1. What is capital budgeting?
2. What are some characteristics that make capital budgeting different from other types of budgets (like a sales budget or cash budget)? It is the process by which management plans, evaluates, and controls investments in fixed assets. 3. Why is the concept of present value relevant to capital budgeting, but not so relevant to other types of budgeting? An investment in fixed assets may be viewed as purchasing a series of net cash flows over a period of time. 4. Describe the Payback Period in your own words. Under what circumstances would Payback be an effective method to use in evaluating competing investment alternatives? The expected period of time that will elapse between the date of a capital expenditure and the complete recovery in cash (or equivalent) of the amount invested. 5. Describe the Accounting Rate of Return in your own words. What are its weaknesses as an investment evaluation tool? It measures the average income as a percent of the average investment. Disadvantages are not directly considering the expected cash flows from the proposal nor directly considering the timing of the expected cash flows. 6. Describe the calculation of NPV in your own words. What does the word "Net" in Net Present Value refer to? Capital investments that focus on the present value of the cash flows expected from the investments. 7. Define the Internal Rate of Return.
Internal Rate of Return uses present value concepts to compute the rate of return from the net cash flows expected from the investment. 8. Johnson Company plans to spend $3,993 on a 5 year project that will return $1,000 cash per year. Calculate the IRR; is it 8%? Yes, it’s 8%.
9. Johnson Company spends $2709 for an investment that returns $2,000 the first year, and $1,000 the second year. Is the IRR also 8%? Yes.
10. In practice, it seems that the NPV method is used more often than IRR. Why do you think this would be the case? When the two methods lead to different...
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