ch21IM11e

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CHAPTER 21 CAPITAL BUDGETING AND COST ANALYSIS LEARNING OBJECTIVES 1. Recognize the multiyear focus of capital budgeting 2. Understand the six stages of capital budgeting for a project 3. Use and evaluate the two main discounted cash flow (DCF) methods: the net present value (NPV) method and the internal rate-of-return (IRR) method 4. Use and evaluate the payback method 5. Use and evaluate the accrual accounting rate-of-return (AARR) method 6. Identify and reduce conflicts from using DCF for capital budgeting decisions and accrual accounting for performance evaluation 7. Identify relevant cash inflows and outflows for capital budgeting decisions CHAPTER OVERVIEW Chapter 21 looks at long-run decisions, those spanning multiple years. The focus moves from operations of a year-by-year approach to that of an entire life span of a project. The accounting for capital budgeting on a project-by-project approach is similar to life-cycle costing introduced in Chapter 12. The role of the management accountant is highlighted in the six stages of capital budgeting. Four quantitative methods used in making capital budgeting decisions are described and illustrated. The two methods that focus on cash flows and the time value of money are net present value and internal rate- of-return, discounted-cash flow models. Typically, the discounted cash-flow methods are superior for providing information in the decision-making process because they are the most comprehensive in scope. The concept of money having time value is a main feature of these models. The other methods presented are the payback method and the accrual accounting rate-of-return. The payback method does use cash flow as a basis but does not incorporate time value of money nor profitability. The accrual accounting rate-of-return does not focus on cash flow but uses measures from the income statement. The role of income taxes is incorporated within the chapter and the role of inflation is in the appendix to the chapter. Though the methods presented provide a basis on which to make a quantitative financial decision, the chapter examines the importance of nonfinancial quantitative and qualitative aspects for each decision. The tension of evaluating a decision using a different model than the one used to make the initial decision is discussed.
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CHAPTER OUTLINE I. Capital budgeting overview A. Challenge to managers to balance long-run and short-run issues B. Analysis of ways to increase capital (value) of business with projects that span multiple years II. Two dimensions of cost analysis Learning Objective 1: Recognize the multiyear focus of capital budgeting A. A project dimension for capital budgeting over entire life of project (horizontal) [Exhibit 21-1] 1. Life of a project is more than one year 2. All cash flows or cash savings over entire life considered B. An accounting-period dimension with focus on income determination and routine planning and control that cuts across all projects (vertical) 1.
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This note was uploaded on 01/10/2009 for the course ACG 3341 taught by Professor Jomosankara during the Spring '09 term at FAU.

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