View by Category

Loading...

PPT – Capital Budgeting and Cost Analysis PowerPoint presentation | free to download

The Adobe Flash plugin is needed to view this content

About This Presentation

Write a Comment

User Comments (0)

Transcript and Presenter's Notes

Capital Budgeting and Cost

Analysis

- AIM 4343 04/12/2004

Introduction

- Capital budgeting methods deal with how to

select projects (or programs) that increase

rather than decrease the capital (value) of

a business. - These methods assist managers in analyzing

projects that span multiple years.

Cost Analysis

- Life-cycle costing accumulates revenues and

costs on a project-by-project basis. - This accumulation extends the accrual accounting

system that measures income on a

period-by-period basis to a system that computes

cash flow or income over the entire project

covering many accounting periods.

Cost Analysis

Project D

Project C

Project B

Project A

2000

2001

2002

2003

2004

Cost Analysis

- The life of the project is usually longer than

one year, so capital budgeting decisions consider

revenues and costs over relatively long periods.

Capital Budgeting

- Capital budgeting is the making of long-run

planning decisions for investments in projects

and programs. - It is a decision-making and control tool that

focuses primarily on projects or programs that

span multiple years.

Capital Budgeting

- Capital budgeting is a six-stage process
- Identification stage. To distinguish which types

of capital expenditure projects are necessary to

accomplish organization objectives. - Search stage. To explore alternative capital

investments that will achieve organization

objectives.

Capital Budgeting

- Information-acquisition stage. To consider the

expected costs and the expected benefits of

alternative capital investments. - Selection stage. To choose projects for

implementation. - Financing stage. To obtain project funding.
- Implementation and control stage. To get projects

underway and monitor their performance.

Capital Budgeting

- Healthy Living is a non-profit organization.
- One of its goals is to improve the diagnostic

capabilities of its Miami facility. - Management identifies a need to consider the

purchase of new, state-of-the-art equipment. - The search stage yields several alternative

models, but management focuses on one machine as

being particularly suitable.

Capital Budgeting

- The administration next begins to acquire

information to do more detailed evaluation. - The required net initial investment consists of

the cost of the new machine (245,000) plus an

additional cash investment in working capital

(supplies and spare parts) of 5,000. - Management expects the new machine to have a

three-year useful life and a 0 terminal disposal

price at the end of the three years.

Capital Budgeting

- This proposed investment will yield net cash

savings of 125,000, 130,000, and 110,000 over

its life. - The working capital investment of 5,000 is

expected to be recovered at the end of year 3. - Operating cash flows are assumed to occur at the

end of the year.

Capital Budgeting

- Management also identifies the following

nonfinancial quantitative and qualitative

benefits of investing in the new diagnostic

machine. - Improved diagnoses and patient care
- Reduced inconvenience of transporting patients to

other facilities for diagnoses

Capital Budgeting

- Nonfinancial benefits are not incorporated into

the analysis. - In the selection stage, management must decide

whether Healthy Living should purchase the new

machine. - Assume that the required rate of return for

Healthy Living is 10.

Discounted Cash Flow

- Discounted cash-flow (DCF) methods measure all

expected future cash inflows and outflows of

a project as if they occurred at a single point

in time. - The discounted cash-flow methods incorporate the

time value of money.

Discounted Cash Flow

- The time value of money means that a dollar

received today is worth more than a

dollar received at any future time. - Why?
- Because it can earn income and become greater in

the future.

Net Present Value

- The NPV method computes the expected net

monetary gain or loss from a project by

discounting all expected cash flows to the

present point in time, using the required rate of

return. - Managements minimum desired rate of return is

also called the discount rate, hurdle rate,

required rate of return, or cost of capital.

Net Present Value

- Only projects with a zero or positive net present

value are acceptable. - What is the the net present value of the

diagnostic machine?

Net Present Value

Sketch of Relevant Cash Flows

0

1

2

3

Net initial investment

(250,000)

125,000

130,000

115,000

Annual cash inflow

Net Present Value

- Net Cash

NPV of Net Year 10 Col. Inflows

Cash Inflows - 1 0.909 125,000 113,625
- 2 0.826 130,000 107,380
- 3 0.751 115,000 86,365

Total PV of net

cash inflows 307,370 Investment 250,000

Net present value of project 57,370

Net Present Value

- This project is acceptable because its net

present value is 57,370. - Assume that Healthy Living is considering another

investment that will generate 80,000 per year

for three years, and have a residual value of

4,000 at the end of the third year.

Net Present Value

- The cost of this investment is 250,000 including

working capital. - The working capital investment of 5,000 is

expected to be recovered at the end of year 3. - Healthy Living expects a return of 10.
- Should the investment be made?

Net Present Value

- No, the net present value is negative.
- Net Cash

NPV of Net Years 10 Col. Inflows

Cash Inflows 1-3 2.487 80,000 198,960

3 0.751 9,000 6,759 Total

PV of net cash inflows 205,719 Investment

250,000 Net present value of project

(44,281)

Internal Rate of Return...

- is another model using discounted cash flows.
- The internal rate-of-return (IRR) method

calculates the discount rate at which the present

value of expected cash inflows from a project

equals the present value of expected cash

outflows.

Internal Rate of Return

- Investment Expected annual net cash inflow PV

annuity factor - Investment Expected annual net cash inflow

PV annuity factor

Internal Rate of Return

- Assume that Healthy Living is considering

investing 303,280 in a scanning machine that

will yield net cash savings of 80,000 per year

over its five-year life. - What is the IRR of this project?
- 303,280 80,000 3.791 (PV annuity factor)

Internal Rate of Return

- The annuity table shows that 3.791 is in

the 10 column for a 5 period row in this

example. - Therefore, 10 is the internal rate of return of

this project. - If the minimum desired rate of return is 10 or

less, Healthy Living should undertake this

project.

Comparison of NPV and IRR

- The NPV method has the important advantage that

the end result of the computations is expressed

in dollars and not in a percentage. - Individual projects can be added to see the

effect of accepting a combination of projects. - It can be used in situations where the required

rate of return varies over the life of the

project.

Comparison of NPV and IRR

- The IRR of individual projects cannot be added or

averaged to derive the IRR of a combination of

projects.

Relevant Cash Flows

- Relevant cash flows are expected future cash

flows that differ among the alternatives. - Capital investment projects typically have three

major categories of cash flows - Net initial investment
- Cash flow from operations
- Cash flow from terminal disposal of assets and

recovery of working capital

Relevant Cash Flows

- Typically, net initial investment components are
- Initial asset investment
- Initial working capital investment
- Current disposal value of old asset

Net Initial Investment

- The original Healthy Living example included the

following - Initial machine investment 245,000

Initial working capital investment 5,000

Current disposal value of old machine 0

Cash Flow From Operations

- Cash inflows may result from producing and

selling additional goods or services, or, as in

the Healthy Living example, from savings in cash

operating costs. - Depreciation is irrelevant in DCF analysis

because it is a noncash allocation of costs. - DCF is based on inflows and outflows of cash.

Terminal Disposal Price

- At the end of the machines useful life the

terminal disposal price may be zero or an amount

considerably less than the initial machine

investment. - The original Healthy Living example assumed zero

disposal value of the new diagnostic machine.

Working Capital Recovery

- The initial investment in working capital is

usually fully recouped when the project is

terminated. - The relevant working capital cash inflow is the

5,000 that Healthy Living will recover in year

3.

Payback Method

- Payback measures the time it will take to recoup,

in the form of expected future cash flows, the

initial investment in a project.

Payback Method

- Assume that Healthy Living is considering buying

some equipment (Machine 1) for 210,000, with an

estimated useful life of 10 years, and zero

predicted residual value. - Managers expect use of the equipment to generate

35,000 of net cash inflows from operations per

year.

Payback Method

- How long would it take to recover the investment?
- 210,000 35,000 6 years
- 6 years is the payback period.

Payback Method

- Suppose that an alternative to the 210,000 piece

of equipment, there is another one (Machine 2)

that also costs 210,000 but will save 42,000

per year during its five-year life. - What is the payback period?
- 210,000 42,000 5 years
- Which piece of equipment is preferable?

Payback Method

- Machine 1 is preferable because it will continue

to generate net cash inflows for four years

after its payback period. - This will give the company an additional net

cash inflow of 140,000.

Payback Method

- When cash flows are uneven, calculations must

take a cumulative form. - Assume that Healthy Livings diagnostic machine

investment is going to yield net cash savings

of 160,000, 180,000, and 110,000 over its

life. - The initial investment is 250,000.
- What is the payback period?

Payback Method

- Year 1 brings in 160,000.
- Recovery of the amount invested occurs in Year

2.

Payback Method

- Payback
- 1 year
- 90,000 needed to complete recovery 180,000

net cash inflow in Year 2 - 1 year 0.5 year 1.5 years or,
- 1 year and 6 months

Income-Tax Considerations

- Although depreciation is a noncash expense, it

is a deductible cost for calculating tax outflow. - Taxes saved as a result of depreciation

deductions increase cash flows in discounted

cash-flow (DCF) computations.

Income-Tax Considerations

- Assume Miami Transit is considering the

replacement of an old piece of equipment with

new, more modern equipment. - The income tax rate is 40.
- The company uses straight-line depreciation.
- The tax effects of cash inflows and outflows

occur at the same time that the inflows and

outflows occur.

Income-Tax Considerations

- Old equipment

Current book value 50,000

Current disposal price 3,000

Terminal disposal price

(5 years) 0

Annual depreciation 10,000 Working

capital 5,000

Income-Tax Considerations

- Current disposal price of

old equipment 3,000

Deduct current book value

of old equipment 50,000

Loss on disposal of equipment 47,000 - How much is the tax savings?
- 47,000 0.40 18,800

Income-Tax Considerations

- What is the after-tax cash flow from current

disposal of old equipment? - Current disposal price 3,000

Tax savings on loss 18,800

Total 21,800

Income-Tax Considerations

- New equipment

Current book value 225,000

Current disposal price is irrelevant

Terminal disposal price (5 years)

0 Annual depreciation 45,000 Working

capital 15,000

Income-Tax Considerations

- How much is the net investment for the new

equipment? - Current cost 225,000 Add

increase in working capital 10,000 Deduct

after-tax cash flow from current

disposal of old equipment 21,800 Net

investment 213,200

Income-Tax Considerations

- Assume 90,000 pretax annual cash flow from

operations (excluding depreciation effect). - What is the after-tax flow from operations?
- Cash flow from operations 90,000 Deduct income

tax (40) 36,000 Annual after-tax flow from

operations 54,000

Income-Tax Considerations

- What is the difference in depreciation deduction?
- Annual depreciation of new

equipment 45,000 Deduct annual depreciation

of old equipment

10,000 Difference 35,000

Income-Tax Considerations

- What is the annual increase in income tax savings

from depreciation? - Increase in depreciation 35,000

Multiply by tax

rate .40 Income tax cash

savings from

additional depreciation 14,000

Income-Tax Considerations

- What is the cash flow from operations, net of

income taxes? - Annual after-tax flow from

operations 54,000 Income tax cash savings

from additional

depreciation 14,000 Cash flow from

operations, net

of income taxes 68,000

Income-Tax Considerations

- Miami Transit requires 14 rate of return on

its investments. - What is the net present value of the new

equipment incorporating income taxes?

Income-Tax Considerations

- Net Cash

NPV of Net Years 14 Col. Inflows

Cash Inflows - 1-5 3.433 68,000 233,444
- 5 0.519 10,000 5,190

Total PV of net cash inflows 238,636

Investment 213,200 Net present value of

new equipment 25,436

Postinvestment Audit

- A postinvestment audit compares the actual

results for a project to the costs and benefits

expected at the time the project was selected. - It provides management with feedback about

performance.

Intangible Assets

- Intangible assets are critical to most

organizations. - These assets have the potential to yield net cash

inflows many years into the future. - Top management can use a capital budgeting tool,

such as NPV, to summarize the difference in the

future net cash inflows from an intangible asset

at two different points in time.

About PowerShow.com

PowerShow.com is a leading presentation/slideshow sharing website. Whether your application is business, how-to, education, medicine, school, church, sales, marketing, online training or just for fun, PowerShow.com is a great resource. And, best of all, most of its cool features are free and easy to use.

You can use PowerShow.com to find and download example online PowerPoint ppt presentations on just about any topic you can imagine so you can learn how to improve your own slides and presentations for free. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free. Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world. Or use it to create really cool photo slideshows - with 2D and 3D transitions, animation, and your choice of music - that you can share with your Facebook friends or Google+ circles. That's all free as well!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

You can use PowerShow.com to find and download example online PowerPoint ppt presentations on just about any topic you can imagine so you can learn how to improve your own slides and presentations for free. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free. Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world. Or use it to create really cool photo slideshows - with 2D and 3D transitions, animation, and your choice of music - that you can share with your Facebook friends or Google+ circles. That's all free as well!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

presentations for free. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free. Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world. Or use it to create really cool photo slideshows - with 2D and 3D transitions, animation, and your choice of music - that you can share with your Facebook friends or Google+ circles. That's all free as well!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

Recommended

«

/ »

Page of

«

/ »

Promoted Presentations

Related Presentations

We were unable to find related items.

Page of

Page of

CrystalGraphics Sales Tel: (800) 394-0700 x 1 or Send an email

Home About Us Terms and Conditions Privacy Policy Contact Us Send Us Feedback

Copyright 2014 CrystalGraphics, Inc. — All rights Reserved. PowerShow.com is a trademark of CrystalGraphics, Inc.

Copyright 2014 CrystalGraphics, Inc. — All rights Reserved. PowerShow.com is a trademark of CrystalGraphics, Inc.

The PowerPoint PPT presentation: "Capital Budgeting and Cost Analysis" is the property of its rightful owner.

Do you have PowerPoint slides to share? If so, share your PPT presentation slides online with PowerShow.com. It's FREE!

Committed to assisting Utdallas University and other schools with their online training by sharing educational presentations for free