Exam 11: Capital Budgeting

Which of the following statement regarding the payback method is incorrect?

A problem in which you must calculate the value now of a series of equal amounts to be received for some specified number of periods in the future is a:

The payback period is defined as the average net income divided by the initial investment

The value today of cash flow to be received in the future is called:

Imagine you are a managerial accountant in charge of operations for an architectural firm whose work focuses on green building initiatives. To be consistent with the firm's principles, you propose three separate green initiatives to the board. The first proposal is to install low-water plumbing throughout the building. The second proposal is to install solar panels on the south-facing side of the building to reduce electric costs. The third proposal is to eliminate food and package waste from the break area by partnering with a sustainable food pantry. All three initiatives would include educational materials for clients, architects, and staff of the firm to underscore the firm's commitment to environmental matters. To convince the board of directors of the viability of these options, you prepare the following analysis. a-f. Fill in the missing spaces within the table above. Which project would the board of directors choose if it values: g. a fast payback period? h. internal rate of return? i. net present value? j. initial cost outlay? k. If you make your recommendation based on the profitability index, in which order would you recommend the projects be prioritized?

Fargo Corp. is considering the purchase of a new piece of equipment. The equipment costs $50,000, and will have a salvage value of $5,000 after nine years. Using the new piece of equipment will increase Fargo's annual cash flows by $6,000. Fargo has a hurdle rate of 12%. a. How much is Fargo's annual depreciation on the equipment? b. What is Fargo's projected annual increase in net income? c. What is the accounting rate of return for purchasing the new piece of equipment? d. Based on financial factors, should Fargo purchase the new equipment? Why or why not?

When making screening decisions using the net present value method, a project is acceptable if:

When comparing mutually exclusive capital investments, managers should:

Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $500,000 to purchase, and maintenance costs would be $20,000 per year. After five years, Emerson estimates it could sell the equipment for $100,000. If Emerson leases the equipment, it would pay $150,000 each year, which would include all maintenance costs. Emerson's hurdle rate is 12%. a. What is the net present value of the cost of purchasing the equipment? b. What is the net present value of the cost of leasing the equipment? c. Based on financial factors, should Emerson purchase or lease the equipment? Why?

When a project has a positive net present value, it has a profitability index:

Newport Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $900,000 and have a 6-year life. There is no salvage value for the equipment. If the hurdle rate is 8%, what is the approximate net present value? Ignore income taxes.