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UNT ACCT 2020 - Capital Budgeting Decsions
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I. Capital BudgetingII. Time Value of MoneyIII. Net Present ValueIV. Internal Rate of ReturnV. Comparing ApproachesACCT 2020 1st Edition Lecture 19Outline of Last Lecture I. Decentralization in OrganizationsII. Cost, Profit, Investment CentersIII. Return on InvestmentIV. Residual IncomeV. Delivery Performance MeasuresVI. Balanced ScorecardOutline of Current LectureI. Capital BudgetingII. Time Value of MoneyIII. Net Present ValueIV. Internal Rate of ReturnV. Comparing ApproachesCurrent LectureI. Capital Budgeting - Common Decisionso Plant Expansion: new product line would bring in new revenue, is it worth it to usto spend that money right now to gain that revenueThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best Used as a supplement to your own notes, not as a substitute.o Equipment Replacemento Equipment Selectiono Lease or Buy: pay all up front or pay a bit each yearo Cost Reduction: Invest in something that promises to reduce our costs?- Types of Decisions o Screening decision. Does a proposed project meet some present standard of acceptanceo Preference decisions: selecting from several competing courses of actionII. Time Value of Money- A dollar today is worth more than a dollar a year from now. $100 now, $100 in a year, I would rather have that $100 now to earn interest through investment of my own. Therefore projects that promise earlier returns are preferable to those that promise laterreturns. o For example, my minimum required return is %5. The cost of borrowing money, and how much I can normally earn also needs to be considered. Lets say I can always earn %5 interest on any investment and lets say that someone gives choice between 2 opportunities:1. Choice A: receive $100 Today, in one year will still be $1002. Choice B: Receive $100 in a year, but will earn %5 interests. = $105o For another example:1. Choice A: receive $100 Today, in one year will still be $1052. Choice B: Receive $100 Today, $110 in a yearIII. Net Present Value- If the net present value is positive, than it is an acceptable project. If it’s zero, than it is also acceptable. If it’s negative, it will not be accepted. Net present value is all based on the cash we pay and cash we receive. Depreciation not relevant. - Cash Outflowso Initial investmento Working capital (cash tied up within the project)o Repairs and maintenanceo Incremental operating costs- Cash Inflowso Salvage valueo Release of working capitalo Reduction of costs o Incremental revenues- The longer you wait for the dollar to be paid to you; the less it will be worth. This can be seen by using a present value chart and the interest rate to find the value of the annuity. At a 10% interest rate, the $1 would be worth:o Year 1: .909 Year 2: .826 Year 3: .751 Year 4: .683o Add these up to get $3.17. o $3.17 is the value of a $1 annuity received for 4 years. o If the question is 1000 at net present value x $3.17, you get 3170 witch is exactly the amount that meets our 10% minimum. So Net present value is 0. o Example 1: Annual Net cash inflow from operations 750,000(400,000)(270,000)80,000 Net present value methodInvestment in Equip. (160,000)Working Capital need (100,000)Annual net cash flow 303,280 = (80,000 x 3.791) PV annuity 80,000/5yrs Refining of equip. (22530) = (30,000 x .751) PV of 30,000/ 3yrs @10%Salvage value Equip. 3105 = (5,000 x .621) PV of 5,000 / 5yrs @ 10%Wrk capital released 62,100 = (100,000 x .621) PV 100,000/5yrs @10%Net Present Value 85,955o Example 2:Net present value methodInvestment in Equip. (250,000)Working Capital need (20,000)Ann. net cash inflow 349,680 = (120,000 x 2.914) PV annuity 120,000/4yr @14%Refining of Equip. (69,210) = (90,000 x .769) PV of 90,000/ 2yrs @14%Salvage value Equip. 5,920 = (10,000 x .592) PV of 10,000 / 4yrs @ 14%Wrk capital released 11,840 = (20,000 x .592) PV 100,000/4yrs @14%Net Present Value 28,230IV. Internal Rate of Return- Take the project as it is, to calculate the rate of return. Find the rate that requires the netpresent value to be zero. If the cash flows are the same every year, than it doesn’t work quite as well. We use this when we have an initial investment and the same cash inflows every. Can compare the rate of return found to the required rate of return. - PV Factor for the Internal Rate of Return = Investment RequiredAnnual Net Cash Flows- The internal rate of return is found by taking the factor and looking at the chart for the allotted years and find the correlating rate according to that PV. - Exampleo 79,310/ 22,000= 3.605. For 5 years it can be found on the chart on the 5th period line under the 12% interest rate mark. So 12% is the rate. V. Comparing Approaches- Net present value is often simpler to use and can consider more things. Clear findings with the positive, negative, zero meanings. There is a major flaw with Internal rate of return because we are assuming that all cash inflows are invested at the same rate. - To compare competing investment polices we can use 2 approacheso Total cost; can compare the total costs using the annuity tables and net present values by comparing our answers. By comparing NPV for botho Incremental cost; instead, the incremental changes can be compared and the NPV can be taken on only the incremental changes. The same answer is found, just more


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UNT ACCT 2020 - Capital Budgeting Decsions

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