Managerial Accounting Chapter 13 Notes Capital Budgeting ...
Managerial Accounting Chapter 13 Notes Capital Budgeting ...
Managerial Accounting Chapter 13 Notes Capital Budgeting ...
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<strong>Managerial</strong> <strong>Accounting</strong><br />
<strong>Chapter</strong> <strong>13</strong> <strong>Notes</strong><br />
<strong>Capital</strong> <strong>Budgeting</strong> (generally an investment in a long-term asset) decisions.<br />
In my opinion, the two best methods for decision making are:<br />
1) Present value analysis (PV) (p 581-587 and 590-595)<br />
2) Internal rate of return (IRR) (p 587-590)<br />
Refer to problem <strong>13</strong>-6 on page 608. Rather than doing the required (simple rate of return), I will solve according to<br />
Present Value (PV) and Internal Rate of Return (IRR) methods.<br />
I also changed the cost of the machine to $100,000 (at $80,000 the IRR was > 25%).<br />
(95,000)<br />
23,000 23000 23000 23000 23000 23000 23000 23000 23000 23000<br />
|------------------ ------|------ ------|------ ------|------ ------|------ ------|------ ------|------ ------|------ ------|------ ------|------ ----------|<br />
0 1 2 3 4 5 6 7 8 9 10<br />
Cash outflows:<br />
Cash inflows:<br />
Buy new machine 100,000 Operating costs of old 33,000<br />
Trade-in old (5,000) Operating costs of new (10,000)<br />
Net cash out 95,000 Annual savings 23,000<br />
Present value analysis (assuming we need to make 14% minimum).<br />
PV of annuity; 14%, 10 periods (years) = 5.216<br />
x 23,000<br />
119,968 Present Value of future cash flows<br />
- 95,000 Investment<br />
24,968 Net Present Value of Investment<br />
Do we buy the equipment Yes. If NPV of investment is >= zero, then we make<br />
at least the minimum required rate of return (14% in this problem).<br />
Internal rate of return<br />
Calculate where the PV of future cash flows = the required investment.<br />
( $95,000 in this problem) annual cash inflows investment.<br />
23,000 x = 95,000<br />
= 4.<strong>13</strong>0<br />
Now find that factor (4.<strong>13</strong>0) in the PV of annuity table (Table 4 or <strong>13</strong>B-2 in book),<br />
using the number of periods of cash flows (10 years in this problem).<br />
From <strong>13</strong>B-2 on page 630:<br />
20% = 4.192<br />
21% = 4.054<br />
Therefore IRR is slightly above 20%, so we will accept this investment opportunity<br />
as our minimum desired rate of return is the 14% cost of capital.<br />
You do not need to "interpolate" the IRR. Recognizing it falls between 20-21% is close enough.<br />
<strong>Chapter</strong> <strong>13</strong> Quiz:<br />
8 multiple choice, 1 problem<br />
3 mc @ 2 pts, relationship between NPV, IRR and PI (profitability index)<br />
3 mc @ 3 pts, calculate PI, rank projects based on PI<br />
2 mc @ 4 pts, calculate NPV, calculate IRR<br />
1 problem @ 7 pts, calculate NPV (with salvage value)
ACCT2203 - <strong>Chapter</strong> <strong>13</strong> Handout<br />
Time value of money concepts: Handout Table Table in textbook<br />
1Future Value of $1 1 n/a<br />
2Future Value of an Annuity 2 n/a<br />
3Present Value of $1 3 <strong>13</strong>B-1 p. 629<br />
4Present Value of an Annuity 4 <strong>13</strong>B-2 p. 630<br />
1) You invest $10,000 in a certificate of deposit (CD) earning 6% per year for 5 years.<br />
What is the maturity value of the investment<br />
Future Value of $1 (Solution = $<strong>13</strong>,380)<br />
2) You put $2000 per year into your retirement account in each of the 30 years you work for the<br />
company. Assuming you average 10% return, how much is in the account at retirement<br />
Future Value of an Annuity (Solution = $328,988)<br />
3) Your child was born today. You want to buy him a $10,000 car when he turns 16.<br />
How much do you need to invest today at 10% to have $10,000 when he turns 16<br />
Present Value of $1 (Solution = $2,180)<br />
4) You wish to have enough at retirement to draw $50,000 per year for 30 years from your retirement<br />
account. Assuming you average 10% return, how much do you need to have in the account at<br />
retirement<br />
Present Value of an Annuity (Solution = $471,350)<br />
<strong>Capital</strong> <strong>Budgeting</strong> decision<br />
Do you buy a machine for $10,000 that will generate $2000 per year of net income for 10 years<br />
- If you desire a minimum average rate of return of 10% <br />
- If you desire a minimum average rate of return of 20%
<strong>Chapter</strong> <strong>13</strong><br />
Handout Examples<br />
Factor Amount FV or PV<br />
1 1.338 $ 10,000 $ <strong>13</strong>,380<br />
2 164.494 $ 2,000 $ 328,988<br />
3 0.218 $ 10,000 $ 2,180<br />
4 9.427 $ 50,000 $ 471,350<br />
<strong>Capital</strong> <strong>Budgeting</strong><br />
Present Value factor: % Periods Factor<br />
Present Value of Annuity 10% 10 6.145<br />
Factor Amount PV of FCF<br />
Present Value of Annuity 6.145 $ 2,000 12,290<br />
Less: Investment required -10,000<br />
Net Present Value of Investment 2,290<br />
Is this an acceptable investment YES<br />
Present Value factor: % Periods Factor<br />
Present Value of Annuity 20% 10 4.192<br />
Factor Amount PV of FCF<br />
Present Value of Annuity 4.192 $ 2,000 8,384<br />
Less: Investment required -10,000<br />
Net Present Value of Investment -1,616<br />
Is this an acceptable investment NO
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