ACCT 210 1st Edition Lecture 18 Outline of Current Lecture I. Capital budgetingII. Screening vs. preference decisionsIII. Identifying project cash flowsIV. Exercise 9-1Current LectureI. Capital budgetinga. A systematic approach for evaluating long-range investment proposals for the purpose of allocating limited resourcesb. Capital assets: have a useful life of over one accounting period. Also called “depreciable assets”c. For expected future returnsi. Return of investment: When do I get my investment back?ii. Return on investment: When do I get my investment back plus how much am I going to make?d. Example: if you buy four shares of stock for $26 and sell it one month later for $32.50i. Return of investment = $26ii. Return on investment = $6.50II. Screening vs. preference decisionsa. Screening: which projects meet hurdle rate?i. Hurdle rate = minimum rate of returnii. Which of the projects are acceptable for the organization in light of its goals?b. Preference: of the acceptable projects, which ones should be implemented?III. Identifying project cash flowsa. Cash receipts:i. Additional sales revenueii. Salvage value of equipmentiii. Cost savingsb. Cash disbursements:i. Purchase priceii. Additional operating costs1. Direct materials2. Direct labor3. Manufacturing overhead4. Sales, general & adminiii. Do not include interest from financing or acquisition of the assetIV. Exercise 9-1a.b.Cash Flow Timing AmountPurchase of new equipment Year 0 $-1,247,000 (neg; outflow)Salvage of old equipment Year 0 $172,400 (pos; inflow)Sales revenue Years 1-4 $832,500 (33000 * 25)Valuable costs Years 1-4 $-466,200 (33000 * 14)Additional fixed costs Years 1-4 $-70,000Salvage of new equipment Year 4 $221,400V. Other capital budgeting techniquesa. Payback periodi. How long will it take to get back a return of investment for a particular periodii. Pay back period = initial investment / net annual cash flowb. Accounting rate of returni. This method uses net operating income, not cash flowsii. Acceptable by GAAPiii. Depreciation expenses are considerediv. Accounting rate of return = (projected revenues – projected operating expenses) / (initial investment – salvage value of old equipment)1. Numerator also called incremental
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