Financial Management & Capital Budgets Flashcards
Avoidable Costs
Avoidable Costs represent the costs they can be averted by selecting different courses of action and are considered relevant
Sunk Costs
Sunk costs are unavoidable regardless of whatever alternative is ultimately selected. Since they have already been incurred, sunk costs are not relevant.
Decision Analysis
In decision analysis, financial factors and non-financial factors are relevant. Relevant non-financial factors would include employee morale that could lead to loss of productivity.
Depreciation Calculation (capital budget)
In capital budgeting decisions, tax depreciation rather than book depreciation is considered relevant because tax depreciation reduces the taxable income thereby reducing the cash payments for taxes.
Net Cash Flow Calculation
cash flow in – cash flow out total cash flow from operations – depreciation taxable income tax rate tax to be paid net cash flow after taxes(cash flow from operations - taxes to be paid)
Net Present Value (capital budgeting)
Net Present Value like most capital budgeting techniques, focuses on cash flow. Cash flow is a pure measure of financial performance that limits the decision-making to the amount of cash the firm takes in and pays out for an investment.
The decision to replace old the asset
The decision to replace old the asset will result in the company paying the purchase price of the new assets, receiving the disposal price of the old asset, and recognizing a gain and paying taxes on the sale of the old asset based on the cost space less accumulated depreciation.
Purchase price new
- disposal price old
recognize gain
minus taxes on sale of old (based on cost less accumulated depreciation)
Annual Net Cash Inflow
The annual net cash inflow includes the dollar amount of cash inflows times 1 minus the tax rate. Annual net cash inflow includes the depreciation expense times the tax rate. Although depreciation expense is not a cash expense, there is a cash inflow from depreciation. The depreciation expense on the tax return times the tax rate equals the annual depreciation shield, which is an additional cash inflow
Accounting Rate of Return
The accounting rate of return is based on accrual basis income rather than cash flows. It does not consider the time value of money and is considered inferior to the discount cash flow methods.
Payback Method
The payback method takes the total investment in the project and divides it by its annual cash flows to determine the number of years it will take to gain a return of the initial investment. The payback method does not consider the time value of money or the return after initial investment is recovered. The paycheck method focuses on liquidity and the time it takes to recover initial investment
Net Present Value (Computed)
Salvage value (times discount factor) \+ annual cash inflow (times discount factor) = present value total cash inflow – present value total cash outflow = total net present value
Internal Rate of Return
The internal rate of return is the rate that provides a zero net present value. The internal rate of return is equal to the discount rate at which the net present value of the investment is equal to zero. Note often the internal rate of return needs to be calculated by trial and error.
Differential and Incremental Costs
Differential and incremental costs represent the change in costs associated with two separate courses of action and are considered relevant.
Discretionary Costs
Discretionary costs arise from periodic budgeting decisions; a company’s decision to spend more on research and development is discretionary. Discretionary costs can change, so they are relevant.
