Accounting Study Set 8
Quiz 26 :
The capital budgeting decision process is a complete multifaceted and analytical process. Capital budgeting analysis estimates, such as the cash flows, discount rate, time period and total investment amount. This results of analysis should be used to either support or reject a project, capital budgeting should not be used to justify an assumed net present value. The analyst should not work backward, filling assumed numbers that will produce the desired net present value. Such a reverse approach reduces the credibility of the entire process. In the given case, Danielle who is new analyst analysis the purchasing of warehouse according to standards and reject the construction because purchase of warehouse does not add much value to business and does not increase sales as a result of warehouse. But Jerrod who is plant manager argued the Danielle that warehouse is needed to store the production and if we can store more goods, then we will have more sales. On the basis of above information, the contention of Jerrod is not correct because purchasing of warehouses does not guaranty to increase sales. Hence Danielle is advised t not to consider the Jerrod plea.
The average rate of return has the following disadvantages: The principal objections to the use of the average rate of return method are its failure to consider the expected cash flows from the proposals and the timing of these flows.
Average rate of return (ARR): The ARR is based on accounting concept of return on investment or rate of return. The ARR may be defined as the annualized net income earned on the average funds invested in a project. In other words, the annual returns of a project are expressed as a percentage of the net investment in the project. Testing equipment =$3,120 =$52,000 -- =6% The ARR of 6% should be compared to the minimum rate of return required by Bio Metrics Inc.'s management. If the ARR equals or exceeds the minimum rate, the project should be accepted. Vehicle =$1,920 =$16,000 =12% The ARR of 12% should be compared to the minimum rate of return required by Bio Metrics Inc.'s management. If the ARR equals or exceeds the minimum rate, the project should be accepted.