Chapter 12

Chapter 12

Investments in Operating Assets

QUESTIONS

1. Tangible assets have physical substance and capabilities. Intangible assets have no physical substance or properties; they give the firm the right of ownership or use. Both tangible and intangible assets increase the firm’s potential profitability.

Examples of tangible assets include property, plant, equipment, oil, gas, and other natural resources.

Examples of intangible assets include patents, copyrights, leaseholds, trademarks, franchises, and goodwill.

2. Capital budgeting is the process of planning, setting goals and priorities, arranging financing, and identifying criteria for making long-term investments. For example, a company may be thinking of acquiring a new plant for its expanded production facilities. If there are many models and makes of equipment available in the market, then the company would have to analyze the possible choices and make decisions about financing alternatives.

3. The first model is the payback period. The payback period is simply the time it takes for the firm to recover its original investment, calculated by dividing the original investment by the net annual cash flows received from the investment. Another commonly used evaluation method is to compute an accounting rate of return equal to the average accounting income earned by the asset divided by the investment in the asset. Another decision model used in making capital budgeting decisions is the net present value method. The net present value method incorporates the concept of the time value of money, which is that dollars to be received far in the future are not worth as much as dollars to be received right now. The decision rule underlying the net present value method is that a project should be undertaken only if the present value of the cash inflows from the project exceeds the present value of the cash outflows.

4. Standard accounting practice dictates that the cost of property, plant,...