Ch 21 Flashcards
(40 cards)
5 stages of capital budgeting process?
1 identify projects 2 obtain info 3 make predictions 4 make decision among alternatives 5 implement the decision, evaluate the performance and Learn
Capital budgeting
Process of making long-run planning decisions for
Investments in projects
Capital budgeting stage 1: identify projects
Identify potential capital investments that agree with
The organization’s strategy
Capital budgeting stage 2: obtain information?
Gather info from all parts of value chain to evaluate
Alternative projects
Capital budgeting stage 3: make predictions
Forecast all potential cash flows attributable to
Alternative projects
Capital budgeting stage 4: make decisions by choosing among alternatives
Determine which investment yields the greatest benefit
And the least cost to the organization
Capital budgeting stage 5: implement the decision, evaluate performance, and learn. 2 phases?
Obtain funding and make investments selected stage 4
Track realized cash flows, compare against estimated
numbers and revise plans if necessary
4 capital budgeting methods used to analyze financial info?
1 net present value (NPV)
2 Internal rate of return (IRR)
3 payback
4 Accrual accounting rate of return (AARR)
2 discounted cash flow methods?
1 net present value NPV
2 internal rate of return IRR
Discounted cash flow methods, define
Measure all expected future cash inflows and outflows
Of project discounted back to present point in time
Time value of money
Dollar received today is worth more than dollar received
At any future time
Required rate of return AKA discount rate, hurdle rate, cost of capital or opportunity cost
Minimum acceptable annual rate of return on an
investment
Net present value (NPV) method Calculates expected monetary gain or loss from project by…
discounting all expected future cash inflows + outflows
Back to present point in time using required rate of return
3 steps to use the net present value (NPV) method?
1 draw sketch of relevant cash inflows and outflows
2 discount cash flows using the correct compound
Interest tables and sum them
3 make project decision on calculated NPV
Internal rate of return (IRR) calculates…
discounted rate where investment’s present value (PV)
of all expected cash inflows = PV of expected cash outflows
Payback method
Measures time it takes to recoup, in form of expected
Future cash flows, net initial investment of project
Uniform cash flows: payback period equation?
Payback period =
net initial investment/uniform increase in annual future cash flows
3 conditions that make payback method a useful measure?
1 preliminary screening of many proposals is necessary
2 interest rates are high
3 expected cash flows in later years of projects are
Uncertain
2 weaknesses of payback period?
Doesn’t consider time value of money
Doesn’t consider cash flows after payback period
Discounted payback method
Calculates amount of time required for present value of
Cash inflows to equal PV of outflows
accrual accounting rate of return (AARR) method
Divides avg. annual (accrual accounting) income of project
By measure of investment in it
Accrual accounting rate of return equation?
Accrual accounting rate of return =
Increase in expected avg. annual after tax income/
Net initial investment
3 categories of cash flows in capital investment project?
1 net initial investment in project
2 after tax cash flow from operations
3 after tax cash flow from disposal of asset and recovery
Of working capital
What does that net initial investment in a project include?
(Acquisition of assets) + (associated additions to working
capital) - (after tax cash flow from disposable existing asset)
