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Chapter 26: Q16E (page 1467)

Question: Defining capital investments and the capital budgeting process

Match each capital budgeting method with its definition.

Methods

1. Accounting rate of return

2. Internal rate of return

3. Net present value

4. Payback

Definitions

  1. Is only concerned with the time it takes to get cash outflows returned.
  2. Considers operating income but not the time value of money in its analyses.
  3. Compares the present value of cash outflows to the present value of cash inflows to determine investment worthiness.
  4. The true rate of return an investment earns.

Short Answer

Expert verified

Answer

  1. b
  2. d
  3. c
  4. a

Step by step solution

01

Meaning of capital investments

Capital investment is a sum of cash to assist a company in accomplishing its objectives or buying long-term resources. The word 'capital investment' is employed in two distinctive ways in a commercial environment.

The primary relates to monies apportioned to help the company accomplish its goals. The second category incorporates monies used to procure fixed assets for the firm instead of funds used for day-to-day operations.

02

Meaning of the Capital budgeting process

Capital budgeting is the method of deciding long-term asset investment choices. It is the method of deciding whether or not to contribute to a particular venture since all investment alternatives may not be beneficial.

03

Match each capital budgeting method with its definition

S.no.

Methods

Definition

Explanation

1

Accounting rate of return

Considers operating income but not the time value of the money.

The Accounting rate of return calculates the average rate of return earned by a venture based on its investment, but it disregards the time value of money.

2

Internal rate of return

The true rate of return an investment earns.

The internal rate of return is the rate of return that the venture will get after considering the current value of both inflows and outflows.

3

Net present value

Considers the present values of cash outflows with inflows to know the worth.

The concept of net present value underpins the net return conceivable from an extent after considering the show value of inflows and outflows over the project's whole life cycle.

4

Payback

Is only concerned with the time it takes to get the cash outflows returned.

The concept of a "payback period" is based on calculating the time it'll take for the initial venture in a project to be reimbursed.

Note: Furthermore, it should be noted that the various strategies are based on distinct ideas that are matched to the given situation.

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Most popular questions from this chapter

Your grandfather would like to share some of his fortune with you. He offers to give you money under one of the following scenarios (you get to choose):

1. \(7,250 per year at the end of each of the next eight years

2. \)49,650 (lump sum) now

3. $98,650 (lump sum) eight years from now

Requirements

1. Calculate the present value of each scenario using an 8% discount rate. Which scenario yields the highest present value? Round to nearest whole dollar.

2. Would your preference change if you used a 10% discount rate?

What are some criticisms of the payback method?

Match the following business activities to the steps in capital budgeting process.

Steps in the capital budgeting process:

a. Develop strategies

b. Plan

c. Direct

d. Control

Business activities:

1. A manager evaluates progress one year into the project.

2. Employees submit suggestions for new investments.

3. The company builds a new factory.

4. Top management attends a retreat to set long-term goals.

5. Proposed investments are analyzed.

6. Proposed investments are ranked.

7. New equipment is purchased.

Using the time value of money Helen wants to take the next four years off work to travel around the world. She estimates her annual cash needs at $31,000 (if she needs more, she will work odd jobs). Helen believes she can invest her savings at 10% until she depletes her funds. Requirements

  1. How much money does Helen need now to fund her travels?
  2. After speaking with a number of banks, Helen learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels?

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