CHAPTER 26

INCREMENTAL ANALYSIS AND CAPITAL BUDGETING

OVERVIEW

When managers have alternative courses of action, they choose the alternative which best fits the profit and/or other objectives of the business. In order to make the best decision, management should analyze the “differentials” of the various alternatives. That is, management should analyze the difference between revenue and cost factors that each alternative would produce. This type of analysis, known as incremental (differential) analysis, is discussed in this chapter.

Capital expenditures have a continuing impact on a company for an extended period of time. Because of this continuing impact, any decision to allocate a substantial amount of assets is a critical business decision. Proposed alternative capital expenditures should be compared on the basis of their profitability. We also discuss capital budgeting techniques in this chapter.

SUMMARY OF STUDY OBJECTIVES

  1. Identify the steps in management's decision-making process. Management's decision-making process is: (a) identify the problem and assign responsibility, (b) determine and evaluate possible courses of action, (c) make the decision, and (d) review the results of the decision.
  2. Describe the concept of incremental analysis. Incremental analysis identifies financial data that change under alternative courses of action. These data are relevant to the decision because they will vary in the future among the possible alternatives.
  3. Identify the relevant costs in accepting ...

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