ACCT 210 1st Edition Lecture 18 Outline of Current Lecture I Capital budgeting II Screening vs preference decisions III Identifying project cash flows IV Exercise 9 1 Current Lecture I Capital budgeting a A systematic approach for evaluating long range investment proposals for the purpose of allocating limited resources b Capital assets have a useful life of over one accounting period Also called depreciable assets c For expected future returns i 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 50 i Return of investment 26 ii Return on investment 6 50 II Screening vs preference decisions a Screening which projects meet hurdle rate i Hurdle rate minimum rate of return ii 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 flows a Cash receipts i Additional sales revenue ii Salvage value of equipment iii Cost savings b Cash disbursements i Purchase price ii Additional operating costs 1 Direct materials 2 Direct labor 3 Manufacturing overhead 4 Sales general admin iii Do not include interest from financing or acquisition of the asset IV Exercise 9 1 a b Cash Flow Purchase of new equipment Salvage of old equipment Sales revenue Valuable costs Additional fixed costs Salvage of new equipment Timing Year 0 Year 0 Years 1 4 Years 1 4 Years 1 4 Year 4 Amount 1 247 000 neg outflow 172 400 pos inflow 832 500 33000 25 466 200 33000 14 70 000 221 400 V Other capital budgeting techniques a Payback period i How long will it take to get back a return of investment for a particular period ii Pay back period initial investment net annual cash flow b Accounting rate of return i This method uses net operating income not cash flows ii Acceptable by GAAP iii Depreciation expenses are considered iv Accounting rate of return projected revenues projected operating expenses initial investment salvage value of old equipment 1 Numerator also called incremental income
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