Special decisions Flashcards
What are the three decisions?
Asset replacement
Capital rationing
Lease or buy
What is an asset replacement decision?
Decision on how often an asset should be replaced.
In an asset replacement decision, which cashflows need to be considered?
Purchase costs
Maintenance costs
Scrap proceeds
The longer the replacement cycle the better the ……….. cost, but the greater the ……. cost
purchase/maintenance
What is an EAC?
Equivalent annual cost
How do you calculate the EAC?
- PV of costs for each cycle
- EAC for each cycle
EAC = PV over one cycle/ Annuity factor for that cycle.
What are the limitations of the EAC method?
It assumes assets are replaced by identical ones
Inflation is ignored
No change in productivity of the company
What is capital rationing?
A decision is made on how to prioritise investments with positive NPV’s when there are limited funds available.
Which type of rationing is this:
‘funds are internally rations (eg. to control rates of expansion/uncertain economy)’
Soft Rationing
Which type of rationing is this:
funds are externally rationed (e.g banks unwilling to provide funds)
Hard rationing
What is Non-divisibility?
A project(s) that cannot be part invested in
Divisibility
A project(s) can be part invested in and earn a proportion of the returns
Mutually exclusive projects
Cannot be done together
How do we work out which projects to take on if they are non divisible?
Trial and error
How do we work out which projects to take on if they are divisible?
Profitability index - NPV/initial Investment
