Kế toán, kiểm toán - Chapter 16: Cost analysis for decision making

CHAPTER 16COST ANALYSIS FOR DECISION MAKINGMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning ObjectivesWhat are the meaning and application of the following “cost” terms: differential, allocated, sunk, and opportunity?How are costs determined to be relevant for short-run decisions?What is the special pricing decision when a firm is at full vs. idle capacity?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning ObjectivesWhat are the attributes of capital budgeting that make it a significantly different activity from operational budgeting?Why is present value analysis appropriate in capital budgeting?What is the concept of the cost of capital, and why is it used in capital budgeting?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning ObjectivesWhat are the uses of and differences between various capital budgeting techniques: net present value, present value ratio, and internal rate of return?How are issues concerning estimates, income taxes, and the timing of cash flows and investments treated in the capital budgeting process?How is the payback period of a capital expenditure project calculated?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning ObjectivesHow is the accounting rate of return of a project calculated, and how can it be used most appropriately?Why are not all management decisions make strictly on the basis of quantitative analysis techniques?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 1What are the meaning and application of the following “cost” terms: differential, allocated, sunk, and opportunity?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Strategic, Operational, and Financial PlanningPlanning and Control CyclePerformance Analysis: Plans vs. Actual Results (Controlling)Executing Operational Activities (Managing)Revisit PlansImplement PlansData Collection and Performance FeedbackMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Cost Classifications for Other Analytical PurposesA differential cost is one that will differ according to the alternative activity selectedAllocated costs are those that have been assigned to a product or activity using some sort of arithmetic processDo not arbitrarily allocate costs because costs may not behave the way assumed in the allocation methodMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 2How are costs determined to be relevant for short-run decisions?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Relevant CostsShort-run decisions may affect only a few days or weeksCan involve:The utilization of resources not otherwise activeThe opportunity to reduce costs by adjusting the mix of resourcesThe ability to improve profits by further processing a productMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Decision Analysis ClassificationsRelevant costs are:Differential costsOpportunity costsIrrelevant costs are:Allocated costsSunk costsMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 3What is the special pricing decision when a firm is at full vs. idle capacity?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Special Pricing DecisionFirm is presented with a special offer for their product below the normal selling priceNeed to know where the firm is operating relative to capacityNeed to consider only relevant costs – not allocated fixed costsAlso must consider other factor such as affect on other customersMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 4What are the attributes of capital budgeting that make it a significantly different activity from operational budgeting?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Capital BudgetingCapital budgeting is the process of analyzing proposed capital expendituresCapital expenditures are investments in plant, equipment, new products, etc.Want to determine if a large enough return on the investment can be generated over timeMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Capital Budgeting vs. Operational BudgetingThe time frame being considered is different – longer – in capital budgetingCapital budgeting provides an overall blueprint to help the firm meet its long-term growth objectivesOperational budget reflects firm’s strategic plans to achieve current period profitabilityMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 5Why is present value analysis appropriate in capital budgeting?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Investment Decision Special ConsiderationsInvestment decisions involve committing financial resources now in anticipation of a return in the futureThe time value of money must be considered due to the length of time involvedMost firms have more investment opportunities than resources availableCapital budgeting procedures help management identify favorable alternativesMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Qualitative FactorsFactors other than quantitative factors also must be consideredMust consider things such as competitive risk, managements’ personal goals, effects of selling additional stock if necessaryUsually large expenditures require the approval of the board of directorsMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 6What is the concept of the cost of capital, and why is it used in capital budgeting?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Cost of CapitalThe cost of capital is the rate of return on assets that must be earned to permit the firm to meet its interest obligations and provide the expected return to ownersDetermining a firm’s cost of capital is a complex processCost of capital is a composite of borrowing costs and stockholder dividends and earnings’ growth potentialMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Discount RateThe cost of capital is the discount rate used to determine the present value of the investment proposal being analyzedThe discount rate is the interest rate at which future period cash flows are discountedRanges from 10 – 20%McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Capital Budgeting TechniquesMethods that use present value analysis:Net present value (NPV) methodInternal rate of return (IRR) methodMethods that do not use present value analysis:Payback methodAccounting rate of return methodMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Variables Used in Capital Budgeting MethodsAll methods use the amount to be investedThe amount of cash generated by the investment is used in the NPV, IRR, and payback methodsThe accounting rate of return uses accrual accounting net income resulting from the investmentMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 7What are the uses of and differences between various capital budgeting techniques: net present value, present value ratio, and internal rate of return?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Net Present ValueNet present value method involves calculating the present value of the expected cash flows from the project using the cost of capital as the discount rateThen the net present value result is compared to the amount of investment requiredNPV often referred to as the hurdle rateMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Internal Rate of ReturnThe IRR method solves for the actual rate of return that will be earned by the investmentThe IRR is the discount rate at which the present value of the cash flows from the project will equal the investment in the projectMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 8How are issues concerning estimates, income taxes, and the timing of cash flows and investments treated in the capital budgeting process?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Some Analytical ConsiderationsEstimates – the validity of the present value calculations will depend on the accuracy of the cash flow projectionsCash flows far in the future – due to uncertainty, usually do not consider cash flows more than ten years in the futureTiming of cash flows within the year – present value factors assume cash flows are received at the end of the year, but usually received throughout the yearMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Some More Analytical ConsiderationsInvestment made over a period of time – payments on the project may be made over a period of time, so interest on cash disbursements needs to be consideredIncome tax effects of cash flows from the project – must include income tax expenditures in cash flow projectionsMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Still More Analytical ConsiderationsWorking capital investment – working capital needs will increase due to increases in accounts receivables and inventories and is treated like an additional investmentLeast cost projects – some expenditures are required by law, so need to choose the project with the lowest net costMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 9How is the payback period of a capital expenditure project calculated?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Payback MethodThe payback method is used to evaluate proposed capital expenditures by determining the length of time necessary to recover the amount of the investmentAdd up the cash inflows until the total equals the investmentThen determine how many years it has taken to recover the investmentVery simple method, but does not consider the time value of moneyMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 10How is the accounting rate of return of a project calculated, and how can it be used most appropriately?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Accounting Rate of ReturnAccounting rate of return focuses on the impact of the investment project on the financial statementsDone on a year-by-year basisDrawback is time value of money is not consideredOften computed so stockholders will know the effect of the project on the financial statementsMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Learning Objective 11Why are not all management decisions make strictly on the basis of quantitative analysis techniques?McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002The Investment DecisionBoth quantitative and qualitative factors are consideredQualitative factors may include:Commitment to a segmentRegulations that require an investmentTechnological developmentsLimited resourcesManagement’s judgments about the accuracy of the estimates usedMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002Integration of Capital Budget with Operating BudgetsSeveral aspects of the capital budget interact with the development of the operating budget:Contribution margin increases and cost savings need to be included in the income statement budgetsCash disbursements need to be included in the cash budgetCapital expenditures need to be included in the balance sheet budgetMcGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002