Exam 11: Capital Budgeting

Long- term planning for making and financing investments that affect financial results over more than one year

Depreciation and book values are relevant operating cash flows.

Most of the depreciation taken on an asset occurs at the end of its life when using accelerated depreciation.

The differential approach can be used to compare any number of projects.

Acme Company, with pre- tax income of $80,000, is required to pay taxes of 25% on all income up to $20,000 and 35% on any income in excess of $20,000. Acme Company's average tax rate is:

The only relevant cash flows are those that will differ among alternatives.

The "break- even" cash flow is the point at which:

The IRR model determines the interest rate at which the NPV equals zero.

ARR does not ignore the time value of money.

A type of capital- budgeting model that focuses on cash inflows and outflows and the time value of money

ARR = increase in expected average annual operating income x initial required investment.

"If DCF approaches are superior to the payback and the accounting rate- of- return methods, why should we bother to learn the others? All it does is confuse things." Answer this contention.

Because future inflation has no effect on the current purchase price of an asset, inflation factors can be ignored when capital- budgeting decisions are made.

A depreciation deduction lowers a company's tax liability.

Howell Company is considering the purchase of some equipment. The initial investment will be $80,000. The estimated useful life of the equipment will be 5 years, at which point it will have a zero terminal salvage value. The annual savings in cash operating costs will equal $19,000, and the company has a minimum desired rate of return of 12%. Use straight- line depreciation and ignore income taxes. Compute: a. Net present value b. Payback period c. Accounting rate of return using initial investment

The tax effect of a loss on disposal

DCF does not focus on net income.

An asset with a book value of $160,000 is sold at a loss (before taxes are considered) of $40,000. If the applicable tax rate is 20%, the net after- tax cash effect of this transaction is a(n):

Capital- budgeting decisions have significant financial effects beyond the current year.

The economic life of an asset may exceed the recovery period of the asset.