AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 Chapter 14, Module 2 Slide 1 AMIS 212Introductory Managerial AccountingProfessor Marc SmithCHAPTER 1 MODULE 1Chapter 14 Module 2 Hi everyone, welcome back. Now that we’ve learned all about the net present value let’s see if we can apply it and let’s take a look at a couple of examples applying the concepts we’ve learned. Now let’s get started, move to the next slide with me.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 Slide 2 Net Present ValueNPV = Present Value of Cash Inflows -Present Value of Cash OutflowsNOTE: Use the cost of capital to find thepresent values of the cash flowsChapter 14 Module 2: Net Present Value And just as a quick refresher there is how to calculate the NPV. It’s the present value of all cash inflows associated with a given project minus the present value of the cash outflows of the project. And remember in order to find the present values we’re going to need to know an interest rate and the rate that we use is the cost of capital. With that under our belt go to the next slide and let’s take a look at example #1 from the website problems.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 Slide 3 Present value of a lump sumfactor for 5 years at 20%.YearsCash Flows 20% FactorPresent ValueInitial Investment Now $ <6,000> 1.0000 <6,000>$ Annual Labor Savings 1-5 2,000 2.9906 5,981Salvage Value 51,0000.4019 402Net present value$ 383Present value of an annuity factor for 5 years at 20%.A cash flow occurring now is already stated at present value; use a factor of 1.0000Chapter 14 Module 2: Example #1 Let’s just read it together. Here’s what it says, MT Glass is considering purchasing a new machine that is capable of performing certain operations that are now performed manually. The machine will cost $6,000 new and will last for 5 years. At the end of the 5 year period the machine can be sold for its $1,000 salvage value. Use of the machine will reduce labor costs by $2,000 per year. That’s why we are considering buying it in the first place. Buying it will allow the machine to do work that we’re currently paying people to do. So by using the machine we’ll save money spent on labor to the tune of $2,000 per year.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 MT Glass uses a cost of capital of 20% on all investment projects. That means in order to do a project it must generate a return that is at least equal to 20%. With that said the requirement is to calculate the NPV, let’s do it. And I think you're going to find with these net present value calculations it’s very helpful, it’s going to make your life a lot easier if you set it up in this sort of nice table format, almost like Excel. And we’ll have some columns, column for the year that we have the cash flow, column for the amount of the cash flow, a column for our present value factor, and the whole idea is to find the present value of the cash flows so our last column is the present value of the cash flow. And let’s just enter the cash flows into our schedule. The very first one they tell us about is the initial investment. What we have to spend to purchase the equipment so that we can then start saving the labor. The initial investment happens now. You need this money immediately, you need to spend this money now so you can buy the equipment, bring it back to the shop and start having the labor savings. And we know from the problem that the initial investment is $6,000. We also know it’s an outflow, so I’m going to put my outflows in brackets. I’m going got use the brackets there. One little trick to watch for, any cash flow occurring now, any cash flow that’s needed immediately right up front is already stated at its present value. Because that’s what we need today in order to buy the equipment.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 So the present value factor is always 1, so any cash flow occurring now, already stated at its present value, that means the PV factor we should use is 1. So we’ll take the $6,000 times the present value factor of 1, the present value of the initial investment is $6,000 outflow. That’s the game we’re going to play, we’re going to do that for every cash flow that we have in our problem. The next one I’m going to include in the schedule would be the annual labor savings. Remember it said that the machine was going to do work that’s currently being done manually thus allowing us to have a savings in labor. And I know that the labor savings will happen every year. Every year for 5 years, the period that we’ll have the machine we will have a savings in labor. And the problem says the labor savings amounts to $2,000 a year, it’s an inflow, no brackets. When I go to find the present value factor to use I remember that this is an annuity. It’s an annuity because it’s happening every year. So I go to the present value of the annuity table, 20%, 5 periods, and you should see your factor, 2.9906. These table factors are of course posted on our website. So if you need to pause me and you want to go grab them so you can just see where I’m getting those numbers from, please do.AMIS 212: Introductory Managerial Accounting Chapter 14, Module 2 AMIS 212 – Professor Marc Smith Chapter 14, Module 2 What we’ll do here is take the amount of the cash flow the $2,000 savings times the present value factor the 2.9906, and a present value of the annual labor savings, $5,981. One more cash flow to incorporate and it was the salvage value. And the problem said once the equipment’s life was over at the end of the 5 years