Flashcards in Capital Budgeting (Managerial Accounting) (M43) Deck (40):
There are ___ stages to capital budgeting
During this stage, management determines the type of capital projects that are necessary to achieve management's objectives and strategies
During this stage, management attempts to identify alternative capital investments that will achieve management's objectives
During this stage, management attempts to revaluate the various investments in terms of their costs and benefits
Management chooses the project that best meets the criteria established
During this stage, management decides on the best source of funding for the project
During this stage, management undertakes the project and monitors the performance of the investment
Implementation & Control Stage
At what stage of the capital budgeting process would management most likely apply present value techniques?
These are committed costs that are not avoidable and are therefore irrelevant to the decision process
Sunk, Past, or Unavoidable Costs
These are costs that will not continue to be incurred if a department or product is terminated
These costs arise from a company's basic commitment to open its doors and engage in business. Examples include: depreciation, property taxes, and management salaries
These costs are fixed costs whose level is set by current management decisions. Examples include: Advertising, R&D
These are future costs that will change as a result of a specific decision
This is the difference in cost between two alternatives
Differential (Incremental) Cost
This is the maximum income or savings (benefit) forgone by rejecting an alternative
This is the number of years to recoup the investment in cash
What are two limitations of the payback period?
1) Ignores total project profitability
2) Doesn't take into account TVM
This method is essentially the same as the payback method, except that in calculating the payback period cash flows are first discounted to their present value
What is a strength of the Payback Period Method?
It is easy to understand
ow is the discounted payback method an improvement over the payback method in evaluating investment projects?
It considers the TVM
The discounted payback method involves a better estimates of cash flows than the payback period method
The discounted payback method considers the variability of the return better than the payback period method
This method computes an approximate rate of return which ignores the TVM
Accounting Rate of Return
An advantage of the accounting rate of return method of evaluating investment returns is that the technique considers the TVM
An advantage of the accounting rate of return method of evaluating investment returns is that the technique corresponds to the measure that is often used to evaluate performance
An advantage of the accounting rate of return method of evaluating investment returns is that the technique considers the risk of the investment
If an investment project has a profitability index of 1.15, then the ...
a) Project's internal rate of return is 15%
b) Project's cost of capital is greater than its internal rate of return
c) Project's internal rate of return exceeds its net present value
d) Net present value of the project is positive
The net present value (NPV) method of investment project analysis assumes that the project’s cash flows are reinvested at the
a) Computed internal rate of return
b) Risk-Free Interest Rate
c) Discount rate used in the NPV Calculation
d) Firm's accounting rate of return
This method of discounted cash flows determines the rate of discount at which the PV of the future cash flows will exactly equal the investment outlay
Internal Time-Adjusted Rate of Return
he internal rate of return is the ...
a) Rate of interest that equates the PV of cash outflows & the PV of cash inflows
b) Minimum acceptable rate of return for a proposed investment
c) Risk-adjusted rate of return
d) Required rate of return
Generally the ____ larger/smaller) the standard deviation, the greater the risk
How do you calculate the payback period?
Investment / Annual Cash Inflow
How do you calculate the Annual Cash Inflow?
Annual Cash Inflow Before Depr/Amort & Taxes
- Depr / Amort Expense
+ Depr / Amort Ex[ense
= Annual Cash Inflow (Net of Taxes)
How do you calculate the Accounting Rate of Return?
Net Income / (Initial or Average) Investment
Amortization is NOT a cash outflow and is thus excluded from the calculation of after-tax NPV
In calculating the Accounting Rate of Return you may need to use the PV of 1 factors
The Accounting Rate of Return IGNORES TVM!!!
If an investment is expected to reduce costs by X amount in the first two years and then by Y amount in year three, how would you you determine the PV of these future savings?
Multiply the X amount by the PV Factor for 2 Periods
Multiply the Y amount by the PV Factor for Pd 3 - Pd 2
The NPV Method uses the firm's _________
Cost of Capital
How do you calculate the internal rate of return?
1) What are the cash inflows?
2) What are the cash outflows?
3) What is the period of time?
4) What PV Factor will make the cash inflows = cash outflows?