Flashcards in Capital Budgeting Deck (28):

1

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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

### Capital Budgeting

2

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Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

### Capital Budgeting

3

## For ONE payment- ONE time.

### Capital Budgeting

4

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

### Capital Budgeting

5

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

Think A for Arrears.

### Capital Budgeting

6

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1 / (( 1+i )^n)

i : interest rate

n : number of periods

### Capital Budgeting

7

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A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money

: PV of Future Cash Flows - Investment

### Capital Budgeting

8

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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)

### Capital Budgeting

9

## The Discount Rate.

### Capital Budgeting

10

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The rate of return on an investment used.

It represents the minimum rate of return required.

### Capital Budgeting

11

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Uses the Time Value of Money

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

Takes risks into consideration

### Capital Budgeting

12

## Not as simple as the Accounting Rate of Return.

### Capital Budgeting

13

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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.

### Capital Budgeting

14

## The minimum rate of return is used.

### Capital Budgeting

15

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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

### Capital Budgeting

16

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

### Capital Budgeting

17

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

Rate of return for NPV is the minimum rate.

### Capital Budgeting

18

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Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR

### Capital Budgeting

19

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When the benefits are greater than the costs.

IRR is greater than the Discount Rate

### Capital Budgeting

20

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When Costs are greater than Benefits

IRR is less than the Discount Rate

### Capital Budgeting

21

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When benefits equal the Costs

IRR : Discount Rate

### Capital Budgeting

22

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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.

### Capital Budgeting

23

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Takes risk into consideration

2 year payback is less risky than a 5 year payback

### Capital Budgeting

24

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Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back

### Capital Budgeting

25

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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.

### Capital Budgeting

26

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Simple to use

People understand easily

### Capital Budgeting

27

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Can be skewed based on Depreciation method that is used.

Ignores the Time Value of Money.

### Capital Budgeting

28