Chapter 12 – 1
Investments in Operating Assets
Tangible assets have physical substance and capabilities. Intangible assets have no physical
substance or properties; they give the firm the right of ownership or use. Both tangible and
intangible assets increase the firm’s potential profitability.
Examples of tangible assets include property, plant, equipment, oil, gas, and other natural
Examples of intangible assets include patents, copyrights, leaseholds, trademarks,
franchises, and goodwill.
Capital budgeting is the process of planning, setting goals and priorities, arranging
financing, and identifying criteria for making long-term investments. For example, a
company may be thinking of acquiring a new plant for its expanded production facilities. If
there are many models and makes of equipment available in the market, then the company
would have to analyze the possible choices and make decisions about financing
The first model is the
. The payback period is simply the time it takes for
the firm to recover its original investment, calculated by dividing the original investment by
the net annual cash flows received from the investment. Another commonly used
evaluation method is to compute an
accounting rate of return
equal to the average
accounting income earned by the asset divided by the investment in the asset. Another
decision model used in making capital budgeting decisions is the
net present value
The net present value method incorporates the concept of the time value of money, which is
that dollars to be received far in the future are not worth as much as dollars to be received
right now. The decision rule underlying the net present value method is that a project
should be undertaken only if the present value of the cash inflows from the project exceeds
the present value of the cash outflows.
Standard accounting practice dictates that the cost of property, plant, and equipment
include any costs necessary to bring the asset to the condition and location for its intended
The following costs should be included in the cost of the new computer:
The costs to modify the computer room would be added to the cost of the building.
If the overhaul or repairs were needed to prepare the asset for its intended use, then the
expenditures should be capitalized. If the overhaul expenditure extends the life or
productive capacity of the asset, the expenditure is capitalized. Routine repairs or other
expenditures that do not enhance the life or capacity of the asset should be expensed.