Chapter%2013%20Lecture%20Notes.2012.Students

# Chapter%2013%20Lecture%20Notes.2012.Students - Acct 2200...

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Acct 2200 Chapter 13 Lecture Notes Capital Budgeting Decisions (2012) Learning Objectives: 1. Evaluate the acceptability of an investment project using the net present value method. 2. Evaluate the acceptability of an investment project using the internal rate of return method. 3. Rank investment projects in order of preference. 4. Determine the payback period for an investment. 5. Compute the simple rate of return for an investment. Part I. Capital Budgeting-Planning Investments 1. Concepts : a. The term capital budgeting is used to describe how managers plan significant investments in projects that have long-term implications such as the purchase of new equipment or the introduction of new products. b. Any decision that involves an outlay now in order to obtain a future return is a capital budgeting decision . Typical capital budgeting decisions include: Cost reduction decisions. Expansion decisions. Equipment selection decisions. Lease or buy decisions. Equipment replacement decisions. c. Capital budgeting decisions fall into two broad categories— screening decisions and preference decisions : Screening decisions relate to whether a proposed project is acceptable— whether it passes a preset hurdle. Preference decisions , by contrast, relate to selecting from among several acceptable alternatives. 2. Traditional Approaches to Capital Investment Decisions Discounting methods rely on the time value of money (e.g., Net Present Value method, Internal Rate of Return method, etc.). Nondiscounting methods ignore the time value of money (e.g., Payback Period method, Simple Rate of Return method, etc.) ( The translation of future dollars into current dollars is known as discounting). 1

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Part II. Net Present Value Method 1. Net Present Value (NPV) = the present value of expected cash inflows - the present value of expected cash outflows McGraw-Hil /Irwin Slide 8 If the Net Present Value is . . . Then the Project is . . . Positive . . . Acceptable because it promises a return greater than the required rate of return. Zero . . . Acceptable because it promises a return equal to the required rate of return. Negative . . . Not acceptable because it promises a return less than the required rate of return. The Net Present Value Method Let: FV = future value PV = present value i =discount rate (also called hurdle rate , required rate of return ) n: number of time periods Future value of a single amount: FV = PV * (1+i) n Present value of single amount (Formula 1): PV = i) + (1 n FV =FV * s Factor PV (n, i) (Exhibit 13B-1) Similarly, present value of annuity (Formula 2): PV =FV * a Factor PV (n, i) (Exhibit 13B-2) ( Annuity is a series of payment of equal amount) EXERCISE 13–1 Net Present Value Method 2
The management of Kunkel Company is considering the purchase of a \$40,000 machine that would reduce operating costs by \$7,000 per year. At the end of the machine's eight-year useful life, it will have zero scrap value. The company's required rate of return is 12%.

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Chapter%2013%20Lecture%20Notes.2012.Students - Acct 2200...

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