ACM5903 Accounting For Business- Importance of Capital Investment

ACM5903 Accounting For Business- Importance of Capital Investment

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ACM5903 Accounting For Business

Task

Part 1

Learning Objectives

This part enables you to:

1.Explain the importance of capital investment decisions. Capital investment is also known as capital budgeting. The terms capital investment and capital budgeting are used interchangeably in this lecture. You must be aware that these terms could also be used interchangeably in practice.

2.Understand and discuss the key issues that are peculiar to capital investment decisions, including the need for various capital investment appraisal methods.

Capital budgeting is the process of considering alternative capital projects and selecting those alternatives that provide the most profitable return on available funds, within the framework of company goals and objectives. A capital project is any available alternative to purchase, build, lease, or renovate buildings, equipment, or other long-range major items of property. The alternative selected usually involves large sums of money and brings about a large increase in fixed costs for a number of years in the future. Once a company builds a plant or undertakes some other capital expenditure, its future plans

Poor capital-budgeting decisions can be costly because of the large sums of money and relatively long periods involved. If a poor capital budgeting decision is implemented, the company can lose all or part of the funds originally invested in the project and not realize the expected benefits.

Part 2

Learning Objectives

This part enables you to:

1.Compute net present values (NPVs) and interpret the computations for relevant decision making.

2.Compute internal rates of return (IRRs) and interpret the computations for relevant decision making.

A project may have a cash outflow in its current year, and a series of cash inflows in the following years. The sum of the cash outflow in the present year and the present values of the cash inflows for each of the following years gives the net present value (NPV).

Decision rule:

A positive NPV indicates that the project will increase the wealth of the entity. As such, projects with positive NPVs will be accepted. Projects with negative NPVs will be rejected, in general.

If there are two more competing projects under consideration and only one of these can be implemented (e.g. due to resource constraints, or only 1 machine is needed and several machines are under consideration), the project that gives the highest NPV will be accepted.

Part 3

Learning Objectives

This part enables you to:

1.Compute payback values (NPVs) and interpret the computations for relevant decision making.

2.Interpret and discuss the implications of the computed quantitative information from a broad perspective, including considerations of the impact on the stakeholders and the general business conditions.  

The payback period is the time it takes for the cumulative sum of the annual net cash inflows from a project to equal the initial net cash outlay. In effect, the payback period answers the question: How long will it take the capital project to recover, or pay back, the initial investment?

ACM5903 Accounting For Business

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