Management control

Management Accounting
(session 8)

Capital-Investment Decision-Making

Investments in production tools = capital investments in fixed assets that are not easily reversible Investments in thecash conversion cycle = Net Working Capital (Current assets - Current liabilities) Reminder: accounts receivable and inventory are parts of current assets. Accounts payable is part of currentliabilities.

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Types of capital investments

Length of time required for cash flows to cover the initial investment In case of even cash flow incomes: payback period = investment / annualcash flow Ex.: if the initial investment is €60,000 and cash flows are €20,000 for 5 years, the payback period is 3 years In case of uneven cash flow incomes: no (easy) formula!

GRANDE ECOLEPayback (1)

Payback is useful when:
Firms face liquidity constraints and require a fast repayment of investments Risky investments are made in uncertain markets that change rapidly Future CF areextremely difficult to predict Used in conjunction with NPV, IRR or ARR

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Payback (2)

Measures the return of a project in terms of income (not using cash flow) ARR = Avge Income /Initial Investment Widely used by managers whose bonuses are linked to net income.

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Accounting Rate of Return (ARR)

Money has a time value, €1 today is worth more value than €1tomorrow! Future Value: FV(n) = I(0) x (1+K)n Present Value: PV = FV(n) / (1+K)n With K refering to the required rate of return (usually the WACC)

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Discounted Cash Flow (DCF)

Riskysecurities should yield higher returns than risk-free securities If cash is invested in a project, it cannot be invested elsewhere, there is an opportunity cost This opportunity cost represents theminimum required rate of return and is equal to the WACC

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Opportunity cost & WACC

Expected Returns High-Tech Startup Developing Company Cyclical Company Risk Premium: 7% Industry...