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Capital Investment Process

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Capital Investment Process
Capital investment analysis is the process that management uses to plan, evaluate and control investments in fixed assets. Capital investments use funds and affect operations for many years and must earn a reasonable rate of return. Capital investment decisions are some of the most important decisions that management makes. There are two types of methods used to evaluate capital investments, Methods that do not use present values and methods that use present values.
The methods not using present values are useful in evaluating capital investment proposals and have short useful lives. The timing of cash flows is less important when using methods that do not use present values. The methods that do not use present values are average rate of return method and the cash payback method. These methods are easy to use and often used to screen proposals. Minimum standards for accepting proposals are set, if proposals do not meet those standards they are eliminated.
The average rate of return method is sometimes referred to as the accounting rate of return and measures the average income as a percent of the average investment. The average rate of returned is computed by dividing the estimated average annual income by the average investment. (Warren, Reeve, & Duchac, 2012) Advantages to the average rate of return method are that it is easy to compute, it includes the entire amount of income earned over the life of the proposal and it emphasizes accounting income. Disadvantages to this method are that it does not directly consider the expected cash flows or timing of those expected cash flows in the proposal.
The short cash payback method is used to quickly repay debts used to purchase investments. Short cash paybacks are highly desirable because the quicker the cash is recovered, the sooner it can be reinvested to earn more income. Advantages…...

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