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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 1335 The TotalCost 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 1336 The IncrementalCost Approach
Under the incrementalcost approach, only
Under the incrementalcost 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 incrementalcost
approach. Managerial Accounting 1337 The IncrementalCost 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
110
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
totalcost or incrementalcost approach. Managerial Accounting Present
Value
$(125,000)
16,920
92,175
40,000
2,702
$ 26,797 1338 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 1339 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 1340 Least Cost Decisions
Buy the New Truck
Cash
Year
Flows
Purchase price
Now
$ (21,000)
Annual operating costs
15
(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
15
(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) 1341 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.
 Spring '09
 R.DUCHARME

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