Skip to ContentGo to accessibility page
OpenStax Logo
Principles of Accounting, Volume 2: Managerial Accounting

Summary

Principles of Accounting, Volume 2: Managerial AccountingSummary

Summary

11.1 Describe Capital Investment Decisions and How They Are Applied

  • Capital investment decisions select a project for future business development. These projects typically require a large outlay of cash, provide an uncertain return, and tie up resources for an extended period of time.
  • Having a large number of alternatives requires a careful budgeting and analysis process. This process includes determining capital needs, exploring resource limitations, establishing baseline criteria for alternatives, evaluating alternatives using screening and preference decisions, and making the decision.
  • Screening decisions help eliminate undesirable alternatives that may waste time and money. Preference decisions rank alternatives emerging from the screening process to help make the final decision. Both decision avenues use capital budgeting methods to select between alternatives.

11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions

  • The payback method determines how long it will take a company to recoup their investment. Annual cash flows are compared to the initial investment but the time value of money is not considered and cashflows beyond the payback period are ignored.
  • The accounting rate of return considers incremental net income as it compares to the initial investment. Time value of money is not considered with this method.
  • Incremental net income determines the net income expected if the company accepts the investment opportunity, as opposed to not investing. Incremental net income is the difference between incremental revenues and incremental expenses.

11.3 Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities

  • A dollar is worth more today than it will be in the future. This is due to many reasons including the power of investment in today’s economy, market inflation, and the ability to use the money in the present to make more money in the future, with interest.
  • Present value expresses the future value of a dollar in today’s (present) value. Present value tables, showing the present value factor intersection of periods and interest rate, are used to multiply by the final payout amount to compute today’s value.
  • The future value shows what the value of an investment will be after a certain period of time. Future value tables, showing the future value factor intersection of periods and interest rate, are used to multiply by the initial investment amount to compute future value.
  • A lump sum is a one-time payment after a certain period of time, whereas an ordinary annuity involves equal installments in a series of payments over time. A business can use lump sum or ordinary annuity calculations for present value and future value calculations.

11.4 Use Discounted Cash Flow Models to Make Capital Investment Decisions

  • The discounted cash flow model assigns values to a project’s alternatives using time value of money and discounts future rates back to present value. Two measurement tools are used in discounted cash flows: net present value and internal rate of return.
  • Net present value considers an expected rate of return, converts future cash flows into present value, and compares that to the initial investment cost. If the outcome is positive, the company would look to invest in the project.
  • Internal rate of return shows the profitability of an investment, where NPV equals zero. If the corresponding interest rate exceeds the expected rate of return, the company would invest in the project.

11.5 Compare and Contrast Non-Time Value-Based Methods and Time Value-Based Methods in Capital Investment Decisions

  • The payback method uses a simple calculation, removes unviable alternatives quickly, and considers investment risk. However, it disregards the time value of money, ignores profitability, and does not consider cash flows after recouping the investment.
  • The accounting rate of return uses a simple calculation, considers profitability, and removes unviable options quickly. However, it disregards the time value of money, values return rates more than risk, and ignores external influential factors.
  • Net present value considers the time value of money, ranks higher risk investments, and compares future earnings in today’s value. However, it cannot easily compare dissimilar investment opportunities, it uses a more difficult calculation, and it has limitations with the estimation of an expected rate of return.
  • Internal rate of return considers the time value of money, removes the dollar bias, and leads a company to a decision, unlike non-time value methods. However, it has a bias toward return rates instead of higher risk investment consideration, it is a more difficult calculation, and it does not consider the time it will take to recoup an investment.
PreviousNext
Order a print copy
Citation/Attribution
Reuse and redistribution of this content in digital or print format:
  • This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax's prior written permission.
  • This book uses the Creative Commons Attribution-NonCommercial-ShareAlike License, which means that you can reuse and modify the material only for noncommercial purposes, must attribute OpenStax, and must distribute any derivative works under the same license.
  • Any commercial printing of this textbook, including using a local or custom printer, must be approved by OpenStax, and proper citation provided.
  • OpenStax-copyrighted images, activities, assessments, and similar components of this book are subject to the same licensing – CC-BY-NC-SA. They can be used for noncommercial purposes with attribution. Commercial use requires permission.
  • Permission requests: Anyone who intends to incorporate this content (including text, images, and other components) into large language models, use it in AI offerings, use it commercially (including in print), and/or has questions about another use case is welcome to complete our reuse request form.
Attribution information
  • If you are redistributing all or part of this book in a noncommercial print format, then you must include on every physical page the following attribution:

    Access for free at https://openstax.org/books/principles-managerial-accounting/pages/1-why-it-matters

  • If you are redistributing all or part of this book in a noncommercial digital format, then for every page that includes OpenStax content, you must license the derivative work under the same CC-BY-NC-SA license as the original, and include on every digital page view the following attribution:

    Access for free at https://openstax.org/books/principles-managerial-accounting/pages/1-why-it-matters

Citation information

The information below includes the information needed to generate citations in most major styles (APA, MLA, etc.); you must reformat and organize the information as needed to fit the requirements of the style. Use the information below to generate a citation. We recommend using a citation tool such as this one.

© Apr 23, 2026 OpenStax. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License. The OpenStax name, OpenStax logo, OpenStax book covers, OpenStax CNX name, and OpenStax CNX logo, and Rice University name, and Rice University logo trademarks, or wordmarks are not subject to the Creative Commons license and may not be reproduced without the prior and express written consent of Rice University.