Acc 2020 Chapter 20

Front 1

4 examples of capital investments

Back 1

◦ Purchasing new equipment
◦ Building new facilities
◦ Automating production
◦ Developing web sites

Front 2

3 facts about Capital budgeting

Front 3

4 methods of capital budgeting Analysis

Back 3

1. Payback Period
2. (ARR) Accounting Rate of Return
3. (NPV) Net Present Value)
4. (IRR) Internal Rate of Return

Front 4

How Operating income differs from cash flows

Back 4

◦ Cash flows do not include noncash expenses

Front 5

(4) Cash inflows

Back 5

◦ Future cash revenue generated
◦ Future savings in ongoing cash operating costs
◦ Future residual value

Front 6

(2) Cash outflows

Back 6

◦ Initial investment
◦ Operating costs, maintenance, repairs

Front 7

6 step capital budgeting process

Back 7

1. Identify potential investments
2. Project net cash inflows
3. Project net cash inflows
4. Analyze using one or more of the methods
5. Capital rationing
6. Post-audits

Front 8

3 facts concerning the payback period

Front 9

Payback Period Formula

Back 9

Payback Period =
Amount Invested / Expected annual net cash inflow

Front 10

2 criticisms of payback period method

Front 11

Which is moree desirable shorter are longer payback periods for investments

Back 11

Investments with shorter
payback periods are
more desirable, all else
being equal

Front 12

Accounting Rate of return (Formula)

Back 12

Average annual operating income from asset /
Average amount invested in asset

Front 13

Should you invest in capital assets if expected accounting rate of return exceeds the
required rate of return?

Back 13

Invest

Front 14

Should you invest in capital assets if expected accounting rate of return is less than the
required rate of return

Back 14

Dont Invest

Front 15

Whats the time value of money ?

Back 15

Invested money earns income over time

Front 16

3 factors that affect the time value of money

Back 16

Principal (p)

Front 17

Principal (p)

Back 17

amount of the investment
◦ Lump sum
◦ Annuity

Front 18

◦ Annuity

Back 18

Stream of equal installments at regular time periods

Front 19

Number of periods (n)

Back 19

◦ From the beginning of the investment until termination

Back 20

annual percentage
◦ Simple interest

Front 21

Future Value (Formula)

Back 21

Future Value = Present Value + Interest earned

Front 22

Present Value (Formula)

Back 22

Future Value - Interest Earned

Front 23

Factors for Present and Future Value

Front 24

How to find the lump sum

Back 24

See Appendix B for present and future factor
tables.
Multiply amount by factor found in table

Front 25

How to find Annuity

Back 25

See Appendix B for present and future factor
tables.

◦ Multiply one period’s installment by the factor found in the
table

Front 26

2 Discounted Cashflow models

Back 26

◦ Net present value (NPV)
◦ Internal rate of return (IRR)

Front 27

3 functions of discounted cash flow models

Front 28

Cash Outflow, Cash Inflow -
Which occurs now ?

Back 28

◦ Cash outflow for investment usually occurs now
◦ Cash inflows usually occur in the future

Front 29

(NPV) Net Present Value

Back 29

Present value of net cash inflows (-) Investment cost =
Net present value

Interest rate used is
desired rate of return

The higher the risk,
the higher the rate

Front 30

When to Invest in capital assets?

Back 30

If NPV is positive. Invest
If NPV is negative. Dont Invest

Front 31

If investment is expected to bring in even cash
flows:

Back 31

Use Present Value of Annuity (PVA) table

Front 32

If Cash Flows amounts are unequal:

Back 32

Present value of each individual cash flow is computed
◦ Use Present Value of $1 (PV) table

Front 33

Profitability Index

Back 33

Number of dollars returned for every dollar
invested

Front 34

How to found dollar amount in profitability Index

Back 34

Present Value of Net Cash Inflows / Investment

Front 35

Internal Rate of Return

Front 36

Internal Rate of Return (formula)

Back 36

Investment Costs - Present value of the investments net cash inflows

Front 37

PVA Factor formula

Back 37

ILocate PVA factor in table using the
project’s life as the number of periods
nvestment's Cost / Annual net cash inflow

Front 38

Should you invest in capital assets if the IRR exceeds the expected rate of return ?

Back 38

Invest

Front 39

Should you invest in capital assets if the IRR is less than the expected rate of return ?

Back 39

Do not invest

Front 40

5 facts about the Payback Period

Back 40

1.Simple to compute
2.Focuses on time it takes to
recover cost of asset
3. Ignores cash flows after the payback period
4. Highlights risks of assets with longer cash recovery periods.
5. Ignores time value of money

Front 41

4 facts about the accounting rate of return

Back 41

1. Uses accrual accounting
2. Shows how investment will impact operating income, which is important to investors.
3. Measures the profitability over the asset’s life.
4. Ignores time value of money

Front 42

4 facts about Net Present Value

Back 42

1. Uses time value of money and asset’s cash flows over its entire life.
2. Indicates whether the asset will earn the minimum required rate of return.
3. Shows excess or deficiency of asset’s present value of net cash flows over its initial cost.
4. Profitability index should be
computed when assets have
differing investment amounts

Front 43

3 facts about the Internal Rate of Return

Back 43

1. Uses time value of money and asset’s cash flows over its entire life.
2. Computes the project’s unique rate of return.
3. No additional steps needed for capital rationing decisions