Q-6-7. Which of the four capital budgeting techniques uses depreciation of new equipment when cash flow net operating income is available but not accrual net operating income? (Check all that apply.) Payback period. Accounting rate of return. Net present value Internal rate of return. Q-6-8. If Gatsby was trading in an old piece of equipment when it purchases the new robotics machine and it receives $50,000 as a trade-in value for the salvageable parts of the old equipment, what is the effect on the accounting rate of return (ARR)? 1. ARR will increase. 2. ARR will decrease. 3. ARR will stay the same. 4. ARR could increase but will never decrease. 5. ARR could decrease but will never increase. Q-6-9. What happens if the four capital budgeting techniques do not all provide the same assurance that a proposal is worth accepting? 1. Put more weight on the internal rate of return and net present value calculations. 2. Put more weight on the payback period and accounting rate of return calculation. 3. Do not accept the proposal. 4. Accept the proposal as long as one of the techniques supports that decision. 5. Accept the proposal if at least two of the four techniques provides support. Q-6-10. What is the discount rate that will cause the net present value of Gatsby's robotics machine project to be zero? 1. 6%. 2. 11%. 3. 20%. 4. 7.9% 5. 12%. CORE CONCEPT REVIEW - Capital Budgeting Techniques Four capital budgeting techniques typically covered in a principles of management accounting course are presented below. The first two-payback period and accounting rate of return- do not require reference to the time value of money. If all revenues are received in cash and all expenses are paid in cash, the difference between net annual cash flow and annual accrual net operating income is simply the annual amount of depreciation expense (a non-cash expense). The following two techniques - net present value and internal rate of return-do incorporate the time value of money and, therefore, should be more useful. When comparing the NPV of multiple projects, calculate the profitability index to control tor size of the investments. CORE CONCEPT REVIEW - Time Value of Money Capital budgeting techniques that recognize that cash flows in the future are not the same as cash flows today will result in better information. A dollar to be received in the future is worth less today because we assume we can put that dollar in the bank (or some type of investment) and earn interest compounded annually, monthly, or continuously. Stated differently, a dollar in hand today is worth more than a dollar to be received in the future. When future cash inflows and outflows of a project are discounted back to today, then we can add them to the initial investment required today to make an apples-to-apples comparison. If the benefits (cash inflows) exceed the costs (cash outflows), then we can recommend going forward with a project. These calculations rely on the company's minimum required rate of return, which is used as a hurdle or discount rate. Time value of money calculations can be done quite easily with tables, Excel, and/or financial registers on calculators. Each of these tools conveniently translates the mathematical relationships between a dollar received either today or in the future, the number of compounding periods, and the discount rate that corresponds to a compounding period. These formulas are: - Future value of $1 to be received in n periods earning i\% each period: =(1+i)n - Present value of $1 to be received in n periods earning i\% each period: =(1+i)n1 If you expect to receive (or pay) \$1 each period, then the formulas are: - Future value of an annuity of $1 to be received each of n periods earning i\% each period: =1(1+i)n1) - Present value of an annuity $1 to be received in each of n periods earning i% each period: =i1[1(1+i)n1]
