ACTTG 211 1st Edition Lecture 25 Outline of Last Lecture I Capital Investment and Time Value of Money II Capital Budget Approaches a Payback period b Accounting Rate of Return c Net Present Value d Weight Average Cost of Capital Outline of Current Lecture II Example Problem a Payback Period b Accounting Rate of Return c Net Present Value Current Lecture I II III Example Problem of Capital Budget Approaches a Bill owns a sandwich shop Bill is considering two expansion plans The first would open 8 smaller shops at a cost of 8 440 000 Expected annual cash inflows are 1 600 000 with zero residual value at the end of 10 years The second plan has Bill opening 3 larger shops at a cost of 8 340 000 This plan will generate net cash inflows of 1 100 000 per year for 10 years Estimated residual value is 1 000 000 Bill uses straight line depreciation and requires an annual return of 8 i Compute the payback period the ARR and the NPV of the two plans ii What plan should Bill choose Payback Period a Payback Period Amount Invested Expected Annual Cash Inflow i Plan A 8 440 000 1 600 000 5 3 years ii Plan B 8 340 000 1 100 000 7 6 years Accounting Rate of Return ARR a ARR Average operating income from asset Initial Investment i Avg operating income from asset Average annual cash inflow from asset annual depreciation expense b Plan A 1 600 000 844 000 8 440 000 8 96 c Plan B 1 100 000 734 000 8 340 000 4 93 These notes represent a detailed interpretation of the professor s lecture Grade Buddy is best used as a supplement to your own notes not as a substitute IV NPV a Method 1 i Lump Sum the receipt or payment of one dollar amount at a specific point in time Use PV 1 factor table 1 Plan A 2 Plan B b Method 2 i Annuity a recurring dollar amount i e the same dollar amount received or paid at predictable intervals of time for a predictable period of time Use PV Annuity 1 factor table 1 Plan A 2 Plan B Go with Plan A
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