Cost Accounting 101 Practice Test: Capital Budgeting and Cost Analysis — Flashcards

Capital budgeting is a cost-benefit analysis that helps companies decide if long-term investments are profitable. It involves evaluating costs and benefits over a longer period of time, and placing greater emphasis on the time value of money. Capital budgeting can involve acquiring land, purchasing fixed assets, research and development, or expansion. 

The capital budgeting process typically includes the following steps:
Determine the total amount of the investment
Determine the cash flows that the investment will return
Determine the residual/terminal value
Calculate the annual cash flows of the investment
Calculate the NPV of the cash flows
Run a sensitivity analysis 

The key to capital budgeting is the accuracy of the projected cash flows. 
Some other factors to consider include:
Incremental cash flow: The cash inflow or amount of money a new project, product, investment, or campaign generates or subtracts from a company. Forecasting incremental cash flow helps companies decide whether or not a new investment or project will be profitable.
Sunk costs: Unavoidable cash-outflows that are no longer relevant to whether a project should be undertaken. 
 

Some methods of capital budgeting include: Net Present Value (NPV), Internal Rate of Return (IRR), Accounting Rate of Return, Profitability Index, and Discounted Cash Flows.