-Capital Budgeting Flashcards
What is Capital Budgeting? How is it used?
Capital Budgeting is a managerial accounting technique that:
- evaluates different investment options
- Helps management make decisions
- uses both accounting and non-accounting information.
With this technique, the focus is internal and GAAP is not mandatory.
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What values are used in Capital Budgeting?
Capital Budgeting ONLY uses Present Value tables. It NEVER uses Fair Value.
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When is the Present Value of $1 table used?
For ONE payment - ONE time
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When is the Present Value of an Annuity Due used?
The Present Value of an Annuity Due is used on multiple payments made over time—where the payments are made at the START of the period.
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When is the Present Value of an Ordinary Annuity of $1 (PVOA) used?
The Present Value of an Ordinary Annuity of $1 is used on multiple payments over time—where payments are made at the END of the period.
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Think A for Arrears.
What is the calculation for the Present Value of $1?
What is Net Present Value (NPV)?
NPV is a preferred method of evaluating profitability.
It is one of the two methods that use the Time Value of Money:
PV of Future Cash Flows - Investment
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How is NPV used to calculate future benefit?
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, then Cost = Benefit (Management is indifferent)
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What is the rate of return on an investment called?
The Discount Rate
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What does the Discount Rate represent?
The Discount Rate is the rate of return on an investment used. It represents the minimum rate of return required.
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What are the strengths of the Net Present Value system?
Net Present Value uses:
- Time Value of Money
- all cash flows; not just the cash flows to arrive at Payback; and
- takes risks into consideration
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What are the weaknesses of the Net Present Value system?
The NPV system is NOT as simple as the Accounting Rate of Return.
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How do Salvage Value and Depreciation affect Net Present Value?
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.
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If multiple potential rates of return are available, which is used to calculate Net Present Value?
The minimum rate of return is used.
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What is the Internal Rate of Return (IRR)?
The IRR calculates a project’s actual rate of return through the project’s expected cash flows.
It is the rate of return required for PV of future cash flows to EQUAL the investment.
Investment / After-Tax Annual Cash Inflow = PV Factor
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