Tutor profile: Natalia L.
Explain the law of diminishing returns.
The law of diminishing returns simple states that after adding new inputs to any process, at some point the marginal returns will be getting smaller and smaller. The prime example is a big factory with no workers. Well you add the first worker, you get your first input, since someone needs to turn on the machines, etc. As you keep adding more essential workers, you see your marginal input increasing. However, if you continue adding workers, you will reach a point of diminishing returns, as adding an extra workers add a smaller extra output and so on. That´s because you already hired your batch of essential workers and now, you are hiring people to slightly better the process. Still, if you keep hiring more workers you will get a crowded factory that might actually deliever negative marginal returns.
Subject: Corporate Finance
What measure should be used to choose between several projects in a capital budjeting decision?
The most reliable method in any circumstance is to choose the project with the highest NPV (Net Present Value), as long as the highest one is positive. NPV is simply the present value of all the cash inflows and outflows of the project discounted at the cost of capital of the project. Another method frequently used, the IRR (Internal Rate of Return), can be tricky for comparing projects and give wrong results for projects with irregular cash flows.
What is the difference between accrual accounting and cash accounting?
Cash accounting considers the occurence of a transaction when cash changes hands, meaning someone paid for the service or product. Accrual accounting, however, recognizes a transaction when the service or product is provided to the customer, regardless if the payment is made in advance or later on. The income statement in GAAP uses accrual accounting, while the Statement of Cash Flows uses cash accounting.
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