Chapter 14
Capital Budgeting Decisions
Solutions to Questions
14-1 A screening decision is concerned with 14-10 The cost of capital is a hurdle that must
whether a proposed investment project passes a be cleared before an investment project is
preset hurdle, such as a 15% rate of return. A accepted. (a) In the case of the net present
preference decision is concerned with choosing value method, the cost of capital is used as the
from among two or more alternative investment discount rate. If the net present value of the
projects, each of which has passed the hurdle. project is positive, then the project is acceptable
because its rate of return is greater than the
14-2 The ―time value of money‖ recognizes a cost of capital. (b) In the case of the internal
dollar received today is more valuable than a rate of return method, the cost of capital is
dollar received in the future because a dollar compared to a project’s internal rate of return. If
received today can be invested to yield more the project’s internal rate of return is greater
than a dollar in the future. than the cost of capital, then the project is
acceptable.
14-3 Discounting is the process of computing
the present value of a future cash flow. 14-11 No. As the discount rate increases, the
Discounting gives recognition to the time value present value of a given future cash flow
of money and makes it possible to meaningfully decreases. For example, the present value factor
add together cash flows occurring at different for a discount rate of 12% for cash to be
times. received ten years from now is 0.322, whereas
the present value factor for a discount rate of
14-4 Accounting net income is based on 14% over the same period is 0.270. If the cash
accruals rather than cash flows. Both the net to be received in ten years is $10,000, the
present value and internal rate of return present value in the first case is $3,220, but only
methods focus on cash flows. $2,700 in the second case. Thus, as the
discount rate increases, the present value of a
14-5 Unlike other common capital budgeting given future cash flow decreases.
methods, discounted cash flow methods
recognize the time value of money and take into 14-12 The internal rate of return is more than
account all future cash flows. 14% because the net present value is positive.
The internal rate of return would be 14% only if
14-6 Net present value is the present value of the net present value (evaluated using a 14%
cash inflows less the present value of the cash discount rate) is zero. The internal rate of return
outflows. The net present value can be negative would be less than 14% if the net present value
if the present value of the outflows is greater (evaluated using a 14% discount rate) is
than the present value of the inflows. negative.
14-7 One assumption is all cash flows occur 14-13 The profitability index is computed by
at the end of a period. Another is all cash dividing the present value of a project’s cash
inflows are immediately reinvested at a rate of inflows by its required investment. It helps
return equal to the discount rate. managers choose among competing projects by
stating their cash inflows as a percent of the
14-8 No. The cost of capital is not solely the investment required. The higher the profitability
interest paid on long-term debt. The cost of index, the more desirable is the investment
capital is a weighted average of the costs of all project.
sources of financing, both debt and equity.
14-14 The payback period is the length of time
14-9 The internal rate of return is the rate of for an investment to fully recover its initial cost
return on an investment project over its life. It is out of the cash receipts it generates. The
computed by finding the discount rate that payback method is used as a screening tool for
results in a zero net present value. investment proposals. The payback method is
useful when a company has cash flow problems.
© The McGraw-Hill Companies, Inc., 2012
,296 Managerial Accounting, 14th Edition
,The payback method is also used in industries received in the future is weighed the same as a
where obsolescence is very rapid. dollar received today. Furthermore, the payback
method ignores all cash flows occurring after the
14-15 Neither the payback method nor the initial investment has been recovered.
simple rate of return method considers the time
value of money. Under both methods, a dollar
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 14 297
, Chapter 14: Applying Excel
The completed worksheet is shown below.
Note: Your worksheet may differ from the above in rows 29 and 30. The
worksheet above has been set to use the rounded-off discount factors
rather than more exact factors without rounding. For example, the factor
0.519 is rounded off from 0.519368664. If the more exact factor is used to
calculate the present value of the $150,000 total cash flow at the end of
year 5, the answer is $77,905 rather than $77,850. These rounding errors
accumulate so that the more exact net present value is $31,493 rather
than the $31,410 as displayed. Either answer is okay.
Copyright © 2024 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 14
Capital Budgeting Decisions
Solutions to Questions
14-1 A screening decision is concerned with 14-10 The cost of capital is a hurdle that must
whether a proposed investment project passes a be cleared before an investment project is
preset hurdle, such as a 15% rate of return. A accepted. (a) In the case of the net present
preference decision is concerned with choosing value method, the cost of capital is used as the
from among two or more alternative investment discount rate. If the net present value of the
projects, each of which has passed the hurdle. project is positive, then the project is acceptable
because its rate of return is greater than the
14-2 The ―time value of money‖ recognizes a cost of capital. (b) In the case of the internal
dollar received today is more valuable than a rate of return method, the cost of capital is
dollar received in the future because a dollar compared to a project’s internal rate of return. If
received today can be invested to yield more the project’s internal rate of return is greater
than a dollar in the future. than the cost of capital, then the project is
acceptable.
14-3 Discounting is the process of computing
the present value of a future cash flow. 14-11 No. As the discount rate increases, the
Discounting gives recognition to the time value present value of a given future cash flow
of money and makes it possible to meaningfully decreases. For example, the present value factor
add together cash flows occurring at different for a discount rate of 12% for cash to be
times. received ten years from now is 0.322, whereas
the present value factor for a discount rate of
14-4 Accounting net income is based on 14% over the same period is 0.270. If the cash
accruals rather than cash flows. Both the net to be received in ten years is $10,000, the
present value and internal rate of return present value in the first case is $3,220, but only
methods focus on cash flows. $2,700 in the second case. Thus, as the
discount rate increases, the present value of a
14-5 Unlike other common capital budgeting given future cash flow decreases.
methods, discounted cash flow methods
recognize the time value of money and take into 14-12 The internal rate of return is more than
account all future cash flows. 14% because the net present value is positive.
The internal rate of return would be 14% only if
14-6 Net present value is the present value of the net present value (evaluated using a 14%
cash inflows less the present value of the cash discount rate) is zero. The internal rate of return
outflows. The net present value can be negative would be less than 14% if the net present value
if the present value of the outflows is greater (evaluated using a 14% discount rate) is
than the present value of the inflows. negative.
14-7 One assumption is all cash flows occur 14-13 The profitability index is computed by
at the end of a period. Another is all cash dividing the present value of a project’s cash
inflows are immediately reinvested at a rate of inflows by its required investment. It helps
return equal to the discount rate. managers choose among competing projects by
stating their cash inflows as a percent of the
14-8 No. The cost of capital is not solely the investment required. The higher the profitability
interest paid on long-term debt. The cost of index, the more desirable is the investment
capital is a weighted average of the costs of all project.
sources of financing, both debt and equity.
14-14 The payback period is the length of time
14-9 The internal rate of return is the rate of for an investment to fully recover its initial cost
return on an investment project over its life. It is out of the cash receipts it generates. The
computed by finding the discount rate that payback method is used as a screening tool for
results in a zero net present value. investment proposals. The payback method is
useful when a company has cash flow problems.
© The McGraw-Hill Companies, Inc., 2012
,296 Managerial Accounting, 14th Edition
,The payback method is also used in industries received in the future is weighed the same as a
where obsolescence is very rapid. dollar received today. Furthermore, the payback
method ignores all cash flows occurring after the
14-15 Neither the payback method nor the initial investment has been recovered.
simple rate of return method considers the time
value of money. Under both methods, a dollar
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 14 297
, Chapter 14: Applying Excel
The completed worksheet is shown below.
Note: Your worksheet may differ from the above in rows 29 and 30. The
worksheet above has been set to use the rounded-off discount factors
rather than more exact factors without rounding. For example, the factor
0.519 is rounded off from 0.519368664. If the more exact factor is used to
calculate the present value of the $150,000 total cash flow at the end of
year 5, the answer is $77,905 rather than $77,850. These rounding errors
accumulate so that the more exact net present value is $31,493 rather
than the $31,410 as displayed. Either answer is okay.
Copyright © 2024 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 14
