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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 139 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 unrecovered 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 15 as shown, the investment would be fully
recovered in year 4.
Managerial Accounting 1310 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 1311 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 10year 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 1312 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 1313 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 1314 The Net Present Value Method
General decision rule . . . Managerial Accounting 1315 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 1316 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.
 Spring '09
 R.DUCHARME

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