Capital Budgeting Flashcards

1
Q

Managerial Accounting technique used to evaluate different investment options

Helps management make decisions

Uses both accounting and non-accounting information

Internal focus

GAAP is not mandatory

A

Capital Budgeting

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2
Q

Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

A

Capital Budgeting

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3
Q

For ONE payment- ONE time.

A

Capital Budgeting

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4
Q

Multiple payments made over time- where the payments are made at the START of the period.

A

Capital Budgeting

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5
Q

Multiple payments over time- where payments are made at the END of the period.

Think A for Arrears.

A

Capital Budgeting

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6
Q

1 / (( 1+i )^n)

i : interest rate
n : number of periods

A

Capital Budgeting

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7
Q

A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money
: PV of Future Cash Flows - Investment

A

Capital Budgeting

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8
Q

NPV : PV Future Cash Flows - Investment

If NPV is Negative- Cost is greater than benefits (bad investment)

If NPV is Positive- Cost is less than benefit (good investment)

If NPV : 0- Cost : Benefit (Management is indifferent)

A

Capital Budgeting

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9
Q

The Discount Rate.

A

Capital Budgeting

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10
Q

The rate of return on an investment used.

It represents the minimum rate of return required.

A

Capital Budgeting

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11
Q

Uses the Time Value of Money

Uses all cash flows- not just the cash flows to arrive at Payback

Takes risks into consideration

A

Capital Budgeting

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12
Q

Not as simple as the Accounting Rate of Return.

A

Capital Budgeting

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13
Q

NPV includes Salvage Value because it is a future cash inflow.

NPV does NOT include depreciation because it is non-cash.

Exception - If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.

A

Capital Budgeting

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14
Q

The minimum rate of return is used.

A

Capital Budgeting

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15
Q

It calculates a project’s actual rate of return through the project’s expected cash flows.

IRR is the rate of return required for PV of future cash flows to EQUAL the investment.

Investment / After Tax Annual Cash Inflow : PV Factor

A

Capital Budgeting

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16
Q

Cash flows are re-invested at the rate of return earned by the original investment.

A

Capital Budgeting

17
Q

Rate of return for IRR is the rate earned by the investment.

Rate of return for NPV is the minimum rate.

A

Capital Budgeting

18
Q

Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR

A

Capital Budgeting

19
Q

When the benefits are greater than the costs.

IRR is greater than the Discount Rate

A

Capital Budgeting

20
Q

When Costs are greater than Benefits

IRR is less than the Discount Rate

A

Capital Budgeting

21
Q

When benefits equal the Costs

IRR : Discount Rate

A

Capital Budgeting

22
Q

It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow

Investment / Annual Cash Inflow : Payback Method

Compare to a targeted timeframe; if payback is shorter than target- it’s a good investment. If payback is longer than target- it’s a bad investment.

A

Capital Budgeting

23
Q

Takes risk into consideration

2 year payback is less risky than a 5 year payback

A

Capital Budgeting

24
Q

Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back

A

Capital Budgeting

25
An approximate rate of return on assets ARR : Net Income / Average Investment Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.
Capital Budgeting
26
Simple to use People understand easily
Capital Budgeting
27
Can be skewed based on Depreciation method that is used. Ignores the Time Value of Money.
Capital Budgeting
28
An approximate rate of return on assets.
Capital Budgeting