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ACCOUNTING 342 Chapter 14 Homework Solutions

Solutions to Questions

14-1 Capital budgeting screening decisions concern whether a proposed investment project passes a preset hurdle, such as a 15% rate of return. Capital budgeting preference decisions are concerned with choosing from among two or more alternative investment projects, each of which has passed the hurdle. 14-4 Accounting net income is based on accruals rather than on cash flows. Both the net present value and internal rate of return methods focus on cash flows. 14-5 Discounted cash flow methods are superior to other methods of making capital budgeting decisions because they give specific recognition to the time value of money. 14-9 The internal rate of return is the rate of return of an investment project over its life. It is computed by finding that discount rate that results in a zero net present value for the project. 14-10 The cost of capital is a hurdle that must be cleared before an investment project will be accepted. In the case of the net present value method, the cost of capital is used as the discount rate. If the net present value of the project is positive, then the project is acceptable, since its rate of return will be greater than the cost of capital. In the case of the internal rate of return method, the cost of capital is compared to a project s internal rate of return. If the project s internal rate of return is greater than the cost of capital, then the project is acceptable. 14-14 No. If the project profitability index is negative, then the net present value of the project is negative, indicating that it does not provide the required minimum rate of return. 14-17 An outlay that is tax deductible results in some savings in taxes. The after-tax cost of an item is the amount of the outlay less the tax savings. In capital budgeting decisions, all tax-deductible cash expenses should be included on an after-tax cost basis, since the after-tax amount represents the actual net cash...