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Management Reporting > Investment Decisions > Flashcards

Investment Decisions Flashcards

1
Q

What do you call the types of decisions made by companies to evaluate or assess a project?

A

Investment Decisions
Capital Budgeting Decisions

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2
Q

It is prepared and administered separately from other budgets, perhaps due to its long-term nature.

A

Capital Budget

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3
Q

It is usually prepared for three to five years.

A

Capital Budget

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4
Q

It usually involves the outlay of large amounts of cash, and the benefits are long-term.

A

Capital Expenditure

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5
Q

Investment decisions must go through a process of what?

A
  1. Appraisal
  2. Control
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6
Q

CDI

Three Distinct Phases of an Investment Decision

A
  1. Creation
  2. Decision
  3. Implementation
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7
Q

An entity must set up a mechanism to search for investment opportunities based on the business environment.

A

Creation

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8
Q

It involves conducting a financial analysis of the investment proposals and comparing them with possible alternatives.

A

Decision

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9
Q

It includes approval and reviewing the decision through a post-completion audit.

A

Implementation

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10
Q

It is an objective, independent assessment of the success of a capital project concerning a plan.

A

Post-Completion Audit

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11
Q

WICMII

Purpose of Post-Completion Audit

A
  1. Will motivate managers to work to achieve the promised benefits of the project.
  2. If there’s an inefficiency, steps can be taken to improve efficiency.
  3. Can form part of the performance appraisal of managers.
  4. Managers will most likely provide more realistic estimates if they were aware that they will be audited.
  5. Identify weaknesses in forecasting and estimating techniques to improve their forecasting in future proposals
  6. Identify areas for improvement that can help achieve better results from the project.
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12
Q

When does PCA is usually carried out?

A

Within one year after the completion of the investment

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13
Q

What will happen when PCA is carried out too soon?

A

Information may be incomplete

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14
Q

What will happen if PCA is carried out too late?

A

The results will be less useful.

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15
Q

AS

PCA need not be performed on what and what must the management decide?

A
  1. Need not be performed on ALL projects.
  2. Management must decide which project will be SUBJECT TO PCA.
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16
Q

AC

PCA may not necessarily focus on what and where should they focus?

A
  1. All aspects of the investment
  2. Focus on the critical aspects of the project’s success.
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17
Q

OE

Who should perform PCA?

A
  1. Someone other than the line management directly involved in the investment decision.
  2. External Consultants.
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18
Q

MCMB

Limitations of Post-Completion Audit

A
  1. May not be possible to identify the costs and benefits separately.
  2. Costly and time-consuming
  3. May lead managers to become overly conservative
  4. Benefits may take years to materialize
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19
Q

It cannot reverse an investment decision and capital outlay incurred but has a particular management control value.

A

PCA

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20
Q

The time the company takes to recover the initial cost of investment in a project.

A

Payback Period

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21
Q

What should the company do when a project passes through the first screening?

A

It must be evaluated further using other project evaluation methods.

22
Q

Which does the company favor when selecting between two or more projects using the payback period?

A

One with the shortest payback period

23
Q

What should be determined first when calculating the payback period?

A

The annual after-tax cash inflows the investment is estimated to generate.

24
Q

CA

Steps in Computing the Annual After-Tax Cash Inflows

A
  1. Calculate the after-tax net income. Deduct income tax from the Net Income.
  2. Add the depreciation expense to the after-tax net income to get the purely cash income called “Annual Cash Inflow”.
25
Q

Why should the depreciation be added back?

A

Because it’s a non-cash expense and was deducted during the net income computation.

26
Q

IIUM

Limitations of Payback Period

A
  1. Ignores time value of money.
  2. Ignores additional cash flows after payback period has been reached.
  3. Unable to distinguish between projects with the same payback period.
  4. May lead to excessive investment in short-term projects.
27
Q

SPRR

Advantages of Payback Period

A
  1. Simple to calculate and easily understood.
  2. Preserves liquidity by preferring early cash flows.
  3. Relies on cash flows instead of accounting profits.
  4. Reduces risk since short-term forecasts are more reliable.
28
Q

It is a method of evaluating a project by calculating the project’s return on investment.

A

Accounting Rate of Return

29
Q

What happens if a project exceeds the target rate of return?

A

It will be considered.

30
Q

The calculations here are based on income after depreciation.

A

Accounting Rate of Return

31
Q

IBDA

Limitations of Accounting Rate of Return

A
  1. Ignores time value of money.
  2. Based on accounting profits which are subject to different accounting treatments.
  3. Does not take into account the length of the project.
  4. A relative measure and does not consider the size of investment.
32
Q

SRC

Advantages of Accounting Rate of Return

A
  1. Simple to calculate and easily understood.
  2. Relies on accounting profits that are readily available from the accounting systems.
  3. Considers the profits of the entire project life.
33
Q

It is the difference between the sum of the projected discounted cash inflows and outflows attributable to capital investment or other long-term projects.

A

Net Present Value

34
Q

How to compute for NPV if the cash flows are different?

A
  1. Divide PVF 1 to 1 + rate to get the PVF for Year 1.
  2. Summation of the product of the PV Factor for the Year to the corresponding Cash Flow to get the PV of cash flow.
35
Q

How to compute for NPV if the cash flows are the same?

A
  1. Compute the PVF with [1-(1/1+r^t)]/r
  2. Then multiply it to the cash flow to get the PV of Cash Inflows.
  3. PV of Cash Inflows - Acquisition Cost = NPV
36
Q

It compares the present value of all cash inflows from a project with the present value of all project cash outflows.

A

Net Present Value

37
Q

What should the company do to a project if the NPV is positive?

A

It should be undertaken.

38
Q

What should the company do to a project if the NPV is negative?

A

The project should not.

39
Q

It measures the number of times a project recovers the initial funds invested.

A

Profitability Index

40
Q

What happens if the profitability index is greater than one?

A

The project if acceptable.

41
Q

What happens after the profitability index indicates that a project is acceptable?

A

It can rank other projects to determine which must be prioritized.

42
Q

What does a profitability index of less than one indicates?

A

That the outflows are greater than the inflows. Project must not be accepted.

43
Q

It is the annual percentage return a project achieves, at which the sum of the discounted cash inflows over the project’s life equals the sum of the discounted cash outflows.

A

Internal Rate of Return

44
Q

It is another evaluation method to calculate the rate of return the project is expected to achieve.

A

Internal Rate of Return

45
Q

It is also known as the rate at which the NPV is zero.

A

Internal Rate of Return

46
Q

Without MS Excel, one may calculate the IRR using what method?

A

Hit-and-miss or Trial and Error

47
Q

IWM

Limitations of Internal Rate of Return

A
  1. Ignores the relative size of the investment.
  2. When discount rates differ over the project’s life, such variations can be incorporated into NPV calculations but not IRR.
  3. May provide a different order of ranking as compared to NPV.
48
Q

How to compute Payback Period?

A

Years Before Breakeven + [(Unrecovered Amount ÷ Cash Flow in Recovery Year) * 12 months]

49
Q

How to compute for the payback period without a table?

A
  1. Annual Operating Costs - Depreciation Expense = Cash Operating Costs
  2. Compute for Annual Cash Inflows. Capacity divided by copies to get the production. Then multiply it by the contribution margin per unit to get the total contribution margin. Deduct the Cash Operating Costs to it to get the Annual Cash Inflow.
  3. Compute for the estimated disposal value. Acquisition Cost - Accumulated Depreciation = Estimated Disposal.
  4. Add the estimated disposal to the cash inflow at the end of useful life.
  5. Make a table and compute for the Payback Period.
50
Q

Do investment opportunities appear just out of thin air?

A

No. They must be created.

51
Q

How to compute for Accounting Rate of Return?

A

ARR = (Average Annual Profit from Investment/Average Profit after Depreciation ÷ Average Investment) * 100%

52
Q

How to compute for Profitability Index?

A

PV of Net Cash Inflows ÷ Initial Investment

Management Reporting (8 decks)

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