Question

Why are book rates of return reported not useful inputs for capital investment decisions?

Please provide more then a sequence explanation.

Answer 1

fit to the Answer. Q- Every enterprise Company takes investment de cision for a project on the basis of futurce cashflow- This is called capital budgeting Major part of this investment will add vonomic benefit to ta company in folcene. ii Decisions are based on cash flows, not accounting income. The relevant cash flows you to considen as part of the capital budgeting process are incremental cash flow. Different adjusth under different accocenting Standang makes the book rate of Pretcern inrelevant while taking investment decision. Vittorrent adjustments ili- example Suppose an accountant follow's aggressive depreciation method 16 Double declining balance method to pay less tax in the initial years. for 6 years. In th year the income will 190 lep sudolenly. Depriciation is a non. locosh - expense. So Actical cashflow is different Cash flow = net income + Depreciation I'Amorefiration Suppese net income in year 1=1008 As this is non cash Depreciation -20% expenses

iv So we while have taking to use a investment techniques decision 1) NPV NPV is the sum of 1 present value of all increme wash flow S is a project is enden the discount rate is the cost of capital of the firem. [ Incremental moject is anderetaron t con Crot CEI Cro NPV = Fot CFL Cf2 t. tr (lty (140) A positive NPV project is expected to increase sharte holden wealth. 2) IRR It is the discount reate that makes the priesent value of the expected Incremental after-tax ! Cash flow jest egreal to the initial costof project PVC of low- pv (out flow) 9€ 9RR) requerceg rcate of returen, accept the project 9f9RR C required rate of retur reject the project
Book rate of return is not used to take investment decision because of different adjustments under different accounting standards(IFRS,U.S GAAP).