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Accounting > Capital investment appraisal > Flashcards

Capital investment appraisal Flashcards

1
Q

Why are non-current assets purchased?

A

With the intention that they will generate profits for the business for some years into the future as they will be used by the business for more then one financial period

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2
Q

What are some examples of NCA?

A

Land
Buildings
Machinery
Plant
Vehicles
Office equipment

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3
Q

Why must capital expenditure be very carefully planned?

A

Cash is a limited resource so they must get the best value from it with maximum benefits

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4
Q

How are capital investment projects appraised?

A

according to potential earning power

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5
Q

Why must care be taken with capital investment decisions?

A

Large sums of money generally involved
Money may be tied up for considerable length
Decisions cannot generally be reversed easily
Money committed usually non-returnable

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6
Q

What might be some of the sources of information for a capital investment project?

A

Human resources
Sales
Finance
Production
Purchasing

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7
Q

Why might investment appraisal need to be done with machines?

A

Different prices
Different qualities
Produce different quantities and qualities of goods
Different lifespans
Different rates of obsolescence (outdated)

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8
Q

What are the 2 main methods of evaluating a capital project?

A

Payback methods
Net present value method (NPV)

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9
Q

What are opportunity costs?

A

the benefit from the alternative use of resources that is forgone when a new project is undertaken

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10
Q

What are sunk costs?

A

unrecovered expenditures already incurred before a project is undertaken (paid anyway)

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11
Q

What is disregarded when a new project is taken on?

A

Sunk costs with no influence on new project

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12
Q

What is the payback period with capital investment?

A

length of time required for total for the total net cash flows to equal the initial capital investment

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13
Q

Why is risk an important factor when considering a long term project?

A

As the sooner capital expenditure recouped the better the payback method

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14
Q

Why is payback method widely used?

A

as most businesses are concerned with short term horizons especially in fast moving markets or when liquidity is poor

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15
Q

What does a long payback period mean for the business?

A

increases the possibility that the original cost will not be recouped
Longer periods may mean cash inflows will be less reliable

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16
Q

How is the payback period measured?

A

Years and months (weeks or days)

17
Q

How do you calculate payback period?

A

work out years first, using cumulative net cashflow, then work the month for the final payback year

18
Q

What is the formula for payback?

A

(Amount needed from that year/ amount available that year) X 12 or 52 or 365

19
Q

Why do you multiply by different numbers for payback?

A

X12= months
X52= weeks
X365= days

20
Q

What are the 2 types of investment appraisal when cash flow is not given?

A

Adding back depreciation
Deducting cash outflow from cash in flow

21
Q

What are the advantages of the payback method?

A

Simple to calculate
Fairly easy for non-accountants to understand
Use of cash more objective then profits that are dependant on the accounting policies decided by managers
Payback shows which project involves the least risk as it recognises cash received earlier is safer
Shows projects which benefit liquidity
Good in fast moving market with poor liquidity

22
Q

What are the disadvantages of the payback method?

A

Ignores time-value of money
Ignores life expectancy of project
Does not consider all cash flows (after payback period are ignored)
Projects might have different cash flow patterns

23
Q

How will mangers evaluate a project?

A

By comparing the capital investment with the future return of the project

24
Q

What is the general pattern for money over time?

A

tendency for money to become less valuable

25
Q

What is cost capital based on?

A

The weighted average cost of capital available to a business

26
Q

What is cost capital based on?

A

The weighted average cost of capital available to a business

27
Q

How is the net present value method of investment calculated?

A

taking present day value of all future net cash flows based on the businesses cost of capital and subtracting initial cost of investment

28
Q

What does a discounting factor allow for?

A

the value of all future cash flows to be calculated in terms of their value if they were received today

29
Q

What should you do if you are given a number of discounting factors to choose from?

A

select the one identified in the question as the cost capital (interest rate)

30
Q

What projects should be considered with net present value?

A

Any project that yields a positive

31
Q

Why might projects which have a negative present value still be accepted?

A

Keep customer happy
Keep good skilled workforce in business
Chance of future orders

32
Q

What are the advantages of net present value method?

A

Can use different discount factors to view the impact of different scenarios
Opportunity cost can be considered
Time value of money taken into account
Relatively easily understood
Greater importance given to earlier cash flow

33
Q

What does it mean that net present value accounts for money time value?

A

Takes into account value of current and future cash flows

34
Q

What are the disadvantages of net present value method?

A

Inflows and outflows difficult to predict
Current cost of capital may change over project life
Life of project difficult to predict
Hard to compare projects with different initial cost
Complex to calculate
Not very realistic to have one discount factor over long period

35
Q

What are the limitations of investment appraisal methods?

A

Figures used are only estimates
Hard to make direct comparisons between projects
Do not incorporate non-financial factors (social worthwhile)

36
Q

What are relevant costs and revenues?

A

costs and revenue of future that will be affected by the decision

37
Q

What is an example of an irrelevant costs?

A

a sunk cost as it has already occurred (so is a past cost not a future one)

Accounting (30 decks)

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