CAPITAL BUDGETING AND COST ANALYSIS
Homework Assignment: 21-2, 21-6, 21-7, 21-13, 21-16, 21-17, 21-18 (1 only),
21-19 (1 only)
numbers represent minimum requirement
In essence, the discounted cash-flow method calculates the expected cash inflows and
outflows of a project as if they occurred at a single point in time so that they can be aggregated
(added, subtracted, etc.) in an appropriate way.
This enables comparison with cash flows from
other projects that might occur over different time periods.
The payback method measures the time it will take to recoup, in the form of expected
future net cash inflows, the net initial investment in a project. The payback method is simple and
easy to understand. It is a handy method when screening many proposals and particularly when
predicted cash flows in later years are highly uncertain. The main weaknesses of the payback
method are its neglect of the time value of money and of the cash flows after the payback period.
The accrual accounting rate-of-return (AARR) method divides an accrual accounting
measure of average annual income of a project by an accrual accounting measure of investment.
The strengths of the accrual accounting rate of return method are that it is simple, easy to
understand, and considers profitability. Its weaknesses are that it ignores the time value of money
and does not consider the cash flows for a project.
Income taxes can affect the cash inflows or outflows in a motor vehicle replacement
decision as follows:
Tax is payable on gain or loss on disposal of the existing motor vehicle,
Tax is payable on any change in the operating costs of the new vehicle vis-à-vis the
existing vehicle, and
Tax is payable on gain or loss on the sale of the new vehicle at the project termination
Additional depreciation deductions for the new vehicle result in tax cash savings.
Exercises in compound interest, no income taxes.
The answers to these exercises are printed after the last problem, at the end of the chapter.
Capital budget methods, no income taxes.
The table for the present value of annuities (Appendix B, Table 4) shows:
5 periods at 12% = 3.605
Net present value
= $60,000 (3.605) – $160,000
= $216,300 – $160,000 = $56,300