Reading 44: Capital Budgeting LOSb习题精选 principles, statements, following, budgeting, 2010

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LOS b: Discuss the basic principles of capital budgeting, including the choice of the proper cash flows.

Ashlyn Lutz makes the following statements to her supervisor, Paul Ulring, regarding the basic principles of capital budgeting:

Statement 1: The timing of expected cash flows is crucial for determining the profitability of a capital budgeting project.

Statement 2: Capital budgeting decisions should be based on the after-tax net income produced by the capital project.

Which of the following regarding Lutz’s statements is most accurate?

Statement 1

Statement 2

A) Correct Incorrect

B) Correct Correct

C) Incorrect Correct

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Lutz’s first statement is correct. The timing of cash flows is important for making correct capital budgeting decisions. Capital budgeting decisions account for the time value of money. Lutz’s second statement is incorrect. Capital budgeting decisions should be based on incremental after-tax cash flows, not net (accounting) income.

 

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Financing costs for a capital project are:

A) subtracted from the net present value of a project.

B) captured in the project’s required rate of return.

C) subtracted from estimates of a project’s future cash flows.

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Financing costs are reflected in a project’s required rate of return. Project specific financing costs should not be included as project cash flows. The firm's overall weighted average cost of capital, adjusted for project risk, should be used to discount expected project cash flows.

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Mason Webb makes the following statements to his boss, Laine DeWalt about the principles of capital budgeting.

Statement 1: Opportunity costs are not true cash outflows and should not be considered in a capital budgeting analysis.

Statement 2: Cash flows should be analyzed on an after-tax basis.

Should DeWalt agree or disagree with Webb’s statements?

Statement 1

Statement 2

A) Agree Agree

B) Disagree Disagree

C) Disagree Agree

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DeWalt should disagree with Webb’s first statement. Cash flows are based on opportunity costs. Any cash flows that the firm gives up because a project is undertaken should be charged to the project. DeWalt should agree with Webb’s second statement. The impact of taxes must be considered when analyzing capital budgeting projects.

honeycfa

One of the basic principles of capital budgeting is that:

A) cash flows should be analyzed on a pre-tax basis.

B) decisions are based on cash flows, not accounting income.

C) opportunity costs should be excluded from the analysis of a project.

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The five key principles of the capital budgeting process are:

1. Decisions are based on cash flows, not accounting income.
2. Cash flows are based on opportunity costs.
3. The timing of cash flows is important.
4. Cash flows are analyzed on an after-tax basis.
5. Financing costs are reflected in the project’s required rate of return.