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Week10 CapitalBudgeting
Week10 CapitalBudgeting
Chapter 11
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 11 - 1
Capital Budgeting
Capital budgeting describes the long-term planning for making and financing major long-term projects. 1. Identify potential investments. 2. Choose an investment. 3. Follow-up or postaudit.
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Payback Model
Payback time, or payback period, is the time it will take to recoup, in the form of cash inflows from operations, the initial dollars invested in a project. P = I Incremental inflow
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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NPV Example
Original investment (cash outflow): $6,075
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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NPV Example
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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1 0.9091 1 0.1
At a discount rate of 10%, the PV Factor for Year 2:
1 0.8264 2 (1 0.1)
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Decision Rules
Managers determine the sum of the present values of all expected cash flows from the project. If the sum of the present values is positive, the project is desirable. If the sum of the present values is negative, the project is undesirable.
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Sensitivity Analysis
Sensitivity analysis shows the financial consequences that would occur if actual cash inflows and outflows differ from those expected.
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(3.1699 Cash flow) $6,075 = 0 Cash flow = $6,075 3.1698 = $1,916 If the annual cash flow is less than $1,916, the NPV is negative, and the project should be rejected.
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Post Audit
Investment expenditures are on time and within budget. Comparing actual versus predicted cash flows. Improving future predictions of cash flows. Evaluating the continuation of the project.
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Advantages measures profitability, easy to use Disadvantages ignores time value of money
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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
What are the advantages/disadvantages of this method? Advantages considers time value of money, considers relevant cash flows Disadvantages discount factor is subjective
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