Chapter 8
Capital Budgeting Decisions
Solutions to Questions
8-1 A capital budgeting screening decision is
decision is concerned with choosing from among
two or more alternative investment projects,
than a dollar received in the future simply
because a dollar received today can be invested
to yield more than a dollar in the future.
Discounting gives recognition to the time value
of money and makes it possible to meaningfully
accruals rather than on cash flows. Both the net
present value and internal rate of return
methods focus on cash flows.
recognize the time value of money and take into
account all future cash flows.
if the present value of the outflows is greater
than the present value of the inflows.
rate of return equal to the discount rate.
8-8 No. The cost of capital is not simply the
8-9 The internal rate of return is the rate of
8-10 The cost of capital is a hurdle that must
be cleared before an investment project will be
project is positive, then the project is acceptable
because its rate of return is greater than the
the cost of capital, then the project is
acceptable.
for a discount rate of 12% for cash to be
received ten years from now is 0.322, whereas
the present value factor for a discount rate of
$2,700 in the second case. Thus, as the
discount rate increases, the present value of a
The internal rate of return would be 14% only if
the net present value (evaluated using a 14%
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358 Managerial Accounting for Managers, 3rd Edition
discount rate) is zero. The internal rate of return
would be less than 14% if the net present value
(evaluated using a 14% discount rate) is
negative.
8-13 The project profitability index is
the profit (in terms of net present value)
provided by each dollar of investment in a
for an investment to fully recover its initial cost
out of the cash receipts that it generates. The
payback method is used as a screening tool for
investment proposals. The payback method is
useful when a company has cash flow problems.
The payback method is also used in industries
where obsolescence is very rapid.
value of money. Under both methods, a dollar
received in the future is weighed the same as a
