Slide 1Slide 2Capital Investment Decisions and the Time Value of MoneyLearning Objective 1Capital BudgetingFour Popular Methods of Capital Budgeting AnalysisCash Basis vs. Accrual BasisCash FlowsCapital Budgeting ProcessS12-1Learning Objective 2Payback PeriodPayback Period ExampleExhibit 12-2: Payback with Equal Net Cash InflowsExhibit 12-3: Payback with Unequal Net Cash InflowsCriticism of Payback Method Slide 17Accounting Rate of ReturnAccounting Rate of Return ExampleARR: Unequal Net CashSlide 21E12-17A: Compute Payback Period—Equal Cash InflowsE12-18A: Compute Payback Period—Unequal Cash InflowsE12-19: ARR with Unequal Cash FlowsE12-19: ARR with Unequal Cash Flows (continued)Learning Objective 3Time Value of MoneyTime Value of Money FactorsExhibit 12-6: Simple Interest CalculationExhibit 12-6: Compound Interest CalculationPresent Value & Future ValuePresent Value and Future ValueFuture Value of an AnnuityE12-21A: Compare Retirement Savings Plan—Req #1E12-21A : Compare Retirement Savings Plans—Req #2E12-21A: Compare Retirement Savings Plans —Req #4E12-23A: Fund Future Cash FlowsE12-24A: Choosing a Lottery Payout OptionLearning Objective 4Discounted Cash Flow ModelsNet Present Value MethodSlide 42Net Present ValueE12-26AE12-26A (continued)Net Present Value for Unequal Cash InflowsExhibit 12-11: Unequal Cash FlowsE12-28A: Calculate NPV—Equal Annual Cash InflowsE12-28A: Calculate NPV—Equal Annual Cash Inflows (continued)Profitability IndexProfitability Index ExampleE12-30A: Capital Rationing DecisionInternal Rate of ReturnSlide 54IRR with Unequal Periodic Cash FlowsInternal Rate of ReturnE12-27A: Calculate IRR—Equal Cash InflowsE12-27A (continued)Learning Objective 5Comparison of Capital Budgeting ModelsSlide 61Slide 62Slide 63End of Chapter 12Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.2Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Capital Investment Decisions and the Time Value of MoneyChapter 123Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Learning Objective 1Describe the importance of capital investments and the capital budgeting process4Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Capital BudgetingAcquisition of assets used for a long period of time and which require large sums of money5Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Four Popular Methods of Capital Budgeting AnalysisMethod Advantage/DisadvantagePayback periodQuick and easy to calculate, used for shorter life span investmentsAccounting Rate of Return (ARR)Net Present Value (NPV)More difficult to calculate, used for longer life span investments, considers time value of moneyInternal Rate of Return (IRR)6Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Cash Basis vs. Accrual Basis•Cash versus accrual basis –Accrual basis required by Generally Accepted Accounting Principles (GAAP)–Capital budgeting focuses on cash flows–Only Accounting Rate of Return method uses accrual-based accounting income7Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Cash Flows•Cash flows include:–Future cash revenue –Any future savings in ongoing cash operating costs –Any future residual value of the asset 8Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Capital Budgeting Process•Identify potential investments•Project the net cash inflows•Analyze the investments•Choose among alternative capital investmentsCapital rationingPost-audit 9Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. S12-1Place the following activities in sequence to illustrate the capital budgeting process:a. Budget capital investmentsb. Project investments’ cash flowsc. Perform post-auditsd. Make investmentse. Use feedback to reassess investments already madef. Identify potential capital investmentsg. Screen/analyze investments using one or more of the methods discussedA.B.C.D.E.F.G.10Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Learning Objective 2Use the payback and accounting rate of return methods to make capital investment decisions11Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Payback PeriodPayback –length of time it takes to recover the cost of the capital outlayAmount investedExpected annual net cash inflows12Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Payback Period ExampleTierra Firma is considering investing $240,000 in hardware and software to develop a business-to-business (B2B) portal. The company expects the portal to save $60,000 each year for the six years of its useful life. Amount investedExpected annual net cash inflowsAmount investedExpected annual net cash inflows$240,000 $60,000=4 years to recover investment13Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Exhibit 12-2: Payback with Equal Net Cash InflowsAccumulate net cash inflows until amount invested is recoveredNet Cash FlowYears Amount Invested Annual Accumulated Annual Accumulated0 $240,000 - - - - - - - - - - - -1 - - - $60,000 $60,000$80,000 $80,0002 - - - $60,000 $120,000$80,000 $160,0003 - - - $60,000 $180,000$80,000 $240,0004 - - - $60,000 $240,0005 - - - $60,000 $300,0006 - - - $60,000 $360,000Useful LifeUseful Life4 year vs. 3 year payback14Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Exhibit 12-3: Payback with Unequal Net Cash InflowsAccumulate net cash inflows until amount invested is recoveredNet Cash FlowYears Amount Invested Annual Accumulated0 $240,000 - - - - - -1 - - - $100,000 $100,0002 - - - $80,000 $180,0003 - - - $50,000 $230,0004 - - - $50,000 $280,0005 - - - $50,000 $330,0006 - - - $30,000 $390,000Useful Life15Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Criticism of Payback Method •Focuses only on time, not on profitability•Considers only those cash flows that occur during the payback period. 16Copyright © 2010 Pearson Education, Inc. Publishing as