ch13-AFM102s2012

# Made in net present value analysis all cash flows

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Unformatted text preview: e of return equal to the discount rate. Managerial Accounting 13-17 Choosing a Discount Rate The firm’s cost of capital is usually regarded as cost the minimum required rate of return. the The cost of capital is the average rate of return The the company must pay to its long-term creditors and shareholders for the use of their funds. and Managerial Accounting 13-18 The Net Present Value Method: An Example Lester Company has been offered a five year contract to provide component parts for a large manufacturer. Managerial Accounting 13-19 The Net Present Value Method: An Example At the end of five years the working capital will be At the end of five years the working capital will be released and may be used elsewhere by Lester. released and may be used elsewhere by Lester. Lester Company uses a discount rate of 10%. Lester Company uses a discount rate of 10%. Should the contract be accepted? Should the contract be accepted? Managerial Accounting 13-20 The Net Present Value Method: An Example Annual net cash inflow from operations Managerial Accounting 13-21 The Net Present Value Method: An Example Accept the contract because the project has a positive net present value. positive Managerial Accounting 13-22 Internal Rate of Return Method The internal rate of return is the rate of return The internal promised by an investment project over its useful life. It is computed by finding the discount rate that will cause the net present value of a project to be zero. net zero It works very well if a project’s cash flows are identical It every year. If the annual cash flows are not identical, a trial and error process must be used to find the internal rate of return. rate Managerial Accounting 13-23 Internal Rate of Return Method General decision rule . . . If the Internal Rate of Return is . . . Then the Project is . . . Equal to or greater than the minimum required rate of return . . . Acceptable. Less than the minimum required rate of return . . . Rejected. When using the internal rate of return, the cost of capital acts as a hurdle rate that a project must clear for acceptance. Managerial Accounting 13-24 Internal Rate of Return Method: An Example Decker Company can purchase a new Decker Company can purchase a new machine at a cost of \$104,320 that will save machine at a cost of \$104,320 that will save \$20,000 per year in cash operating costs. \$20,000 per year in cash operating costs. The machine has a 10-year life. The machine has a 10-year life. Managerial Accounting 13-25 Internal Rate of Return Method: An Example Future cash flows are the same every year in this Future cash flows are the same every year in this example, so we can calculate the internal rate of example, so we can calculate the internal rate of return as follows: return as follows: PV factor for the = internal rate of return \$104, 320 \$20,000 Managerial Accounting Investment required Net annual cash flows = 5.216 13-26 Internal Rate of Return Method: An Example Using the present value of a...
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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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