ACCT 2230 Chapter Notes - Chapter 13: Net Present Value, Discounted Cash Flow, Capital Budgeting

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11 Feb 2015

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Capital budgeting: the process of planning significant outlays on projects that have long-term implications (i. e; introducing a new product) Screening decision: a decision as to whether a proposed investment meets some pre- established profitability hurdle (projects can only be accepted if they promise a certain rate of return) Preference decision: a decision as to which of several competing acceptable investment proposals is best. Typical decisions to consider: cost-reduction decisions, expansion decisions, equipment selection decisions, lease or buy decisions, equipment replacement decisions. Npv- the difference between the present value of the cash inflows and the present value of the cash outflows associated with an investment project. Typical cash outflows: immediate cash outflow to invest in assets or equipment. Salvage value realized is accounted for as a cash inflow or a discount to the original investment: expand working capital (current assets/current liabilities) I. e; purchasing sales registers and opening new ar accounts: periodic outlays for maintenance and repairs, incremental operating costs.

Related Questions

Blaine Company is considering four investment proposals, each requiring the same amount of initial cash investment. The excess present value index for each proposal is listed below. Using the index as a selection criterion, identify the index of the most attractive proposal.

a. 90

b. 100

c. 110

d. 115

The primary limitation of the cash payback method is that it

a. Uses before-tax cash flows.

b. Identifies the length of time it will take to recover the investment outlay in cash.

c. Ignores the profitability of one investment project as compared to another.

d. Involves a more sophisticated analysis than the net present value method.

Which of the following is not one of the considerations given to capital budgeting proposals?

Select one:

A. Whether there is an immediate need to replace or repair critical assets

B. Whether the proposal is in compliance with capital budgeting policies

C. Whether the proposal would meet the established minimum return on capital

D. Whether the proposal is congruent with the firm's long-term goals

E. All of the above are considerations given to capital budgeting proposals

Capital Budgeting
Glacier Creek Textiles is planning to purchase new manufacturing equipment. The equipment has an acquisition cost of $100,000, an estimated useful life of five years and no residual value. The company uses a 12% rate of return to evaluate capital projects. The cash flows for the five years:

Year	Net Cash Outflows	Net Cash Inflows
Year	Amount invested	Net Cash Inflows
0	($100,000)
1		25,000
2		29,000
3		26,000
4		28,000
5		35,000


Requirements
1. Compute the accounting rate of return.
2. Compute the net present value of the investment using Excel's PV function.
3. Compute the net present value of the investment using Excel's NPV function.
4. Compute the profitability index, rounded to two decimal places.
5. Compute the internal rate of return of the investment using Excel's IRR function. Display to two decimal places, but do not round.

Excel Skills
1. Function PV
2. Function NPV
3. Function IRR

	Evaluate Glacier Creek Textiles' new manufacturing equipment.

	Data
	Annual discount Rate	0.12
	Cash Flow Year 0 (Cost)	(100,000)
	Cash Flow Year 1	25,000
	Cash Flow Year 2	29,000
	Cash Flow Year 3	26,000
	Cash Flow Year 4	28,000
	Cash Flow Year 5	35,000
	Useful Life in years	5
	Residual value	0



Requirement 1	Compute the Accounting Rate of Return

	Average annual operating income	Average amount invested	Accounting Rate of Return - ARR
	xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx	xxxxxxxxxxxxxx	xxxxxxxxxxxxxxxxx



Requirement 2	Compute the net present value of the investment using Excel's PV function.

	Period	Cash Flows
	1	(22,321)	Note: The first period is shown as an example.
	2	xxxxxxxx
	3	xxxxxxxx
	4	xxxxxxxx
	5	xxxxxxxx
	Present value of net cash flows	xxxxxxxx	Note: PV calculates the present value as a negative amount.
	Cost of Asset	xxxxxxxx
	Net Present Value	xxxxxxxx



Requirement 3	Compute the net present value of the investment using Excel's NPV function


	Present value of net cash flows	xxxxxxxxxx
	Cost of asset	xxxxxxxxxx
	Net Present Value	xxxxxxxxxx


Requirement 4	Compute the profitability index, rounded to two decimal places.

	Profitability index	xxxxxxxxxx


Requirement 5	Compute the internal rate of return of the investment using Excel's IRR function.
	Display to two decimal places, but do not round.

	IRR	xxxxxxxxx	Note: IRR requires a negative amount for the investment.

Places with xxxxx's are what needs to be filled in, and it's for excel so if I could see the references to which numbers and the formula used that would be helpful. Thank you!!

tanimpala296

RozzisRozzis

Construction is analyzing its capital expenditure proposals forthe purchase of equipment in the coming year. The capital budget islimited to

$ 5 comma 000 comma 000$5,000,000

for the year.

LindaLinda

BensonBenson?,

staff analyst at

RozzisRozzis?,

is preparing an analysis of the three projects underconsideration by

ChesterChester

RozzisRozzis?,

the? company's owner.

Requirement 1. Because the? company's cash is?limited,

RozzisRozzis

thinks the payback method should be used to choose between thecapital budgeting projects.

a. What are the benefits and limitations ofusing the payback method to choose between? projects?

Benefits of the payback? method:

Easy to understand and captures uncertainty about expected cashflows in later years of a project

Your answer is correct.

Indicates whether or not the project will earn the? company'sminimum required rate of return

Utilizes the time value of money and computes each? project'sunique rate of return

All of the above

Limitations of the payback? method:

Cannot be used when? management's required rate of return variesfrom one period to the next.

Cannot be used for projects with unequal periodic cash flows

Fails to incorporate the time value of money and does notconsider a? project's cash flows after the payback period

All of the above

Data Table:

Project A

Project B

Project C

Projected cash outflow

Net initial investment

$3,000,000

$2,100,000

$3,000,000

Projected cash inflows

Year 1

$1,200,000

$1,700,000

Year 2

1,200,000

600,000

1,700,000

Year 3

1,200,000

500,000

200,000

Year 4

1,200,000

100,000

Required rate of return

Requirements:

1.	Because the? company's cash is? limited, RozzisRozzis thinks the payback method should be used to choose between thecapital budgeting projects.
	a.	What are the benefits and limitations of using the paybackmethod to choose between? projects?
	b.	Calculate the payback period for each of the three projects. Ignoreincome taxes. Using the payback? method, which projects should RozzisRozzis ?choose?
2.	BensonBenson thinks that projects should be selected based on their NPVs. Assumeall cash flows occur at the end of the year except for initialinvestment amounts. Calculate the NPV for each project. Ignoreincome taxes.
3.	Which? projects, if? any, would you recommend? funding? Brieflyexplain why.

amaranthtrout588

ACCT 2230 Chapter Notes - Chapter 13: Net Present Value, Discounted Cash Flow, Capital Budgeting

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