04 - Capital Budgeting Concepts

The decision making process with respect to investment in fixed assets.

Achieved by spreading fixed costs over a larger volume of output, thus reducing the average cost per unit.

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.

An asset's cost is expensed over its useful life.

The present value of a project's annual net cash flows less the project's initial outlay.

Capital-budgeting decision-making criteria that are based on the time value of money.

The ratio of the present value of the future net cash flows to the initial outlay.

Reflects the rate of return a project earns.

Discount rate that equates the PV of the inflows with the PV of the outflows.

The number of years required to recover the initial cash investment.

An estimate of the time required for the discounted future cash flows of a project to recoup the initial outlay.

Relates the returns generated by the project, as measured by average accounting profits, to the average dollar size of the investment required.

Firms that are well integrated within the imputation tax system.

• - Pay franked dividends
• - Shareholders effectively use franking credits.

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.

(The in-between case) Companies that are partially integrated with the imputation system.

- Shareholders make partial use of franking credits.