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Lecture Managerial accounting: Creating value in a dynamic business environment (9/e): Chapter 16 - Ronald W. Hilton

Chapter 16 - Capital expenditure decisions. After completing this chapter, you should be able to: Use the net-present-value method and the internal-rate-of-return method to evaluate an investment proposal; compare the net-present-value and internal-rate-of-return methods, and state the assumptions underlying each method; use both the total-cost approach and the incremental-cost approach to evaluate an investment proposal. | Capital Expenditure Decisions Chapter 16 Discounted-Cash-Flow Analysis Cost reduction Plant expansion Equipment selection Lease or buy Equipment replacement Learning Objective 1 Net-Present-Value Method Prepare a table showing cash flows for each year, Calculate the present value of each cash flow using a discount rate, Compute net present value, If the net present value (NPV) is positive, accept the investment proposal. Otherwise, reject it. Net-Present-Value Method Mattson Co. has been offered a five year contract to provide component parts for a large manufacturer. Net-Present-Value Method At the end of five years the working capital will be released and may be used elsewhere by Mattson. Mattson uses a discount rate of 10%. Should the contract be accepted? Net-Present-Value Method Annual net cash inflows from operations Net-Present-Value Method Mattson should accept the contract because the present value of the cash inflows exceeds the present value of the cash outflows by . | Capital Expenditure Decisions Chapter 16 Discounted-Cash-Flow Analysis Cost reduction Plant expansion Equipment selection Lease or buy Equipment replacement Learning Objective 1 Net-Present-Value Method Prepare a table showing cash flows for each year, Calculate the present value of each cash flow using a discount rate, Compute net present value, If the net present value (NPV) is positive, accept the investment proposal. Otherwise, reject it. Net-Present-Value Method Mattson Co. has been offered a five year contract to provide component parts for a large manufacturer. Net-Present-Value Method At the end of five years the working capital will be released and may be used elsewhere by Mattson. Mattson uses a discount rate of 10%. Should the contract be accepted? Net-Present-Value Method Annual net cash inflows from operations Net-Present-Value Method Mattson should accept the contract because the present value of the cash inflows exceeds the present value of the cash outflows by $85,955. The project has a positive net present value. Internal-Rate-of-Return Method The internal rate of return is the true economic return earned by the asset over its life. The internal rate of return is computed by finding the discount rate that will cause the net present value of a project to be zero. Internal-Rate-of-Return Method Black Co. can purchase a new machine at a cost of $104,320 that will save $20,000 per year in cash operating costs. The machine has a 10-year life. Internal-Rate-of-Return Method Future cash flows are the same every year in this example, so we can calculate the internal rate of return as follows: Investment required Net annual cash flows = Present value factor $104, 320 $20,000 = 5.216 Internal-Rate-of-Return Method $104, 320 $20,000 = 5.216 The present value factor (5.216) is located on the Table IV in the Appendix. Scan the 10-period row and locate the value 5.216. Look at the top of the column and you find a rate of 14% which is the internal rate of .