04 - Capital Budgeting Concepts

  1. Capital Budgeting
    The decision making process with respect to investment in fixed assets.
  2. Economies of Scale
    Achieved by spreading fixed costs over a larger volume of output, thus reducing the average cost per unit.
  3. Principles for Selecting Capital Budgeting Criteria
    1 - Rely on cash flows rather than accounting profits to measure a project's costs and benefits.

    2 - Be consistent with the goal of maximising shareholders' wealth.

    3 - Allow for the time value of money.

    4 - Be able to account for the risks of projects.
  4. Depreciation
    An asset's cost is expensed over its useful life.
  5. Net Present Value (NPV)
    The present value of a project's annual net cash flows less the project's initial outlay.
  6. Discounted Cash Flow Criteria
    Capital-budgeting decision-making criteria that are based on the time value of money.
  7. Profitability Index (PI)
    The ratio of the present value of the future net cash flows to the initial outlay.
  8. Internal Rate of Return (IRR)
    Reflects the rate of return a project earns.

    Discount rate that equates the PV of the inflows with the PV of the outflows.
  9. Payback Period
    The number of years required to recover the initial cash investment.
  10. Discounted Payback Period
    An estimate of the time required for the discounted future cash flows of a project to recoup the initial outlay.
  11. Accounting Rate of Return (AROR)
    Relates the returns generated by the project, as measured by average accounting profits, to the average dollar size of the investment required.
  12. Taxation Category 1
    Firms that are well integrated within the imputation tax system.

    • - Pay franked dividends
    • - Shareholders effectively use franking credits.
  13. Taxation Category 2
    Non-company firms and companies that are not integrated with the dividend imputation system.

    • - Sole traders and partnerships.
    • - Owners pay personal tax on the firm's taxable income. If the firm's tax deductions are increased, the owner's pay less tax.
  14. Taxation Category 3
    (The in-between case) Companies that are partially integrated with the imputation system.

    - Shareholders make partial use of franking credits.
Card Set
04 - Capital Budgeting Concepts
211 - Capital Budgeting Concepts