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51 Cards in this Set
- Front
- Back
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Capital Budgeting |
Process of making long-run planning decisions for investments in projects |
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Project dimension |
Horizontal rectangle explaining length of time of project |
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Accounting-period dimension |
Vertical rectangle that represents the dimensions of income determination and routine annual planning and control that cut across all projects that are ongoing that year |
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Capital budgeting process |
1. Identify projects 2. Obtain information 3. Make predictions 4. Make decisions by choosing among alternatives 5. Implement the decision, evaluate performance, and learn |
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1. Identify projects |
Identify potential capital investments that agree with the organization's strategy |
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2. Obtain Information |
Gather information from all parts of the value chain to evaluate alternative projects |
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3. Make predictions |
Forecast all potential cash flows attributable to the alternative projects |
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4. Make Decisions by choosing among alternatives |
Determine which investment yields the greatest benefit and the least cost to the organization |
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5. Implement the decision, evaluate performance, and learn 9 |
• obtain funding and make the investments selected in stage 4 • track realized cash flows, compare against the estimated numbers, and revise plans if necessary |
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Discounted Cash Flows |
• Net Present Value (NPV) • Internal Rate of Return (IRR) Measure all expected future cash inflows and outflows of a project discounted back to the present point in time. TIME VALUE OF MONEY |
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Required rate of Return |
the minimum acceptable annual rate of return on an investment. discount rate, hurdle rate, cost of capital, opportunity cost |
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Net Present Value (NPV) |
calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return |
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Internal Rate of Return (IRR) |
calculates the discount rate at which an investment's present value of all expected cash inflows equals the present value of its expected cash outflows
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Payback Method |
Time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project Net Initial Investment ------------------------------------------------- Uniform increase in annual future cash flows |
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Comparing NPV vs IRR |
1. NPV is expressed in dollars, not percentages 2. NPV is expressed as one unique number 3. NPV can be used when discount rate varies 4. IRR is prone to indicating erroneous decision |
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Comparing Payback method vs DCF |
1. Payback method is not affected by depreciation 2. Useful when: • Preliminary screening is necessary • Interest rates are high • EFCF are uncertain 3. Fails to incorportate TVM 4. Does not consider CF after payback period |
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Accrual Accounting Rate of Return (AARR) |
Average annual income of a project ------------------------------------------------------------ Net initial investment |
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Average AARR |
Net initial investment + Net terminal cash flow ---------------------------------------------------------------------- 2 |
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Relevant Cash Flows in DCF Analysis |
• Two methods based on the income statement • item-by-item method |
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Two Methods based on the income statement |
Operating Cash inflows from investment - Additional depreciation deduction ---------------------------------------------------------- Increase in operating income x Income tax rate ---------------------------------------------------------- - Income taxes ---------------------------------------------------------- Increase in net income Method 1: C-T Method 2: NI +D |
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Item-by-Item Method |
Effect of Cash Operating Flows Operating Cash inflows from investment x income tax rate - income taxes ---------------------------------------------------------- After tax cash flow from operations Effect of Depreciation Additional depreciation deduction x income tax rate ---------------------------------------------------------- income tax cash savings from add'l dep ded + after-tax cash flow from operations ---------------------------------------------------------- Cash flow from operations net of income tax |
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Categories of Cash Flows |
1. Net initial investment 2. after-tax cash flow from operations 3. after-tax cash flow from disposing an asset |
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Post-investment audit |
Provides managers feedback about the performance of a project so they can compare actual results to costs and benefits expected at the time the project was selected |
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Chapter 23 |
Chapter 23 |
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Financial Perspective |
the firm's stock price, net income, return on sales, return on investment, and economic value added |
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Customer Perspective |
Market share in different geographic locations, customer satisfaction, brand image, and average number of repeat visits |
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Internal-business-process perspective |
customer-service time for making reservations, check-in, and restaurant services |
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Learning and growth perspective |
education, skills, and satisfaction levels of the firm's employees; employee turnover and hours of employee training |
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Accounting based performance measures |
1. Choose measures that align with the firm's financial goals 2. choose the details of each performance measure in step 1 3. choose a target level of performance and feedback mechanism for each performance measure in step 1 |
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Investment |
resources or assets used to generate income = total assets - current liabilities |
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Accounting based measures for business units |
1. Return on investment (ROI) 2. Residual income 3. Economic value added 4. return on sales |
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return on investment (ROI) |
Income ------------- Investment 1. Blends all the ingredients of profitability into a single percentage 2. can be compared with the rate of return on opportunities elsewhere, inside or outside the company DuPont Method = Return on sales x investment turnover |
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Return on sales |
Operating income ----------------------------- Revenues |
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Investment turn over |
Revenues ------------------ investment |
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Residual income |
accounting measure of income minus a dollar amount for required return on an accounting measure of investment income - (required rate of return x investment) establishes goal congruence between shareholders and manager |
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Imputed cost |
required rate of return x investment not recognized in financial accounting, because it is an opportunity cost |
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Economic Value Added |
= after-tax OI - [weighted average cost of capital x (total assets - current liabilities) ] variation of RI Charges managers for the cost of their investments in long-term assets and working capital |
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Weighted average cost of capital (WACC) |
after-tax average cost of all the long-term funds (after-tax cost of debt x mv debt) + (cost of equity capital x mv equity) ----------------------------------------------------------------- mv debt + mv equity
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Return on sales |
operating income ------------------------------ revenues |
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Total assets available |
includes all assets, regardless of their intended purpose |
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Total assets employed |
total assets available - sum of idle assets and assets purchased for future expansion |
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Total assets employed minus current liabilities |
Total assets employed excluding assets financed by short-term creditors |
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Stockholders' equity |
calculated by assigning liabilities among subunits and deducting these amounts from the total assets of each subunit
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Current Cost |
cost of purchasing an asset today identical to the one currently held or the cost of purchasing an asset that provides services like the one currently held if an identical asset cannot be purchased |
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Choosing the Timing of Feedback |
1. how critical the information is for the success of the organization 2. the management level receiving the feedback 3. the sophistication of the organization's information technology |
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Moral Hazard |
a situation in which an employee prefers to exert less effort compared with the effort the owner desires because the owner cannot accurately monitor and enforce the employee's effort |
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Diagnostic control systems |
Financial and nonfinancial performance evaluation measures that help managers track their progress toward achieving a company's strategic goals. |
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Boundary systems |
standards of behavior and coes of conduct expected of all employees, especially actions that are off-limits |
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Belief systems |
articulate the mission,purpose, and core values of a company |
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Interactive control systems |
formal information systems managers use to focus the company's attention and learning on key strategic issues |
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After-tax cost of debt |
= Interest rate x (1- tax rate) |
