Which of the following is a capital budgeting method? return on assets net present value inventory turnover return on equity Which of the following is a capital budgeting method that is used to screen potential investments? Return on assets acid test ratio accounting rate of return debt-to-equity ratio Which of the following two methods are typically used for initial screening of investments, rather than for detailed, in-depth analysis? payback and accounting rate of return net present value and payback internal rate of return and net present value accounting rate of return and net present value Which of the following is true of projecting future cash flows of an investment? Information on cash flow will also include non-cash transactions like depredation. Cash inflows and cash outflows are treated separately, rather than being netted together. Cash flows are projected by accounting personnel without considering input from other business functions. The initial investment is always treated separately from all other cash flows. Capital budgeting is: the process of planning the investment in long-term assets. preparing the budget for operating expenses. the process of evaluating the profitability of a business. the process of making pricing decisions for products. Which of the following is a capital budgeting method that ignores the time value of money? payback internal rate of return return on assets net present value Which capital budgeting method uses accrual accounting, rather than net cash flows, as basis for calculations? payback accounting rate of return net present value internal rate of return

General guidance

Concepts and reason

Capital budgeting: Huge projects like setting up a new plant, expanding existing business, and acquiring new businesses take huge amount of capital investments. Capital budgeting techniques help evaluation of these kind of investments.

Time value of money: Value of a cash flow receivable in future is different if the same amount is receivable today. It is because money has time value. Dollar earns interest over period of time. Because of the involvement of interest value of money differs over time.

Fundamentals

Net present value: Net present value is a capital budgeting technique. It discounts future cash flows of the project to present using appropriate discount rate. If present value of cash inflows is more than present value of cash outflows then project is accepted. If present value of cash inflows is less than present value of cash outflows then project is rejected.

Accounting rate of return: Accounting rate of return calculates the rate of return earned in the proposed project. It does not consider time value of money. It is arrived by dividing average net income with average investment amount.

Payback period: Payback period calculates the amount of time required to recover the investment in the project. It is a simple but effective measure of understanding proposed project. It is generally calculated without considering the effect of time value of money but another version is also available which considers the time value of money.

Internal rate of return: Internal rate of return provides the rate of return offered by the proposed capital budgeting project. It considers the effect of time value of money. If project’s internal rate of return is not less than the required rate of return then the project is accepted else rejected.

Step-by-step

Step 1 of 6

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Return on assets: Return on assets is a measure of profitability relative to the total assets invested. It is used in evaluating the performance of a company as a whole but not in capital budgeting decisions. Thus, it is not a capital budgeting method.

Inventory turnover: Inventory turnover measures the number of times inventory was sold and purchased during the year. It is also a performance measurement ratio of a company but not used in capital budgeting decisions. Thus, it is not a capital budgeting method.

Return on equity: Return on equity provides the amount of net wealth created for equity shareholders as a percent of amount contributed by equity shareholders. It is used in measuring profitability of a year and not considers time value of money. It is not used in capital budgeting decisions. Thus, return on equity is not a correct answer choice.

It is critical to distinguish between performance measurement techniques and capital budgeting techniques. Return on assets, inventory turnover, and return on equity are not capital budgeting techniques. Capital budgeting techniques make emphasis on time value of money as projects lasts for several years. Whereas performance measurement techniques emphasize on the performance for a certain period and they do not consider time value of money.

Return on assets and return on equity can be confused for capital budgeting techniques as they also talk about return generated by the project. But they are general techniques used in measuring period performances but they are not capital budgeting techniques.

Determination of correct capital budgeting method from the options given.

Step 2 of 6

Net present value: Net present value is a sophisticated method. It considers the effect of time value of money. First it calculates the cash flows generated by the project at various time periods. Then it discounts the future cash flows to the investment date. It compares the discounted future cash flows to the amount of investment. If discounted future cash flows are more than investment amount then project is accepted else rejected.

Part 232

Net present value is a capital budgeting technique.

Net present value, internal rate or return, payback period, discounted payback period, and accounting rate of return are some popular capital budgeting methods. Time value of money is the core of capital budgeting methods.

Return on assets and return on equity can be confused for capital budgeting techniques as they also talk about return generated by the project. But they are general techniques used in measuring period performance but not they are not capital budgeting techniques.

Determination of methods not used in screening potential capital budgeting investments from the given answer choices.

Step 3 of 6

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Return on assets: return on assets is a measure of profitability relative to the total assets invested. It is used evaluating the performance of a company as a whole but not in capital budgeting decisions. Thus, it is not a capital budgeting method to screen potential investments.

Acid test ratio: Acid test ratio measures the liquidity position of the business entity. It shows the liquidity position to pay current liabilities of the entity. It is not a capital budgeting method to screen potential investments.

Debt to equity ratio: debt to equity ratio measures the financial leverage of the company. It provides an understanding of capital structure of the company but not used to screen potential capital budgeting investments.

Before analyzing capital budgeting projects in detail they are initially screed to check whether the investment is worth analyzing in detail. Because capital budgeting techniques use sophisticated methods to understand its profitability and they require good amount of data they are first screened to proceed further. Return on assets, acid test ratio, and debt to equity ratio are clearly not capital budgeting methods at all and have no role in screening investments as well.

Return on assets can be confused for capital budgeting techniques as they also talk about return generated by the project. But it is a general technique used in measuring period performance but not they are not capital budgeting technique.

Determination of capital budgeting method from the options given.

Step 4 of 6

Accounting rate of return: accounting rate of return is a capital budgeting technique. It provides average rate of return provided by the amount invested in the project. Accounting rate of return is average net profit divided by average investment in the project. Though, time value of money is not considered, it provides an initial rate of return offered by the project. Thus, it is used in screening potential investments.

Part 233

Accounting rate of return technique is used to screen potential capital budgeting investments.

Net present value, internal rate or return, payback period, discounted payback period, and accounting rate of return are some popular capital budgeting methods. Accounting rate of return is a screening technique used to screen potential capital budgeting investment proposals.

Return on assets can be confused for capital budgeting techniques as they also talk about return generated by the project. But it is a general technique used in measuring period performance but not they are not capital budgeting technique.

Determination of methods not to screen potential capital budgeting investments from the given answer choices.

Step 5 of 6

(234)

Net present value and payback period: payback period is used in screening potential investments. But, net present value is not used in screening but used to determine acceptability of the proposal altogether. Thus, the answer choice net present value and payback is not a correct option.

Internal rate of return and net present value: Both internal rate of return and net present value techniques are not used in screening but used in accepting or rejecting the proposal. Thus, the answer choice internal rate of return and net present value is not a correct option.

Accounting rate of return and net present value: Accounting rate of return is used in screening investments. But, net present value technique is not used in screening but used in accepting or rejecting the investment. Thus, the answer choice accounting rate of return and net present value is not a correct option.

Before analyzing capital budgeting projects in detail they are initially screened to check whether the investment is worth analyzing in detail. Net present value technique is not used in screening investments. Internal rate of return technique is also not used in screening investments. They decide acceptability of the investment. The question is about method used in screening investments. Thus, the answer choices containing net present value and interest rate of return techniques become incorrect answer choices.

Net present value technique is a widely used capital budgeting method. Though it is widely used it is not used in screening investments. Answer choice containing Net present value technique should not be taken as correct answer choice. Selecting answer choice with net present value technique will be incorrect.

Determination of correct capital budgeting screening method from the options given.

Step 6 of 6

Payback and accounting rate of return: payback period provides an understanding of time required to recover investment in project. Accounting rate of return provides average rate of return provided by the amount invested in the project. Accounting rate of return is average net profit divided by average investment in the project. Though, time value of money is not considered, it provides an initial rate of return offered by the project. Both of them are used in screening potential investments.

Part 234

Payback and accounting rate of return techniques are used to screen potential capital budgeting investments.

Net present value, internal rate or return, payback period, discounted payback period, and accounting rate of return are some popular capital budgeting methods. Payback and accounting rate of return are screening techniques used to screen potential capital budgeting investment proposals.

Internal rate of return technique is a widely used capital budgeting method. Though it is widely used it is not used in screening investments. Answer choice containing internal rate of return technique should not be taken as correct answer choice. Selecting answer choice with internal rate of return technique will be incorrect.

Answer

Part 232

Net present value is a capital budgeting technique.

Part 233

Accounting rate of return technique is used to screen potential capital budgeting investments.

Part 234

Payback and accounting rate of return techniques are used to screen potential capital budgeting investments.

Answer only

Part 232

Net present value is a capital budgeting technique.

Part 233

Accounting rate of return technique is used to screen potential capital budgeting investments.

Part 234

Payback and accounting rate of return techniques are used to screen potential capital budgeting investments.