Chapter 3 Flashcards
(15 cards)
What is a capital investment decision
Capital Investment decisions are long-term business decisions involving the commitment of large sums of money (relative to the business’s size) and usually entail the acquisition of non-current assets
What are examples of a capital investment decision
Establish a new store purchase new machinery acquire new technology start production of a new product take over an existing business invest in a financial institutions investment fund.
What are the characteristics of a capital investment decision
they involve large sums of money relative to the size of the business
expenditures are usually long term
the decision is difficult to reverse
they are high risk
Why do capital investment decisions have a large impact on the business
it is expected they will: earn a reasonable rate of return improve productivity enable the growth of the business advance product or service quality
What are the qualitative factors affecting capital investment decisions
employee morale effects on other parts of the business environmental impact effect on the future business opportunities effect on the business's image changes to the quality of the product
When making a capital investment, management will want to ensure?
the business:
remains competitive in the marketplace
meets all legal and political requirements
meets customer expectations
Factors affecting capital investment decisions
customer preferences-changing fashion, habits, social values
competition- market approach, productivity, technology, resources, financial investments, environmental impacts
government regulation- health and safety, business zoning, building construction
What are the three ways to analyse a capital investment decision
rate of return on average investment
payback period
net present value
Why use cash flows
Cash inflows and outflows are a better determinant of the success of a capital investment project. They are what truly determines the value of an investment and it is possible to measure the time value of money
What is the time value of money
The time value of money concept is that money today does not have the same value in the future and this is due to inflation and interest rates.
What is risk and return
The higher the risk , the higher the interest rate (or rate of return) and, therefore, the higher the discount rate will be. Investments that are considered at a higher risk of failure will incur a higher cost of capital
What is Payback Period?
The payback period is the period of time it takes for the cash flows from an investment to exceed the initial cost of the investment. The shorter the payback period the better. Therefore, if there are two or more options available, the one with the smallest payback period is the project that should be preferred.
What is net present value
The net present value is the figure that results from discounting all the cash inflows and cash outflows of a project at the minimum discount rate and then adding and subtracting the resultant present values.
What is the net present value decision rule
A positive NPV result indicates that the investment is acceptable, while a negative NPV result indicates that it is not acceptable and should be rejected.
What is an annuity
An annuity is when the cash inflow or cash outflow over a period of time is the same each period.
