Exam 21: Information for Capital Expenditure Decisions

When comparing the net present value [NPV] method with the internal rate of return [IRR] method, NPV considers the time value of money, but IRR does not.

The systematic follow up of each project to see how it turned out is called:

Ranking investment proposals A profitability index can be used to rank investment proposals. i. Define the profitability index. ii. Two projects are under consideration. Project 1 has net present value (NPV) of $20 000, project 2 has NPV of $200 000. Which project is better? Explain. What weakness in the NPV analysis does the profitability index address? Explain. iii. 'Capital rationing' is mentioned as one of the reasons why acceptable investment projects are 'ranked'. (a) In this context, what is an 'acceptable capital project'? (b) One interpretation of 'capital rationing' is that the firm has a limited amount of capital available. If this is true, what problem does this present in the use of the discounted cash flow model? (c) What other reasons besides a lack of capital may lead to the phenomenon described as capital rationing?

One criterion that managers sometimes apply in ranking investment proposals is called the:

Projects with a zero or positive net present value (NPV) are accepted using the net present value method. Why is this so?

Capital budgeting is a tool required for:

Which of the following benefits are likely to be difficult to quantify and are therefore excluded from traditional capital expenditure analysis?

How much money must be invested today to have $25 000 at the end of four years, if the rate of return is 20 per cent?

An investment allowance is a one-off tax deduction in the year the asset is sold.

The manager of Malan Pty Ltd wants to buy a new machine to replace the one currently being used. The new machine will cost $100 000 with no disposal value at the end of a five-year useful life. The manager estimates that the machine will reduce annual operating costs by $30 000. Depreciation will be $20 000 per year for five years. The tax rate for each year is expected to be 20 per cent and the company has an after-tax hurdle rate of 12 per cent. What is the annual after-tax cash flow for years 1 to 5 associated with the purchase of the new machine?

If the initial investment is $4000 and the annual cash inflow is $500, what is the payback period?

Post-audits i. What is a post-audit of a capital investment project? ii. What are the benefits of a post-audit? iii. A manager prepared a proposal for a capital project. The project was not funded. The manager observed that 'the post-audit process within the company will show that this project should have been funded'. Comment on the manager's understanding of the post-audit process.

Which of the following relates to an advantage that the accounting rate of return method has over payback?

The profitability index is calculated by:

Identify and briefly describe the six stages of the capital expenditure decision process.

Estimate the internal rate of return (IRR) Minwest Company invested $140 000 in an eight-year project. Annual cash inflows are estimated at $30 000 per year. Estimate the IRR.

The accounting rate of return equals:

Capital expenditure decisions consider cash inflows and cash outflows. Which of the following cash flow items would be classified as a cash inflow?

The payback method The payback method is a popular way to analyse investment proposals. i. Explain how the payback period is determined and how projects may be ranked using this method. ii. What are the deficiencies of the payback method?

Charlotte Computer Services is considering purchasing equipment at $100 000. It is anticipated the equipment will have a useful life of five years. It will be depreciated on a straight-line basis. Operating revenue is expected to be $74 000 per annum and operating expenses $25 000 per annum. The equipment is subject to an investment allowance of 10 per cent and the tax rate is 30 per cent. The after-tax hurdle rate is 12 per cent. The reduction in tax due to the investment allowance is: