Capital Investment Decision Making - 35% Flashcards
What is a relevant cash flow?
Future, incremental cash flow
What are non relevant costs?
Sunk or past costs
Absorbed fixed overheads
Committed costs
Historical cost depreciation
Notional costs
What is an opportunity cost?
The value of the benefit is sacrificed when one course of action is chosen in preference to an alternative
What are avoidable costs?
The specific costs of an activity or sector of a business which would be avoided if that activity or sector did not exist
What are differential/incremental costs?
The difference in total cost between alternatives. This is calculated to assist decision making.
What is incremental revenue?
Difference I revenues between the alternatives
What are some quantitative costs?
Purchase price of machine
Installation and training costs
What are some quantitative benefits?
Lower direct labour costs
Lower scrap costs and items requiring rework
Lower stock costs
What are some qualitative costs?
Increased noise level
Lower morale if existing staff have to be made redundant
What are some qualititative benefits?
Reduction in product development time
Improved product quality and service
Increase in manufacturing flexibility
What are some internal sources of data?
Sales ledger system
Purchase ledger system
Payroll system
Fixed asset system
Production
Sales and marketing
What are some external sources of data?
Suppliers
Newspapers, journals
Government
Customers
Employees
Banks
Business enquiry agents
Internet
What are the benefits of collecting, analysing, and presenting high-quality data?
Collaborative working
Customer insight
Risk management
Governance
What are the costs of collecting data?
Software licence costs
Software maintenance costs
IT training costs
User training costs
Integration costs
Redundant infrastructure costs
What are the two forms of IT controls?
General controls
Application or program controls
What are general IT controls?
Ensure the organisation has overall control over its information systems.
Personal controls
Access controls
Computer equipment controls
Business continuity planning
What are application or program controls?
Performed automatically by the system and include:
Completioness checks to ensure data is processed
Validity checks
Identification and authorisation checks
Problem management facilities
What does the term BI often used to describe?
Technical architecture of systems that extract, assemble, store and access data to provide reports and analysis
What is at the base of the BI stack?
Source data systems from where date is extracted, translated, and loaded by extract, transform, and load system into a data warehouse.
What is data analytics?
Process of collecting, organising, and analysing large sets of data to generate trends and other information to aid decision making
What is Data mining?
Process of sorting through data to identify patterns and relationships within a data set
What are the benefits of BI?
Sales people are better informed
Greater transparency
Negotiators can be better informed
Advertising and promotional spend can be better focused
Some data may have value outside the business
What is the creation phase of the capital investment process?
Identify objectives
Search for investment opportunities
Identify states of nature
What is the decision phase of the capital investment process?
List possible outcomes
Measure payoffs
Select investment projects
What is the implementation phase of the capital investment process?
Obtain authorisation and implement projects
Review capital investment decisions
What are the functions of a capital expenditure committee?
Coordinate capital expenditure policy
Appraise and authorise capital expenditure on specific projects
Review actual expenditure on capital projects against budget
In a capital investment appraisal what do we initially assume?
All cash inflows and outflows are known with certainty
Sufficient funds are available to undertake all profitable investments
Zero inflation
Zero taxation
What is time value of money?
Money received today is worth more than the same sum received in the future
What are the four widely used investment appraisal methods?
Net present value
Internal rate of return
Payback period
Accounting rate of return
What is the NPV?
Net benefit or loss of benefit in present value terms from an investment opportunity
What is the IRR?
Rate of return at which the project has a NPV if zero
When does capital rationing occur?
When insuffiencient funds are available to undertake all beneficial projects
How do we calculate the profitability index in capital rationing?
NPV of project/inital cash outflows
How do we calculate the discounted payback profitability index?
Present value of net cash inflows/initial cash outlay
What are the different classifications of real options in investment appraisal?
Option to delay/defer
Option to switch/redeploy
Option to expand/contract
Option to abandon
How do you calculate the payback period?
Initial investment/annual cash inflow
How do we calculate the ARR?
Average annual profit/average value of investment
How do you calculate the average value of investment?
Intitial investment plus residual value/2
What are the advantages of payback?
Simplicity
Useful under improving investment conditions
Pray back favours projects with a quick return
Uses cash flows not profits
What are the disadvantages of payback?
Project returns may be ignored
Cash flow timing ignored
Lack of objectivity
Project profitability is ignored
What are the advantages of ARR?
Simple to understand
Widely used and accepted
Considers the whole like of the project
Link with other accounting measures
What are the disadvantages of ARR?
Ignores time value of money
Not a measure of absolute profitability
Does not consider cash flows
Vary with specific accounting policies, and the extent to which project costs are capitalised.
No definite investment signal
Does not provide a reliable basis for project evaluation
How do you calculate the real rate of return?
1 + money cost of capital/1 + rate of inflation
How do u calculate the equivalent annual cost?
PV of costs/annuity factor for year n
What is the method of solution when deciding to replace assets?
Consider each possible replacement cycle
Calculate PV of costs for each cycle
Divide this PV by annuity factor to find equivalent annual cost
Select replacement cycle with the lowest equivalent annual cost
What does the replacement analysis model ignore?
Changing technology
Inflation
Change in production plans
What does the price elasticity of demand measure?
The change in demand as a result of a change in its price
How do u calculate price elasticity?
Change in quantity demanded/change in price
What does it mean if demand is elastic?
Very responsive to change in price.
Revenue increases when price is reduced
Revenue decreases when price increase
What does it mean if demand is inelastic?
Not very responsive to changes in price.
Revenue decreases when price is reduced
Revenue increases when price increases
What factors affect price elasticity?
Scope of the market
Information within the market
Availability of substitutes
Complementary products
Disposable income
Necessities
Habit
What are the limitations of the profit maximisation model?
Unlikely org will be able to determine the demand function for their function
Orgs aim to achieve a target profit
Determining an accurate and reliable figure for marginal or variable cost poses difficulties for the management accountant
Unit marginal costs are likely to vary depending on quantity sold
What are some pricing strategies based on cost?
Target cost plus pricing
Marginal cost plus pricing
Premium pricing
Market skimming
Penetration pricing
Price differentiation
Loss leader pricing
Discount pricing
Controlled pricing
Product bundling
