chapter%209%20-%20ACCT%202332%20-%20spring%202010

chapter%209%20-%20ACCT%202332%20-%20spring%202010 - Chapter...

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Chapter Nine Chapter Nine Capital Budgeting and the opportunity cost of capital
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Objectives Objectives 1. Define capital budgets and capital expenditure decisions. 2. Time value of money approaches to capital expenditure decisions. 3. Evaluate investment opportunities using the net present value approach. 4. Evaluate investment opportunities using the internal rate of return approach.
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Objectives Objectives (continued) (continued) 1. Calculate the depreciation tax shield, and explain why the income tax makes depreciation important in capital budgeting. 2. Use the payback period and the and the accounting rate of accounting rate of return return methods to evaluate investment opportunities. 3. Discuss soft benefits and inflation 4. Explain why managers may focus erroneously on the short-run profitability of investments rather than their long run return.
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Capital budgeting Capital budgeting When companies decide whether to take an investment project or not, they prepare a schedule of all the cash that will go into the project and all the cash that will go out. Many times, the most significant investment is at the beginning (long-lived assets, working capital), and cash from the project is received only in future years. Assume a project needs $100,000 initial investment and produces $28,000 each year in profits for 4 years? Should we take it? It all depends on the time-value of money!
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Time Value of Money Time Value of Money What would you prefer: get a $1,000 now or a $1,000 in 1 year? pay a $1,000 now or a $1,000 in 1 year? Why?
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The money could be invested (in a savings account or in any other investment) and get a return. For example, if you need to pay a $1,000 in one year, and you can earn 10% return meanwhile, you can invest now only $909 and get a $1,000 in a year: $909 x (1+0.1)=$1,000 We get the $909 number by calculating: 1,000/1.1 = 909
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Investment example : a person lets $1,000 sit in a bank account that pays 10% interest per year for 4 years. The amount in the bank after 4 years (also called the Future Value ) will be calculated: Year 1: $1,000 x 1.10 = $1,100.00 Year 2: $1,100 x 1.10 = $1,210.00 Year 3: $1,210 x 1.10 = $1,331.00 Year 4: $1,331 x 1.10 = $1,464.10 Or just: $1,000 x 1.10 4 = 1,464.10
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Another example: To how much will $30,000 grow if left in the bank for 15 years at 8% compound interest? $30,000 x (1+0.08) 15 = $95,165.07
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Present value - the value today of a future cash inflow or outflow Present value calculations are the reverse of future value calculations. In future value calculations, you determine how much money you will have at a date in the future given a certain interest rate. In present value calculations, you determine how much must be invested today given a certain interest rate to get to how much money you want in the future. Present Value
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This note was uploaded on 05/06/2010 for the course ACCT 2332 taught by Professor Howard during the Spring '10 term at University of Texas-Tyler.

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chapter%209%20-%20ACCT%202332%20-%20spring%202010 - Chapter...

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