- Capital budgeting process
a. Stages of capital budgeting
b. Incremental cash flows
c. Income tax considerations
d. Evaluating uncertainty
e. Discount rates - Capital investment analysis methods
a. Net present value (NPV)
b. Internal rate of return (IRR)
c. Payback
d. Comparison of investment analysis methods
e. Sensitivity analysis
Part 2 – Section E.1. Capital budgeting process
The candidate should be able to:
- a. define capital budgeting and identify the steps or stages undertaken in developing and implementing a capital budget for a project
- b. identify and calculate the relevant cash flows of a capital investment project on both a pretax and after-tax basis
- c. demonstrate an understanding of how income taxes affect cash flows
- d. distinguish between cash flows and accounting profits and discuss the relevance to capital budgeting of incremental cash flow, sunk cost, and opportunity cost
- e. explain the importance of changes in net working capital in capital budgeting
- f. discuss how the effects of inflation are reflected in capital budgeting analysis
- g. define hurdle rate
- h. identify alternative approaches to dealing with risk in capital budgeting
- i. distinguish among sensitivity analysis, scenario analysis, and Monte Carlo simulation as risk analysis techniques
- j. explain why a discount rate specifically adjusted for risk should be used when project cash flows are more risky or less risky than is normal for a company or business unit
- k. explain how the value of a capital investment is increased if consideration is given to the possibility of adding on, speeding up, slowing down, or discontinuing early
- l. demonstrate an understanding of real options, including the options to abandon, delay, expand, and scale back (calculations not required)
- m. identify and discuss qualitative considerations involved in the capital budgeting decision
- n. describe the role of the postaudit in the capital budgeting process
Part 2 – Section E.2. Capital investment analysis methods
The candidate should be able to:
- a. demonstrate an understanding of the two main discounted cash flow (DCF) methods, NPV and IRR
- b. calculate NPV and IRR
- c. demonstrate an understanding of the decision criteria used in NPV and IRR analyses to determine acceptable projects
- d. compare NPV and IRR focusing on the relative advantages and disadvantages of each method, particularly with respect to independent vs. mutually exclusive projects and the “multiple IRR problem”
- e. explain why NPV and IRR methods can produce conflicting rankings for capital projects if not applied properly
- f. identify assumptions of NPV and IRR
- g. evaluate and recommend project investments on the basis of DCF analysis
- h. demonstrate an understanding of the payback and discounted payback methods
- i. identify the advantages and disadvantages of the payback and discounted payback methods
- j. calculate payback periods and discounted payback periods
- k. define and calculate the profitability index
- l. describe how sensitivity analysis is used in capital investment decision analysis