Describe the capital budgeting process.
The capital budgeting process is linked with the allocation of funds into the capital assets for the growth of the business.
Budgeting is the process of estimating the future expected revenues and expenses associated with a business entity. Budgets are prepared separately for all the segments of a business and are used to determine growth.
The capital budgeting process refers to the way of organizing and allocating the funds into the capital assets that result in good returns.
In addition, the capital budgeting process passes through four major stages:
Initially, this process requires the development of strategies.
Appropriate planning must be done in order to allocate the funds.
Implementation of the strategies and planning.
Controlling the variances in the outcomes.
Using accounting rate of return to make capital investment decisions
Carter Company is considering three investment opportunities with the following accounting rates of return:
Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company’s required rate of return is 8%.
John Johnson is the majority stockholder in Johnson’s Landscape Company, owning 52% of the company’s stock. John asked his accountant to prepare a capital investment analysis to purchase new mowers. John used the analysis to persuade a loan officer at the local bank to loan the company $100,000. Once the loan was secured, John used the cash to remodel his home, updating the kitchen and bathrooms, installing new flooring, and adding a pool.
1. Are John’s actions fraudulent? Why or why not? Does John’s percentage of ownership affect your answer?
2. What steps could the bank take to prevent this type of activity?
You are planning for early retirement. You would like to retire at age 40 and have enough money saved to be able to withdraw $220,000 per year for the next 30 years (based on family history, you think you will live to age 70). You plan to save by making 20 equal annual instalments (from age 20 to age 40) into a fairly risky investment fund that you expect will earn 8% per year. You will leave the money in this fund until it is completely depleted when you are 70 years old.
1. How much money must you accumulate by retirement to make your plan work? (Hint: Find the present value of the $220,000 withdrawals.)
2. How does this amount compare to the total amount you will withdraw from the investment during retirement? How can these numbers be so different?
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