INCREMENTAL ANALYSIS AND CAPITAL BUDGETING exam elaborations for accounting

INCREMENTAL ANALYSIS AND CAPITAL BUDGETING LEARNING OBJECTIVES 1. Identify the steps in management's decision-making process. Management's decisionmaking process is (a) identify the problem and assign responsibility (b) determine and evaluate possible courses of action, (c) make the decision, and (d) review the results of the decision. 2. Describe the concept of incremental analysis. Incremental analysis identifies financial data that change under alternative courses of action. These data are relevant to the decision because they will vary in the future among the possible alternatives. 3. Identify the relevant costs in accepting an order at a special price. The relevant information in accepting an order at a special price is the difference between the variable costs to produce the special order and expected revenues. For Instructor Use Only 26 - 3Test Bank for Accounting Principles, Eleventh Edition 4. Identify the relevant costs in a make-or-buy decision. In a make-or-buy decision, the relevant costs are (a) the variable manufacturing costs that will be saved, (b) the purchase price, and (c) opportunity costs. 5. Identify the relevant costs in determining whether to sell or process materials further. The decision rule for whether to sell or process materials further is: Process further as long as the incremental revenue from processing exceeds the incremental processing costs. 6. Identify the relevant costs to be considered in repairing, retaining or replacing equipment. The factors to consider in determining whether equipment should be retained or replaced are the effects on variable costs and the cost of the new equipment. Also, any trade-in allowance or cash disposal value of the existing asset must be considered. 7. Identify the relevant costs in deciding whether to eliminate an unprofitable segment or product. In deciding whether to eliminate an unprofitable segment, determine the contribution margin, if any, produced by the segment and the disposition of the segment's fixed expenses. 8. Determine which products to make and sell when resources are limited. When a company has limited resources, find the contribution margin per unit of limited resource. Then multiply this amount by the units of limited resource to determine which product maximizes net income. 9. Contrast annual rate of return and cash payback in capital budgeting. The annual rate of return is obtained by dividing expected annual net income by the average investment. The higher the rate of return, the more attractive the investment. The cash payback technique identifies the time period to recover the cost of the investment. The formula is: Cost of capital expenditure divided by estimated net annual cash flow equals cash payback period. The shorter the payback period, the more attractive the investment. 10. Distinguish between the net present value and internal rate of return methods. Under the net present value method, compare the present value of future net cash flows with the capital investment to determine net present value. The NPV decision rule is: Accept the project if net present value is zero or positive. Reject the investment if net present value is negative. Under the internal rate of return method, find the interest yield of the potential investment. The IRR decision rule is: Accept the project when the internal rate of return is equal to or greater than the required rate of return. Reject the project when the internal rate of return is less than the required rate.