# BEC- Capital Budgeting Flashcards Preview

## CPA Courses > BEC- Capital Budgeting > Flashcards

Flashcards in BEC- Capital Budgeting Deck (28)
1
Q

BEC

What is Capital Budgeting? How is it used?

A

Managerial Accounting technique used to evaluate different investment options

Helps management make decisions

Uses both accounting and non-accounting information

Internal focus

GAAP is not mandatory

4
Q

BEC

What values are used in Capital Budgeting?

A

Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

7
Q

BEC

When is the Present Value of \$1 table used?

A

For ONE payment ONE time.

9
Q

BEC

When is the Present Value of an Annuity Due used?

A

Multiple payments made over time where the payments are made at the START of the period.

11
Q

BEC

When is the Present Value of an Ordinary Annuity of \$1 (PVOA) used?

A

Multiple payments over time where payments are made at the END of the period. Think A for Arrears.

13
Q

BEC

What is the calculation for the Present Value of \$1?

A

1 / (( 1+i )^n)

```i = interest rate
n = number of periods```
15
Q

BEC

What is Net Present Value (NPV)?

A

A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money

= PV of Future Cash Flows - Investment

17
Q

BEC

How is NPV used to calculate future benefit?

A

NPV = PV Future Cash Flows - Investment

If NPV is Negative- Cost is greater than benefits (bad investment)

If NPV is Positive- Cost is less than benefit (good investment)

If NPV = 0- Cost = Benefit (Management is indifferent)

19
Q

BEC

What is the rate of return on an investment called?

A

The Discount Rate.

21
Q

BEC

What does the Discount Rate represent?

A

The rate of return on an investment used.

It represents the minimum rate of return required.

23
Q

BEC

What are the strengths of the Net Present Value system?

A

Uses the Time Value of Money

Uses all cash flows- not just the cash flows to arrive at Payback

Takes risks into consideration

25
Q

BEC

What are the weaknesses of the Net Present Value system?

A

Not as simple as the Accounting Rate of Return.

27
Q

BEC

How do Salvage Value and Depreciation affect Net Present Value?

A

NPV includes Salvage Value because it is a future cash inflow.

NPV does NOT include depreciation because it is non-cash.

Exception – If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.

29
Q

BEC

If multiple potential rates of return are available- which is used to calculate Net Present Value?

A

The minimum rate of return is used.

31
Q

BEC

What is the Internal Rate of Return (IRR)?

A

It calculates a project’s actual rate of return through the project’s expected cash flows.

IRR is the rate of return required for PV of future cash flows to EQUAL the investment.

Investment / After Tax Annual Cash Inflow = PV Factor

33
Q

BEC

Which rate of return is used to re-invest cash flows for Internal Rate of Return?

A

Cash flows are re-invested at the rate of return earned by the original investment.

35
Q

BEC

How does the rate used for Internal Rate of Return (IRR) compare to that used for Net Present Value (NPV)?

A

Rate of return for IRR is the rate earned by the investment.

Rate of return for NPV is the minimum rate.

37
Q

BEC

What are the strengths and weaknesses of the Internal Rate of Return system?

A

Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR

39
Q

BEC

When is NPV on an Investment positive?

A

When the benefits are greater than the costs.

IRR is greater than the Discount Rate

41
Q

BEC

When is NPV on an Investment Negative?

A

When Costs are greater than Benefits

IRR is less than the Discount Rate

43
Q

BEC

When is NPV Zero?

A

When benefits equal the Costs

IRR = Discount Rate

44
Q

BEC

What is the Payback Method? How is it calculated?

A

It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow

Investment / Annual Cash Inflow = Payback Method

Compare to a targeted timeframe; if payback is shorter than target- it’s a good investment. If payback is longer than target- it’s a bad investment.

46
Q

BEC

What are the strengths of the Payback Method?

A

Takes risk into consideration

2 year payback is less risky than a 5 year payback

47
Q

BEC

What are the weaknesses of the payback method?

A

Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back

48
Q

BEC

What is the Accounting Rate of Return?

A

An approximate rate of return on assets

ARR = Net Income / Average Investment

Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.

49
Q

BEC

What are the strengths of the Accounting Rate of Return (ARR)?

A

Simple to use

People understand easily

50
Q

BEC

What are the weaknesses of the Accounting Rate of Return (ARR)?

A

Can be skewed based on Depreciation method that is used.

Ignores the Time Value of Money.

51
Q

BEC

What is an Expected Return?

A

An approximate rate of return on assets.