This preview shows page 1. Sign up to view the full content.
Unformatted text preview: e of
return equal to the discount rate. Managerial Accounting 1317 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 longterm creditors
and shareholders for the use of their funds.
and Managerial Accounting 1318 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 1319 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 1320 The Net Present Value Method: An Example
Annual net cash inflow from operations Managerial Accounting 1321 The Net Present Value Method: An Example Accept the contract because the project has a
positive net present value.
positive Managerial Accounting 1322 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 1323 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 1324 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 10year life.
The machine has a 10year life. Managerial Accounting 1325 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 1326 Internal Rate of Return Method: An Example
Using the present value of a...
View
Full
Document
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

Click to edit the document details