ratio

=operating income/sales revenues

ROI

=Operating income/Average operating assets

RI

Operation income -(Average operating income * cost of capital)

Units to Produce

=Budgeted sales units + desired ending inventory- beginning inventory

NPV

(PV of all future cash inflows) - initial investment

PV

=FV * PV factor of 1$

Capital Budgeting Method Ignoring TVM

payback method

Capital Budgeting Methods Using TVM

Net Present Value (NPV) and Internal Rate of Return (IRR).

Net Present Value (NPV)

The difference between the present value of cash inflows and the present value of cash outflows

NPV Decision Rule

If NPV is positive, accept the proposal. If NPV is negative, reject the proposal.

Internal Rate of Return (IRR)

The discount rate that makes the Net Present Value (NPV) of a project equal to zero.

Payback method

Calculates the time (in years) required to recover the initial investment from net cash inflows.

Master Budget

A comprehensive set of budgets including operating budgets, capital expenditures, and proforma financial statements (Income Statement, Cash, Balance Sheet).

Key problems with ROI

It can lead managers to reject profitable projects if the project's ROI is below the division's current average ROI (goal congruence problem).

Economic Value Added (EVA)

A measure similar to RI, but it uses net operating profit after taxes (adjusted) and adjusted average operating assets.

IRR Decision Rule (Independent project)

Accept if IRR is greater than the required rate of return (RRR); reject if IRR is less than the RRR.