plans to withdraw 15000 from the business at the end of each year for the next

# Plans to withdraw 15000 from the business at the end

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plans to withdraw \$15,000 from the business at the end of each year for the next 5 years. At the end of the fifth year, Sam plans to sell the business for \$110,000 cash. At a 12% discount rate, the equipment's NPV can be calculated as follows: Items Years Amount of cash flow Factor at 12% Present value of cash flows Investment cost Now \$(70,000) 1 \$(70,000) Cost savings 1-5 \$15,000 3.605 \$54,075 Salvage value 5 \$110,000 0.567 \$62,370 Total \$46,445 Exit Angela ACCT310 Managerial Accounting Unit 5: Capital Budgeting, Decentralization, and Performance and Investment Analysis Learning map Internal Rate of Return (IRR) Method Revise: Internal Rate of Return (IRR) Method Revise: Internal Rate of Return (IRR) Method Contact Extras Lesson path 1. 1.Introduction 2. 2.Learning material 3. 3.Interactive example 4. 4.Questions 5. 5.Summary Introduction The internal rate of return (IRR) is the interest rate (discount rate) that results in a net present value (NPV) of zero. When the NPV is equal to zero, the present value of the project’s cash inflows exactly equals the investment outlay. The decision tree for both the NPV and IRR will yield the exact same result. The IRR methods consider the time value of money. Surveys show that the IRR is most popular method, followed by payback period and NPV. Few companies use the accounting rate of return (ARR). In choosing among competing projects, the IRR may lead to the wrong choice, whereas NPV is consistent in providing the correct signal. With mutually exclusive projects, acceptance of one precludes the acceptance of others. Post audit is a follow-up evaluation of capital-budgeting decisions. The purposes of post-audits include the following: To see that investment expenditures proceed on time and within budget. To compare actual cash flows with those originally predicted to motivate To have a careful and honest prediction To provide information for the improvement of future predictions of cash flows To evaluate the continuation of the project Exit Angela ACCT310 Managerial Accounting Unit 5: Capital Budgeting, Decentralization, and Performance and Investment Analysis Learning map Internal Rate of Return (IRR) Method Revise: Internal Rate of Return (IRR) Method Revise: Internal Rate of Return (IRR) Method Contact Extras Lesson path 1. 1.Introduction 2. 2.Learning material 3. 3.Interactive example 4. 4.Questions 5. 5.Summary Learning Material Internal Rate of Return (IRR) Method The internal rate of return (IRR) is defined as the interest rate that sets the present value of a project’s cash inflows equal to the present value of the project’s cost (the point where NPV is equal to zero). The IRR is a rate used to evaluate acceptability of an investment; it equals the rate that yields a NPV of zero for an investment.  #### You've reached the end of your free preview.

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• Spring '11
• Scott
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