Remodels the existing washer remodel costs replace

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Unformatted text preview: 0 6.145 Net present value Present Value $ (175,000) (45,120) 276,525 $ 56,405 If we remodel the existing washer, we will produce a positive net present value of $56,405. Managerial Accounting 13-35 The Total-Cost Approach Both projects yield a positive net present value. However, investing in the new washer will However, produce a higher net present value than remodeling the old washer. remodeling Managerial Accounting 13-36 The Incremental-Cost Approach Under the incremental-cost approach, only Under the incremental-cost approach, only tthose cash flows that differ between the two hose cash flows that differ between the two alternatives are considered. alternatives are considered. Let’s look at an analysis of the White Company decision using the incremental-cost approach. Managerial Accounting 13-37 The Incremental-Cost Approach Incremental investment Incremental cost of brushes Increased net cash inflows Salvage of old equipment Salvage of new equipment Net present value Year Now 6 1-10 Now 10 Cash Flows $(125,000) $ 30,000 15,000 40,000 7,000 10% Factor 1.000 0.564 6.145 1.000 0.386 We get the same answer under either the We total-cost or incremental-cost approach. Managerial Accounting Present Value $(125,000) 16,920 92,175 40,000 2,702 $ 26,797 13-38 Least Cost Decisions In decisions where revenues are not directly involved, managers should choose the alternative that has the least total cost from a present value perspective. Let’s look at the Home Furniture Company. Managerial Accounting 13-39 Least Cost Decisions Home Furniture Company is trying to decide whether to overhaul an old delivery truck now or purchase a new one. The company uses a discount rate of 10%. Here is information about the trucks . . . Old Truck Overhaul cost now Annual operating costs Salvage value in 5 years Salvage value now Managerial Accounting $ 4,500 10,000 250 9,000 13-40 Least Cost Decisions Buy the New Truck Cash Year Flows Purchase price Now $ (21,000) Annual operating costs 1-5 (6,000) Salvage value of old truck Now 9,000 Salvage value of new truck 5 3,000 Net present value Keep the Old Truck Cash Year Flows Overhaul cost Now $ (4,500) Annual operating costs 1-5 (10,000) Salvage value of old truck 5 250 Net present value Managerial Accounting 10% Factor 1.000 3.791 1.000 0.621 10% Factor 1.000 3.791 0.621 Present V alue $ (21,000) (22,746) 9,000 1,863 (32,883) Present Value $ (4,500) (37,910) 155 (42,255) 13-41 Least Cost Decisions Home Furniture should purchase the new truck. Net present value of costs a ssociated with purchase of new truck $(32,883) Net present value of costs a ssociated with remodeling e xisting truck (42,255) Net present value in favour of purchasing the new truck $ 9,372 Managerial Accounting Preference Decisions: Ranking of Capital Projects Unless an organization has unlimited funds to invest in capital projects, a rank ordering of the possibilities will be required. Two approaches to ranking: IRR, highest to lowest NPV: Profitabili...
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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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