Investing in a capital project may involve making screening decisions, preference decisions, and ...

In a screening decision, a proposed project is compared to a performance benchmark to determine whether the project should be considered further. Organizations may set a minimum required return on investment, a minimum number of years in which the project must return the original investment, or both. As projects are proposed, they are compared to the benchmark. If a project's expected outcome is greater than or equal to the benchmark, it becomes a candidate for funding, otherwise, it is dismissed from consideration. The goal of the screening decision is to narrow the list of capital proposals to include only those that are expected to bring the desired level of return. An example of a screening decision is a manager wishing to purchase a new piece of equipment for the factory. If the minimum rate of return set by the company is 8% and the calculated rate of return is 6%, the project will not be considered for funding.

In a preference decision, the projects that have been subjected to a screening decision compete against one another for the available capital funds. In a preference decision, managers determine which project will actually receive funds by rank-ordering them based on selected criteria, both financial and non-financial. The goal of a preference decision is to order the projects from most desirable moving down until funds are not available. An example is when a project meets the minimum rate of return, but because of environmental issues, the managers determine that the benefits of the project do not outweigh the risks of an environmental disaster, penalties, loss of reputation, etc.

Even though managers believe projects deserve funding, in the preference decision phase, funds that were expected may not actually be available. In that case, only those projects for which funds are available will be undertaken. An example might be that a new product line has been accepted for funding. However, because an expected loan for the project was not approved by the bank, the project cannot go forward.

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Investing in a capital project may involve making screening decisions, preference decisions, and ...

Managerial Accounting

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