Capital Investment Analysis CHAPTER 15 2014 Cengage Learning

Capital Investment Analysis CHAPTER 15 © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objectives After studying this chapter, you should be able to: • • • Explain the nature and importance of capital investment analysis Evaluate capital investment proposals using the average rate of return and cash payback methods Evaluate capital investment proposals using the net present value and internal rate of return methods List and describe factors that complicate capital investment analysis Diagram the capital rationing process © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objective 1 Explain the nature and importance of capital investment analysis © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Capital Investment Analysis • Process by which ______ plans, evaluates, and controls investments in fixed assets • Also called ________ • Capital investment decisions are very important for the long-term success of a business © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Methods of Evaluating Capital Investment Proposals • Methods that do not use present values: • __________________ • Methods that use present values • __________________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objective 2 Evaluate capital investment proposals, using the average rate of return and cash payback methods © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Methods That Ignore Present Value • Often used to initially _____ proposals • Useful for proposals with relatively short useful lives because the _____ of cash flows is less important © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Average Rate of Return • Measures the average annual income as a percent of the average investment • Also called the ________ Avg. Rate of Return = Average Investment = + © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Average Rate of Return Avg. Rate of Return = __% $200, 000/4 = ($500, 000 cost + $0 residual)/2 © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Average Rate of Return • If the average rate of return equals or exceeds the company’s _____, the project should be accepted • Advantages: • Easy to compute • ____________________ • Disadvantage: • __________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Cash Payback Method • Cash Payback Period: Expected period of time between the date of an investment and _________________ • ______: Excess of cash flowing in from revenue over the cash flowing out for expenses Cash Payback Period = © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Cash Payback Method Cash Payback Period = _ years = $_______ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Cash Payback Method • If annual cash flows are not equal, the payback period is determined by adding the annual net cash flows until the investment is recovered © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Cash Payback Method • Advantages: • ___________ • _______ payback period is desirable • ____________________ • Disadvantages: • _____________________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objective 3 Evaluate capital investment proposals using the net present value and internal rate of return methods © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Present Value Considerations • Uses both the amount and _______ of cash flows to evaluate an investment • Present value of an amount – the value of $1 today is worth ____ than $1 received in a future date, because today’s $1 can be invested and earn interest • ___________ – sum of the present values of a series of equal cash flows at fixed time intervals © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Time Value of Money © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Present Value Method • Present value tables help us calculate present values for _____ and ______ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Present Value of an Annuity Calculations • Cash Inflow Timeline and Present Value © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Present Value of an Annuity Calculations • Present value tables help us calculate present values for annuities and single sums © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Net Present Value Method • Analyzes capital investment proposals by comparing the initial cash investment with the ___________ • Also called _________ method • The return rate is set by management – often called the ______ rate • If the net present value expected from an investment equals/exceeds the initial investment, the project is ____ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Net Present Value Method • Net present value analysis for the purchase of a $200, 000 machine with a 5 -year useful life. Minimum rate of return is 10% © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Present Value Index • If multiple proposals are being considered, use of the present value index can help determine which projects to accept Present Value Index = © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Internal Rate of Return • Uses _______ concepts to compute the rate of return from the net cash flows expected from capital investment proposals • Also called the _________ method • Starts with net cash flows and works backward to determine the _______ expected from the project © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Internal Rate of Return © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Internal Rate of Return _________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Internal Rate of Return • Trial-and-error procedures are time-consuming. When __________ are expected, the calculation can be simplified © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Internal Rate of Return • When the internal rate of return _____ a company’s cost of capital, the proposal should be considered for acceptance • Advantages: • ____________________________ • Disadvantages: • Computations are more complex • ___________________________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objective 4 List and describe factors that complicate capital investment analysis © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Factors That Complicate Capital Investment Analysis • • • Income tax Proposals with ______ Lease versus ________________ © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Learning Objective 5 Diagram the capital rationing process © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Capital Rationing • The process by which management allocates _____ among competing capital investment proposals • The proposals that meet all _____ (financial) and _____ tests should be ranked for funding • Unfunded proposals may be reconsidered if funds become available later © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Capital Rationing Decision Process Continued… © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Capital Rationing Decision Process …continued © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

End of Chapter 15 © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.