Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
Chapter 20
Capital Investment
2
Capital Investment Decisions
• Capital investment decisions are
concerned with
– The planning process of planning
– Setting goals and priorities
– Arranging financing
– Using certain criteria to select long-term
assets
3
Capital Investment Decisions
• Capital budgeting
– The process of making capital investment
decisions
• Types of capital budgeting projects
– Independent projects
• Projects that, if accepted or rejected, will not affect
the cash flows of another project.
– Mutually exclusive projects
• Projects that, if accepted, preclude the acceptance
of competing projects.
4
Payback and Accounting Rate of
Return: Nondiscounting Methods
Payback Analysis
5
Payback and Accounting Rate of
Return: Nondiscounting Methods
Payback Analysis
• Provides information than can:
– Help control the risks associated with the uncertainty of future
cash flows.
– Help minimize the impact of an investment on a firm’s liquidity
problems.
– Help control the risk of obsolescence.
– Help control the effect of the investment on performance
measures.
• Deficiencies:
– Ignores the time value of money
– Ignores the performance of the investment beyond the payback
period
6
Payback and Accounting Rate of
Return: Nondiscounting Methods
Accounting Rate Of Return (ARR)
Average investment
Major deficiency: ignores (I + S) ÷ 2
the time value of money I = original investment
S = salvage value
7
The Net Present Value Method
Net present value is the difference between the
present value of the cash inflows and outflows
associated with a project.
NPV = P – I
where:
P = the present value of the project’s future
cash inflows
I = the present value of the project’s cost
(usually the initial outlay)
10
The Net Present Value Method
c 11
difference due to rounding
The Net Present Value Method
Decision Criteria for NPV
If NPV > 0:
1. The initial investment has been recovered
2. The required rate of return has been
recovered
For the cell phone project, NPV = $294,600
Polson should manufacture the cell phones.
12
Internal Rate of Return
The internal rate of return (IRR) is the interest
rate that sets the project’s NPV at zero.
$240,000 = $99,900(df)
$240,000 ÷ $99,900 = 2.402
i = 12%
13
Internal Rate of Return
Decision Criteria:
If the IRR > Cost of Capital, accept the project
If the IRR = Cost of Capital, accept or reject
If the IRR < Cost of Capital, reject the project
14
NPV versus IRR:
Mutually Exclusive Projects
• Two major differences between net
present value and the internal rate of
return:
– Reinvestment of cash inflows
• NPV assumes reinvestment at the required rate of
return
• IRR assumes reinvestment at the internal rate of
return
– Measurement of profitability
• NPV measures profitability in absolute dollars
• IRR measures profitability as a percentage
15
NPV versus IRR:
Mutually Exclusive Projects
16
NPV versus IRR:
Mutually Exclusive Projects
a$1,440,000 + [(1.20 x $686,342) - (1.08 x $686,342)]. This last term is what is needed to repay the capital and its cost
at the end of Year 2. 17
b$686,342 + (1.20 x $686,342).
NPV versus IRR:
Mutually Exclusive Projects
Milagro Travel Agency Example
Standard Custom
T2 Travel
18
NPV versus IRR:
Mutually Exclusive Projects
19
NPV versus IRR:
Mutually Exclusive Projects
20
NPV versus IRR:
Mutually Exclusive Projects
21
Computing After-Tax Cash Flows
• Steps in computing cash flows
– Forecast revenues, expenses, and capital
outlays
– Adjust cash flows for inflation and tax effects
• The cost of capital is composed of two
elements
– The real rate
– The inflationary element
22
Computing After-Tax Cash Flows
Disposition of Old Machine
Book Value Sale Price
M1 $ 600,000 $ 780,000
M2 1,500,000 1,200,000
23
Computing After-Tax Cash Flows
24
Computing After-Tax Cash Flows
The two machines are sold:
Sales price, M1 $ 780,000
Sales price, M2 1,200,000
Tax savings 48,000
Net proceeds $2,028,000
25
Computing After-Tax Cash Flows
After-Tax Operating Cash Flows: Life of the Project
A company plans to make a new product that requires new
equipment costing $1,600,000. The new product is
expected to increase the firm’s annual revenue by
$1,200,000. Materials, labor, etc. will be $500,000 per year.
Revenues $1,200,000
Less: Cash operating expenses (500,000)
Depreciation (straight-line) (400,000)
Income before income taxes $ 300,000
Less: Income taxes (40%) (120,000)
Net income $ 180,000
26
Computing After-Tax Cash Flows
After-Tax Operating Cash Flows: Life of the Project
27
Computing After-Tax Cash Flows
MACRS Depreciation
28
Computing After-Tax Cash Flows
MACRS Depreciation
– Half the depreciation for the first year can be claimed regardless
of when the asset is actually placed in service.
– The other half year of depreciation is claimed in the year
following the end of the asset’s class life.
– If the asset is disposed of before the end of its class life, only half
of the depreciation for that year can be claimed.
29
Computing After-Tax Cash Flows
30
Capital Investment:
Advanced Technology and Environmental
Considerations
How Estimates of Operating Cash Flows Differ
A company is evaluating a potential investment in a flexible
manufacturing system (FMS). The choice is to continue
producing with its traditional equipment, expected to last 10
years, or to switch to the new system, which is also expected
to have a useful life of 10 years. The company’s discount rate
is 12 percent.
31
Capital Investment:
Advanced Technology and Environmental
Considerations
32
Capital Investment:
Advanced Technology and Environmental
Considerations
33
Present Value Concepts
Future Value
Let:
F = future value
i = the interest rate
P = the present value or original outlay
n = the number or periods
34
Present Value Concepts
Future Value
Assume the investment is $1,000. The interest
rate is 8%. What is the future value if the money
is invested for one year? Two? Three?
35
Present Value Concepts
Present Value
P = F/(1 + i)n The discount factor df, 1/(1 + i), is computed
for various combinations of i and n.
P = F(df)
37
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
End Chapter 20