Capital Investment Decisions Flashcards
What is capital expenditure?
accountant takes the cash expenditures and divides them into two groups:
1. Current expenditures (e.g. wages)
2. Capital expenditures (e.g. purchase of machines)
When calculating profits what is done?
current expenditures are deducted from current revenues. However accountant does not deduct capital expenditure.
Instead the accountant spreads the cost over its forecasted life by making an annual charge for depreciation.
But when calculating NPV, state capital expenditures are done when they occur, not later when they show up as depreciation.
Does capital expenditure effect cash flow?
it affects cash flow but not profits, while depreciation affects profits but not cash flow.
CF = + depreciation - capital expenditure.
What is incremental working capital?
Difference between current assets and current liabilities. You need working capital at the beginning of the period, in order to buy stock and in order to start selling.
What happens when operational activity levels increase?
inventory/receivables will increase - partly funded by increases in payables - rest is cash flow -> additional investment
What happens when investing at t0?
annual incremental increases as outflows, this is then released at the end of a project e.g. selling assets that were involved in the project such as stocks, equipment - in the last year of project or year after.
How is working capital recovered through liquidation?
Will pay back customers, suppliers etc and then will get everything back that was invested in the project
What is working capital in relation to cash flow?
working capital is a relevant cash flow, must work out incremental change - what additional things need to be invested, if additional cash flows have been recorded.
How is working capital requirement calculated?
percentage given multiplied by sales revenue each year. Number gives the amount of cash flow the company needs
What is taxation?
tax is charged on profits made, incomes will be taxed, expenses will not be tax deductible.
Are capital allowances taxable?
capital allowances change taxable profit for capital expenditure. Can be set against taxable profit, which is a government policy - there are different rules in different jurisdictions.
What is taxable profit?
taxable profit is different to operating profit - it has deducted other expenses such as capital expenditure.
What is the calculation for tax liability?
Tax liability = taxable profit x tax rate
What is capital allowance?
tax relief is given on investments in tangible non-current assets. We assume 25% reducing balance basis, some assets attract greater first year allowances (40,50,100%). Balancing allowances (charges) on disposal proceeds are less (more) than the tax written down value.
What happens if disposal proceeds are greater than remaining balance?
balancing charge - increases taxable profit
What happens if disposal proceeds are less than remaining balance?
balancing allowance - decreases taxable profit
What are some non-financial factors to do with capital investment decisions?
- Compliance with current and future legislation -> some risk with investments e.g. events between Ukraine & Russia
- Impact on staff morale - investment may provide new machinery, less workers needed and so some lose jobs
- Impact on suppliers & customers - project may mean a switch in suppliers, affecting relationships.
- Reputation of organisation - risky investment affects reputation
- Sustainability
