65 answer key testname c18 139 capital budgeting is

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Answer Key Testname: C18 139) Capital budgeting is long - run planning for investment projects that usually have a life that is greater than one year. Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which types of capital investments are necessary to accomplish organisation objectives and strategies. Stage 2 is the obtain information stage in which a firm gathers information from all parts of the value chain to analyse alternative projects. Stage 3 is the make predictions stage in which the firm forecasts all potential cash flows attributable to the alternative projects. Stage 4 is the make decisions by choosing among alternatives stage in which the firm determines which investment yields the greatest benefit and the least cost to the organisation. Stage 5 is the implement the decision, evaluate performance, and learn stage that is further separated into two sub stages: (1) obtain funding and make the investments selected in the stage 4 process, and (2) track the realised cash flows, compare against the forecast numbers, and revise plans if necessary. 140) The managers can use the information to determine which proposal is best under the various alternatives. This may be accomplished by ranking each alternative. Also, the managers must determine the factors that are the most important to the company. For example, if short - run risk is high, a short payback period may be highly desirable. In this case, Proposal 1 is best. However, if total cash returned is critical to the company's operations, then Proposal 4 is probably best. Any time that multiple measures are used there may be confusion because very seldom will one proposal appear to be the best with all models. In this case, payback ranks Proposal 1 the best, NPV ranks Proposal 4 the best, IRR ranks Proposal 2 the best, and AARR ranks Proposal 1 the best. The importance of each ranking will depend upon the circumstances of the organisation and the managers must be attuned as to what is most favourable. The net present value and the internal rate - of - return methods are superior because they consider the time - value of money. 141) Using accrual accounting to evaluate the performance of a manager may create conflicts with using discounted cash flow (DCF) methods for capital budgeting because frequently a project using a DCF method will not report strong operating profit results in the early years of the project under accrual accounting. If this is the case, a manager might be tempted not to use DCF methods even though the decisions based on them might be in the best interests of the company over the long run. The conflict can be reduced by evaluating managers on a project - by - project basis and by looking at their ability to achieve the amounts and timing of forecasted cash flows.
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