Which of the following statements is true with regard to capital budgeting?
A.
Using the net present value method, a proposal is acceptable when the net present value is negative.
B.
The internal rate of return is the highest interest rate that will cause the present value of the proposed capital expenditure to be less than the present value of expected net annual cash flows.
C.
The cash payback technique is used to determine the period of time required to recover the capital investment, plus the expected return, from the annual cash flow produced by the investment.
D.
The annual rate of return technique is used to estimate the profitability of a capital expenditure by dividing the expected annual net income by the average investment.
The annual rate of return method estimates profitability by dividing expected annual net income by the average investment. It is an accounting-based capital budgeting technique and does not directly consider the time value of money. Option A is incorrect because a proposal is normally acceptable under net present value when NPV is positive, not negative. Option B incorrectly describes internal rate of return; IRR is the discount rate at which the present value of cash inflows equals the present value of cash outflows. Option C is incorrect because the payback method measures how long it takes to recover the original investment, not the investment plus expected return. Internal auditors should understand capital budgeting methods when reviewing investment decisions. Therefore, Option D is correct.
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