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 Periodb. Accounting Rate of Return c. Net Present ValueCurrent LectureI. 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 plansii. What plan should Bill chooseII. Payback Perioda. Payback Period = (Amount Invested) / (Expected Annual Cash Inflow) i. Plan A: (8,440,000/1,600,000) = 5.3 yearsii. Plan B: (8,340,000/1,100,000) = 7.6 years III. 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 Bb. Method 2i. 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 A2. Plan BGo with Plan
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