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Flashcards in Capital Budgeting Deck (28):

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


Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

Capital Budgeting


For ONE payment- ONE time.

Capital Budgeting


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

Capital Budgeting


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

Think A for Arrears.

Capital Budgeting


1 / (( 1+i )^n)

i : interest rate
n : number of periods

Capital Budgeting


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


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


The Discount Rate.

Capital Budgeting


The rate of return on an investment used.

It represents the minimum rate of return required.

Capital Budgeting


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


Not as simple as the Accounting Rate of Return.

Capital Budgeting


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


The minimum rate of return is used.

Capital Budgeting


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


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

Capital Budgeting


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

Rate of return for NPV is the minimum rate.

Capital Budgeting


Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR

Capital Budgeting


When the benefits are greater than the costs.

IRR is greater than the Discount Rate

Capital Budgeting


When Costs are greater than Benefits

IRR is less than the Discount Rate

Capital Budgeting


When benefits equal the Costs

IRR : Discount Rate

Capital Budgeting


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


Takes risk into consideration

2 year payback is less risky than a 5 year payback

Capital Budgeting


Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back

Capital Budgeting


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


Simple to use

People understand easily

Capital Budgeting


Can be skewed based on Depreciation method that is used.

Ignores the Time Value of Money.

Capital Budgeting


An approximate rate of return on assets.

Capital Budgeting