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Social Science
Economics
Finance
Accounting 245 Chap. 26
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Terms in this set (33)
Accounting Rate of Return (ARR)
Considers operating income but not the time value of money in its analysis.
Payback
Is only concerned with the time it takes to get cash outflows returned.
Net present value (NPV)
Compares the present value of cash outflows to the present value of cash inflows to determine investment worthiness.
Internal Rate of Return (IRR)
The true rate of return an investment earns.
NPV & IRR
is (are) more appropriate for long term investments.
Payback
Highlights risky investments.
Accounting Rate of Return
shows the effect of the investment on the accrual-based income.
Internal Rate of Return
Is the interest rate that makes the NPV of an investment equal to zero.
Net Present Value
requires management to identify the discount ratio when used.
Payback
Provides management with information on how fast the cash invested will be recouped.
Internal Rate of Return
Is the rate of return, using discounted cash flows, a company can expect to earn by investing in the asset.
Payback
Does not consider the assets profitability.
Accounting Rate of Return
Uses accrual accounting rather than net cash inflows in its computation.
Accounting Rate of Return
Avg. annual Op. Income / Avg. amount invested
Profitability Index
Present value of net cash inflows /Initial Investment
Profitability Index
Management should use this to compare the profitability of each investment.
Payback
Amount invested / Expected annual cash net inflow
Avg. Annual Operating Income
Expected annual net cash inflow - Annual depreciation expense
Depreciation expense
(Initial investment - Residual value) / useful life
Net Present Value
Is based on cash flows, can be used to assess profitability & takes into account the time value of money. It has none of the weaknesses of other modes.
Payback Method
Is easy to understand, is based on cash flows & highlights risks. However, it ignores profitability and the time value of money.
Accounting Rate of Return
Can be used to assess profitability but ignores time value of money.
Profitability Index
It allows us to compare alternative investments in present value terms and it also accounts for differences in the investments initial cost. It has none of the weaknesses of other models.
Capital Asset
An operational asset used for a long period of time.
Capital Rationing
The process of ranking and choosing among alternative capital investments based on the availability of funds.
Capital Budgeting
The process of planning to invest in long-term assets in a way that returns the most profitability to the company.
Capital Investment
The acquisition of a capital investment.
Discount Rate
Management's minimum desired rate of return on a capital investment.
Compound Interest
Interest calculated on the principal and on all previously earned interest.
Annuity
A stream of equal cash payments made at equal time intervals.
Post-Audit
The comparison of the actual results of capital investments to the projected results.
Simple Interest
Interest calculated only on the principal amount.
Operational Assets
used in day to day operations, examples include buildings, manufacturing equipment.
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