Question: Defining capital investments and the capital budgeting process
Match each capital budgeting method with its definition.
1. Accounting rate of return
2. Internal rate of return
3. Net present value
Capital investment is a sum of cash to assist a company in accomplishing its objectives or buying long-term resources. The word 'capital investment' is employed in two distinctive ways in a commercial environment.
The primary relates to monies apportioned to help the company accomplish its goals. The second category incorporates monies used to procure fixed assets for the firm instead of funds used for day-to-day operations.
Capital budgeting is the method of deciding long-term asset investment choices. It is the method of deciding whether or not to contribute to a particular venture since all investment alternatives may not be beneficial.
Accounting rate of return
Considers operating income but not the time value of the money.
The Accounting rate of return calculates the average rate of return earned by a venture based on its investment, but it disregards the time value of money.
Internal rate of return
The true rate of return an investment earns.
The internal rate of return is the rate of return that the venture will get after considering the current value of both inflows and outflows.
Net present value
Considers the present values of cash outflows with inflows to know the worth.
The concept of net present value underpins the net return conceivable from an extent after considering the show value of inflows and outflows over the project's whole life cycle.
Is only concerned with the time it takes to get the cash outflows returned.
The concept of a "payback period" is based on calculating the time it'll take for the initial venture in a project to be reimbursed.
Note: Furthermore, it should be noted that the various strategies are based on distinct ideas that are matched to the given situation.
Water City is considering purchasing a water park in Omaha, Nebraska, for $1,920,000. The new facility will generate annual net cash inflows of $472,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation, and its stockholders demand an annual return of 12% on investments of this nature.
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index of this investment.
2. Recommend whether the company should invest in this project.
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