AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Chapter 14, Module 1 Slide 1 AMIS 212Introductory Managerial AccountingProfessor Marc SmithCHAPTER 1 MODULE 1Chapter 14 Module 1 Hi everyone, welcome back. In this chapter we are going to focus on long term decision making and the techniques that are used in order to make those decisions. Let’s go ahead and get started. Please move to the next slide with me.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Slide 2 Capital budgeting is the process of planning andevaluating investments in plant assets (equipmentand machinery)Capital budgeting decisions tend to be long-run innature They typically involve analyzing alternative longterm investments and deciding which assets toacquire or sellChapter 14 Module 1: Capital Budgeting What this type of decision making is called is capital budgeting. And we can define capital budgeting as the process of planning and evaluating investments in plant assets. Things like equipment and machinery make up your plant assets. Now capital budgeting as I said just a second ago these types of decisions tend to be very long term in nature. And they will typically involve analyzing different alternatives and deciding which of the alternatives or which assets would be best to either acquire or sell. Now if you please go to the next slide with me.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Slide 3 Plant expansionEquipment selectionEquipment replacementLease or buyChapter 14 Module 1: Capital BudgetingTypical capital budgeting decisions include: Here are some examples of common capital budgeting decisions. One of the most common types of capital budgeting decisions is an equipment replacement decision. Basic decision here is alright we have an old piece of equipment do we need to replace it with a new piece of equipment? Does the new equipment generate a high enough return to justify the cost of purchasing it? Other common capital budgeting decisions would be equipment selection decisions. These involve choosing from a list of different choices. Which piece of equipment or which piece of machinery would be the best one to purchase?AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Plant expansion decisions are made using the capital budgeting techniques we are going to talk about. Is this the right time to expand our plant? Does the expansion of our plant generate a high enough return to justify the costs involved? Also lease versus buy…those sorts of decisions are made using capital budgeting techniques. Are we better off purchasing an asset or does it make more sense…is it more beneficial to us to lease it instead of buying? So those are the types of decisions that we’ll see when we make these capital budgeting choices or decisions. Now if you please go to the next slide with me. Slide 4 Cost of CapitalRepresents the smallest rate of return the company is willing to accept on its investment projectsThe cost of capital is also referred to as:minimum required rate of returndiscount ratehurdle rateChapter 14 Module 1: Capital Budgeting One piece of terminology that you need to have down.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 You’ll see if in just about every decision we deal with. It is called the cost of capital. The cost of capital represents the smallest rate of return the company is willing to accept on an investment project. It represents the minimum acceptable rate of return. No project should be accepted where the return is less than this cost of capital. Because the cost of capital represents the smallest return we’re willing to take on a project. One thing you are going to see as you progress through the course, as you progress through your college career and take other classes, often times particularly with capital budgeting the same things are described using a bunch of different words. So the cost of capital is the term we use in this class. But you may also hear it referred to as the minimum required rate of return or the hurdle rate or the discount rate. All of those things mean the same thing. They all represent the smallest acceptable rate of return on a project. In our class, we call that the cost of capital. Now if you please go to the next slide with me.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Slide 5 4 Capital Budgeting Techniques1) Net present value (NPV) method2) Internal rate of return (IRR) method3) Payback period4) Accounting rate of return methodChapter 14 Module 1: Capital Budgeting There are 4 capital budgeting techniques…4 procedures that exist to evaluate these types of decisions and come to what we think is the right thing to do. We’ll talk a little bit about all 4 of these. Let’s just list them out here. Probably the most important, the one we’ll focus the most amount of time on is called the net present value method, the NPV. The second capital budgeting technique is the internal rate of return method. We have the payback period and then the fourth one is called the accounting rate of return. Over the next handful of modules we’ll go through each of these…talk a little bit about what they mean and see how to do the calculations. Now if you please go to the next slide with me.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 1 AMIS 212 – Professor Marc Smith Chapter 14, Module 1 Slide 6 Net Present ValueNPV = Present Value of Cash Inflows -Present Value of Cash OutflowsNOTE: Use the cost of capital to find