Chapter 7 Flashcards
It is the process of planning and controlling investments for long-term projects
Capital budgeting
Decisions of this tend to be relatively inflexible
Capital budgeting
It is the long-term aspect of capital budgeting that presents the management accountant with specific challenges
Long-term projects
It is concerned with long-range decisions such as whether to add a product line to build new facilities or to lease or buy equipment
Capital budgeting
Two types of capital investment decisions
Screening decisions
preference decisions
This is whether the capital investment meets the minimum criteria set by the company
Screening decisions
This is often used to narrow down a set of projects for further consideration
Screening decisions
Evaluate and compare more than one capital investment alternative since companies may have limited capacity to invest in all the project alternatives
Preference decisions
Terms to use in the discussion
Net investment
costs or cash outflows
savings or cash inflows
cost of capital
Costs or cash outflows less cash inflows or savings incidental to the acquisition of the investment projects
Net investment
Initial cash outlay for all expenses on the project up to the time when it is ready for use such as purchase price and incidental project-related cost
Cost or cash outflows
Working capital requirement to operate the project at the desired level
Costs or cash outflows
Market value of an existing, currently idle asset, which will be transferred to or be utilized in the operations of the proposed capital investment project
Costs or cash outflows
Trade-in value of old asset
Savings or cash inflows
Proceeds from sale of old asset to be disposed
Savings or cash inflows
Avoidable costs of immediate refers an old asset to be replaced, netof tax
Savings or cash inflows
The cost of using funds
Cost of capital
It is the weighted average rate the company must pay to its long-term creditors for the use of their funds
Cost of capital
It is also known as the hurdle rate
Cost of capital
It is used to evaluate capital investment alternatives
Capital budgeting methods
The capital budgeting methods
Non discounting methods
discounted cash flow methods
Non discounting methods and their basis
Accounting rate of return - net income
payback period - cash flow
Discounted cash flow methods
Net present value internal rate of return profitability index
all are cash flow
Non discounted capital budgeting techniques
Accounting rate of return
payback period and payback bailout period
Aka annual rate of return simple rate of return or unadjusted rate of return
Accounting rate of return
Tells managers how much net income a potential project is expected to generate as a relative percentage of the investment required
Accounting rate of return
ARR is an unsatisfactory means of evaluating capital projects for two major reasons
The ARR uses accrual basis numbers
The ARR is an average of all of a firm’s capital projects
It shows the amount of time it takes for a capital investment to be recovered by the company using the cash inflows from such investment
Payback period and payback bailout period
Generally projects with shorter payback periods are safer investments than those with longer payback periods
Payback period and payback bailout
formula of ARR based on initial investment
Average net income divided by net investment
formula of ARR based on average investment
Average net income divided by average investment
Formula of payback period if the cash flow per year is uniform
Not investment / annual cash inflow
Formula of payback period when the cash flow per year is not uniform
You have to compute on a year by year basis
It is found by dividing one by the payback period
Payback reciprocal
It is found by accumulating each years discounted net cash flows until the initial investment is recovered
Discounted payback period for an investment
Incorporates the salvage value of the asset into the calculation
Bailout period
This requires a year by year analysis
Bailout payback
