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Managerial Accounting 9e Ch Review Ch12

Managerial Accounting 9e Ch Review Ch12

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Chapter 12, Capital Investment Analysis
Chapter 12
Review of Learning Objectives
LO1 Define
capital investment analysis,
and describe its relation to the managementprocess.
Capital investment decisions focus on when and how much to spend on capital facilitiesand other long-term projects. Capital investment analysis, often referred to as
capital budgeting,
consists of identifying the need for a capital investment, analyzing courses of action to meet that need, preparing reports for management, choosing the best alternative,and dividing funds among competing resource needs.Capital investment analysis spans all phases of the management process. Whenmanagers plan, they analyze capital investment alternatives by screening and evaluatingthem before making funding decisions. They implement their capital investmentdecisions as they perform their duties during the year. In the evaluation phase, theyreview the results of their decisions. They prepare reports to communicate the results of their capital investment decisions as the reports are needed. Based on such reports, theymay decide to modify or curtail projects that are failing to meet expectations or to goforward with new projects.
LO2 State the purpose of the minimum rate of return, and identify the methodsused to arrive at that rate.
The minimum rate of return, or hurdle rate, is used as a screening mechanism to eliminatefrom further consideration capital investment requests with anticipated inadequatereturns. It saves executives’ time by quickly identifying substandard requests. The most
Copyright © Houghton Mifflin Company. All rights reserved.
 
Chapter 12, Capital Investment Analysiscommonly used measures for determining minimum rates of return are (1) cost of capital,(2) corporate return on investment, (3) industry average return on investment, and (4) bank interest rates. The weighted-average cost of capital and the average return oninvestment are the most widely used measures.
LO3 Identify the types of projected costs and revenues used to evaluate alternativesfor capital investment.
The accounting rate-of-return method requires measures of net income. Other methods of evaluating capital investments evaluate net cash inflows or cost savings. The analysis process must take into consideration whether each period’s cash flows will be equal or unequal. Unless the after-income-tax effects on cash flows are being considered, carryingvalues and depreciation expense of assets awaiting replacement are irrelevant. Net proceeds from the sale of an old asset and estimated residual value of a new facilityrepresent future cash flows and must be part of the estimated benefit of a project.Depreciation expense on replacement equipment is relevant to evaluations based on after-tax cash flows.
LO4 Apply the concept of the time value of money.
Cash flows of equal dollar amounts at different times have different values because of theeffect of compound interest. This phenomenon is known as the time value of money. Of the evaluation methods discussed in this chapter, only the net present value method takesinto account the time value of money.
Copyright © Houghton Mifflin Company. All rights reserved.

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