Other Capital Budgeting Issues Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 19

Inflation  Inflation causes revenues and costs to increase in future years  Future cash flows that do not include inflationary effects are underestimated  Which results in smaller present values of future amounts  May cause worthwhile investment opportunities to be rejected  Why?  NPV will appear lower than if inflation was included

Soft Benefits in Capital Budgeting 3  Considerations go beyond financial results  Difficult to quantify  May include (1) A company's reputation (2) Maintaining a competitive advantage (3) Employee moral

Performance Evaluation If managers are evaluated on short-term profitability…….. –Managers focuses on maximizing short-term profit  Causes by a conflict between capital budgeting & performance evaluation Good for the Manager Maximize Accounting Income Short-term focus Good for the Company Maximize Shareholder Wealth Growth-orientation

Conflict Between Capital Budgeting and Performance Evaluation Dewey Cheatham is currently generating a return of 11% in his department. The corporate RRR is 8%. Cheatham is pondering a capital budgeting investment expected to generate a 10% return. Should the manager undertake the investment? Will the manager undertake the investment? 5

Performance Evaluation Remedy  Evaluate managers on other performance factors  Such as  Give managers stock ownership in the company  Motivates them to focus on both the long and short- run when making decisions in an effort to add value to the company  Incorporate the evaluation of capital budgeting projects with overall profitability 6

7 The End