Chapter 13: Capital Investment Decision (Nondiscounting Models (Payback…
Chapter 13: Capital Investment Decision
Types of Capital Investment Decision
Capital Investment Decision:
concerned with the process of planning, setting goals and priorities, arranging financing, and using certain criteria to select long-term assets.
process of making capital investment decisions
projects that, if accepted or rejected, do not affect the cash flows of other projects.
mutually exclusive projects:
those projects that, if accepted, preclude the acceptance of all other competing projects
ignores time value of money
time required for a firm to recover its original investment
: it ignores a project’s total profitability and the time value of money.
Accounting Rate of Return
measures the return on a project in terms of income,
as opposed to using a project’s cash flow
Average income/Original investment
or average investment
Discounting Model: NPV
the difference between the present value of the cash inflows
and outflows associated with a project:
Internal Rate of Return
interest rate that sets the present value of a project’s
cash inflows equal to the present value of the project’s cost
Postaudit of Capital Projects
compares the actual benefits with the estimated benefits and actual operating costs with estimated operating costs; it evaluates the overall outcome of the investment and proposes corrective action if needed.
ensure that resources are used wisely
likely to make such decisions in the best interests of the firm
Mutually Exclusive Projects
NPV Compared with IRR
the project with the largest NPV is chosen
Computation and Adjustment of Cash Flows
Adjusting Forecasts for Inflation
Conversion of Gross Cash Flows to After-Tax Cash Flows