ch13-AFM102s2012

Period consider two projects each with a five year

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Unformatted text preview: 2,000 2,000 2,000 2,000 Project Two Net Cash Inflows $ 1,000 1,000 1,000 1,000 1,000,000 Would you invest in Project One just because it has a shorter payback period? Managerial Accounting 13-9 Payback and Uneven Cash Flows When the cash flows associated with an investment project change from year to year, the payback formula introduced earlier cannot be used. Instead, the un-recovered investment must be tracked year by year. $1,000 $0 $2,000 $1,000 $500 1 2 3 4 5 For example, if a project requires an initial investment of $4,000 and provides uneven net cash inflows in years 1-5 as shown, the investment would be fully recovered in year 4. Managerial Accounting 13-10 Simple Rate of Return Method Does not focus on cash flows -- rather it focuses on accounting net operating income. accounting The following formula is used to calculate the simple rate of return: Simple rate = of return Incremental Incremental expenses, – revenues including depreciation Initial investment* *Should be reduced by any salvage from the sale of the old equipment Managerial Accounting 13-11 Simple Rate of Return Method Management of The Daily Grind wants to install an espresso bar in its restaurant. The espresso bar: 1. Cost $140,000 and has a 10-year life. 1. 2. Will generate incremental revenues of $100,000 2. and incremental expenses of $65,000 including depreciation. What is the simple rate of return on the investment project? Managerial Accounting 13-12 Simple Rate of Return Method Simple rate = of return $100,000 – $65,000 $140,000 = 25% The simple rate of return method is The simple rate of return method is not recommended because it not recommended because it iignores the time value of money gnores the time value of money and the simple rate of return can and the simple rate of return can fluctuate from year to year. fluctuate from year to year. Managerial Accounting 13-13 The Net Present Value Method To determine net present value we . . . Calculate the present value of cash inflows, Calculate the present value of cash outflows, Subtract the present value of the outflows from the present value of the inflows. Managerial Accounting 13-14 The Net Present Value Method General decision rule . . . Managerial Accounting 13-15 The Net Present Value Method Net present value analysis emphasizes cash flows and not accounting net income. The reason is that accounting net income is based on accruals that ignore the timing of cash flows into and out of an organization. Depreciation is not deducted in computing the present value of a project because . . . It is not a current cash outflow. Discounted cash flow methods automatically provide for return of the original investment. Managerial Accounting 13-16 Two Simplifying Assumptions Two simplifying assumptions are usually made in net present value analysis: • All cash flows other than the initial investment occur at the end of periods. • All cash flows generated by an investment project are immediately reinvested at a rat...
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This note was uploaded on 09/30/2013 for the course AFM 102 taught by Professor R.ducharme during the Spring '09 term at Waterloo.

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