Chapter 19 Managerial Accounting Other Capital Budgeting Issues Prepared by Diane Tanner University of North Florida 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 3 Soft Benefits in Capital Budgeting 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 Good for the Company Maximize Accounting Income Maximize Shareholder Wealth Short-term focus 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 6 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 shortrun when making decisions in an effort to add value to the company Incorporate the evaluation of capital budgeting projects with overall profitability The End 7