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Managerial Accounting Second Edition Weygandt / Kieso / Kimmel

Managerial Accounting Second Edition Weygandt / Kieso / Kimmel. Prepared by:. Ellen L. Sweatt. Georgia Perimeter College. ELS. Capital Budgeting. Campbell's. Campbell's. Campbell's. SOUP. SOUP. SOUP. Capital Budgeting. The process of making capital expenditure decisions in business.

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Managerial Accounting Second Edition Weygandt / Kieso / Kimmel

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  1. Managerial AccountingSecond EditionWeygandt / Kieso / Kimmel Prepared by: Ellen L. Sweatt Georgia Perimeter College ELS Capital Budgeting

  2. Campbell's Campbell's Campbell's SOUP SOUP SOUP Capital Budgeting

  3. The process of making capital expenditure decisions in business. Choosing among many capital projects to find the one(s) that will MAXIMIZE a company’s return on its financial investment. Capital Budgeting Is...

  4. Capital Budgeting Authorization

  5. Uses estimated Cash Inflows and Outflows- not accrual-based income statement numbers. Capital Budgeting

  6. Illustration 10-2 Capital Budgeting Cash Outflows: • Initial investment • Repairs and investment • Increased operating cost • Overhaul of equipment Cash Inflows • Sale of old equipment • Increased cash received from customers • Reduced cash outflows related to operating costs • Salvage value of equipment when project is completed.

  7. Illustration 10-3 Data To Be Used In Following Examples Initial investment $130,000 Estimated useful life 10 years Estimated salvage value - 0 - Estimated annual cash flows Cash inflow from customers $200,000 Cash outflows for operating costs 176,000 Net annual cash inflow $ 24,000

  8. A capital budgeting technique that identifies the time period required to recover the cost of a capital investment from the annual cash inflow produced by the investment. Illustration 10-4 Cost of Capital Investment Net Annual Cash Inflow Cash Payback Period  = Cash Payback Technique The shorter the payback period, the better.

  9. Illustration 10-4 Illustration 10-4 Cost of Capital Investment Net Annual Cash Inflow Cash Payback Period  = Cash Payback Technique $130,000  $24,000 = 5.42 years

  10. Cash Payback • Advantages: • May be critical factor if company needs a fast turnaround of money. • Easy to compute and understand. • Disadvantages: • Ignores profitability of project. • Ignore time value of money.

  11. The difference that results when the original capital outlay is subtracted from the discounted cash inflows. Net Present Value

  12. A method used in capital budgeting in which cash inflows are discounted to their present value and then compared to the capital outlay required by the investment. Net Present Value Method

  13. A capital budgeting technique that considers both the estimated total cash inflows from the investment and the time value of money. Discounted Cash Flow Technique

  14. Illustration 10-5 Net Present Value Criteria

  15. Annual cash inflows are $24,000 for all ten years. Illustration 10-6 PV at 12% Discount factor for annuity of $1 for 10 periods 5.65022 Present value of cash flows: $24,000 x 5.65022 $135,605 Illustration 10-7 12% Present value of cash flows: $135,605 Capital investment 130,000 Net present value $ 5,605 Net Present Value The analysis of the proposal by the Net Present Value method is: The proposed capital expenditure is acceptable at the 12% required rate of return because the NPV is positive.

  16. Choosing A Discount Rate • A company uses a discount rate that is equal to its cost of capital. • The cost of capital is a weighted average of the rates paid on borrowed funds and funds from investors in the company’s stock. • A discount rate has two elements: • a cost of capital element • a risk element. • Companies often assume the risk element is zero.

  17. The average rate of return that the firm must pay to obtain borrowed and equity funds. Cost of Capital

  18. Net Present Value Assumptions • All cash flows come at the end of each year. • All cash flows are immediately reinvested in another project that has a similar return. • All cash flows can be predicted with certainty.

  19. Increased quality Safety Employee loyalty To avoid rejecting projects that should be accepted, two possible approaches are suggested: Calculate NPV ignoring intangible benefits and if NPV is negative, ask if intangible benefits are worth at least the negative NPV. Project rough, conservative estimates of the value of the intangible benefits and include those in NPV calculation. Intangible Benefits

  20. Illustration 10-16 Project A Project B Initial investment $40,000 $90,000 Net annual cash inflows 10,000 19,000 Salvage value 5,000 10,000 Net present value 18,112 20,574 Mutually Exclusive Projects 10 year life 12% discount rate

  21. Revised investment information for the two projects is: Illustration 10-18 Project A Project B Initial investment $40,000 $90,000 Net annual cash inflows 10,000 19,000 Salvage value 5,000 10,000 Present value of cash flows: ($10,000 x 5.65022) + ($5,000 x .32197) 58,112 ($19,000 x 5.65022) + ($10,000 x .32197) 110,574 Mutually Exclusive Projects

  22. A method of comparing alternative projects that takes into account: the size of the investment its discounted future cash flows. Present Value of Cash Flows Initial Investment Profitability Index Illustration 10-17  = Profitability Index

  23. Revised investment information for the two projects is: Illustration 10-18 Project A Project B Initial investment $40,000 $90,000 Net annual cash inflows 10,000 19,000 Salvage value 5,000 10,000 Present value of cash flows: ($10,000 x 5.65022) + ($5,000 x .32197) 58,112 ($19,000 x 5.65022) + ($10,000 x .32197) 110,574 Illustration 10-19 Profitability Index = Present Value of Cash Flows Initial Investment Project A Project B $58,112 = 1.45 $110,574 = 1.23 $40,000 $90,000 Profitability Index Project A is better because it has the higher profitability index.

  24. A thorough evaluation of how well a project’s actual performance matches the projections made when the project was proposed. Post-audit

  25. Illustration 10-21 Internal Rate of Return

  26. The rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected annual cash inflows. Internal Rate of Return

  27. A method used in capital budgeting that results in finding the interest yield of the potential investment. Internal Rate of Return Method

  28. The determination of the profitability of a capital expenditure by dividing expected annual net income by the average investment Annual Rate of Return Method

  29. Original Investment + Value at end of usefu1 life Average Investment 2 Illustration 10-23 Annual Rate of Return Method Illustration 10-24 Sales $200,000 Less: Cost and expenses Manufacturing costs $132,000 Depreciation expense ($130,000  5) 26,000 Selling and administrative expenses 22,000 180,000 Income before income taxes 20,000 Income tax expense 7,000 Net income $ 13,000 Illustration 10-25 $13,000  $65,000 = 20%

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