CAPITAL INVESTMENT

21/10/2022 ntaldon 1
 TOTAL CAPITAL INVESTMENT

• The sum of the fixed-capital investment

and the working capital is known as the
total capital investment.

FCl + WC = TCI

21/10/2022 ntaldon 2
 CAPITAL INVESTMENT

• FIXED CAPITAL
The capital needed to supply the
necessary manufacturing and plant
facilities

• WORKING CAPITAL
The capital necessary for the
operation of the plant

21/10/2022 ntaldon 3
 FIXED CAPITAL INVESTMENT
Before an industrial plant can be put into operation, a
large amount of money must be supplied to purchase
and install the necessary machinery and equipment.
Land and service facilities must be obtained, and the
plant must be erected complete with all piping,
controls and services. In addition, it is necessary to
have money available for the payment of expenses
involved in the plant operation.

The fixed-capital portion may be further subdivided

into
• manufacturing fixed-capital investment and
21/10/2022 • non-manufacturing fixed-capital
ntaldon investment. 4
 FIXED CAPITAL INVESTMENT

 Manufacturing fixed-capital investment

represents the capital necessary for the
installed process equipment with all
auxiliaries that are needed for complete
process operation.
 Expenses for piping, instruments,
insulation, foundations, and site
preparation are typical examples of costs
included in the manufacturing fixed-
capital investment.
21/10/2022 ntaldon 5
 WORKING CAPITAL

• The working capital for an industrial plant consists of the total amount of
money invested in
1. raw materials and supplies carried in stocks,
2. finished products in stock and semi-finished products in the process of
being manufactured,
3. accounts receivable,
4. cash kept on hand for monthly payment of
operating expenses, such as salaries, wages, and
raw-materials purchases,
5. accounts payable, and
6. taxes payable.

21/10/2022 ntaldon 6
 ACCOUNTING FUNDAMENTALS
• Assets = liabilities + owner’s equity

 Where:
 assets _are those things of monetary value that the firm possesses,
 liabilities _are those things of monetary value that the firm owes, and
 owner’s equity _is the worth of what the firm owes to the
stockholders (also referred to as equities, net worth, etc.)

• Basic Engineering Accounting Terms:

 Revenue = total income (or total savings)
 Gross profits = Net sales – Costs of Sales
 Net profits = Gross Profits - income tax
 Income tax = (Gross Profits) ( tax rate)
 Cash flow = Net Profits + Depreciation

21/10/2022 ntaldon 7
 FINANCIAL STATEMENTS

• INCOME STATEMENT

• CASH FLOW

• BALANCE SHEET

21/10/2022 ntaldon 8
 A. Income Statement
• The income statement is a computation of the
project’s total revenue and total costs for one period
of fiscal year

• Gross Profit (loss) = Revenues – Expenses

= net Sales – cost of Sales

• Net Profit = Gross Profit- Income Tax

21/10/2022 ntaldon 9
 Pro-f orma Income Statements
Y ears ending: 31 December

1st year 2nd year 3rd year

P ro ductio n (in Units) 308,000 300,000 300,000

A dd: Invento ry, beginning (8,000) (8,000)
Units available fo r sale 308,000 308,000 308,000
Less: Invento ry investments (8,000) (8,000) (8,000)
Sales, gro ss 300,000 300,000 300,000
Sales, gro ss (in P ) 750,000 789,000 828,000
Less: sales returns and allo wances (60,000) (63,120) (66,240)
sales disco unts (15,000) (15,780) (16,560)
Sales, net 675,000 710,100 745,200

Co st o f sales:
Raw materials:
P urchases 57,500 56,160 58,890
A dd: freight in 420 441 463
To tal purchases 57,920 56,601 59,353
A dd:invento ry beginning 5,000 6,000
Co st o f raw materials available fo r use 57,920 61,601 65,353
Less: Invento ry, ending (5,000) (6,000) (7,000)
Co st o f raw materials 52,920 55,601 58,353
A dd: Direct labo r 17,280 18,144 19,051
Overhead:
Indirect materials 113,009 118,659 124,632
Indirect labo r 13,200 13,860 14,553
Heat, light and po wer 50,640 25,162 26,764
M aintenance 7,126 7,126 7,126
Supplies 10,499 11,010 11,471
Depreciatio n 43,010 43,010 43,010
Taxes 2,600 2,600 2,600
Insurance, etc. 4,751 3,819 2,887
M anufacturing co sts 315,035 298,991 310,447
A dd: Go o ds-in pro cess invento ry, begnng 9,000 10,000
Less:Go o ds- inpro cess invento ry, ending (9,000) (10,000) (11,000)
Co sts o f go o ds available fo r sale 306,035 297,991 309,447

A dd: finished-go o ds invento ry, beginning 20,000 21,000

Co sts o f go o ds available fo r sale 306,035 317,991 330,447
Less: finished-go o ds invento ry, ending (20,000) (21,000) (22,000)
Co sts o f sales 286,035 296,991 308,447

21/10/2022 Gro ss pro fit

ntaldon 388,965 413,109 436,753
10
 Gro ss pro fit 388,965 413,109 436,753
Operating expenses: 1s t year 2nd year 3rd year
General and administrative salaries:
General and administrative salaries36,480 38,304 40,220
Fringe benefits 6,511 6,794 7,051
Research and develo pment 180 189 198
Engineering co sts 36,387
Depreciatio n 3,600 3,600 3,600
Taxes
Insurance
Office supplies 5,520 6,012 6,550
Heat, light and po wer 114 120 126
Telepho ne 768 806 846
Water supply
M iscellaneo us: A mo rtizatio n 700 700 700
To tal 90,260 56,525 59,291

Selling expenses:
Salaries 7,439 7,794 8,168
Sto rage o f go o ds 16,620 17,451 18,324
B illing
Transpo rtatio n
P ublic relatio ns
A dvertisment, sales taxes 43,188 45,435 47,681
M iscellaneo us: bad debts 13,500 14,202 14,904
To tal 80,747 84,882 89,077

Operating expenses 171,007 141,407 148,368

Operating pro fit 217,958 271,702 288,385

Financial expenses (net o f o ther inco me):

Interest 28,506 27,714 24,546
B o rro wing co sts
To tal 28,506 27,714 24,546

P ro fit befo re inco me tax 189,452 243,988 263,839

P ro visio n fo r inco me tax (56,308) (75,396) (82,344)

Net inco me (net lo st) 133,144 168,592 181,495

A dd: Retained earnings, beginning 35,106 105,660

Less: Cash dividends, declared (98,038) (98,038) (98,038)

21/10/2022 Retainend earnings, ending ntaldon 35,106 105,660 189,117 11
 CASH FLOW

• The cash-flow statement or the” cash budget” is a

systematic presentation of cash receipts and
disbursements for a given operating period or fiscal
year,

• The budget is used to estimate future loans or financing

needs, optimize the timing of project financing, and
maximize profitability by efficient cash utilization.

21/10/2022 ntaldon 12
 CASH FLOW
• Cash receipts are subdivided into those which flow from financing the
project and those coming from sales revenues.
• Cash flow from financing may take the form of stocks issued including
stock premium or discount being closed, the net of the latter two
accounts being closed to the “paid-in surplus” account; bond issues:
and long-terms loans.
• In computing for cash in-flows from sales revenues; the “profit – before-
income tax” account is entered in the budget, and this is increased to
the period such as depreciation and amortization.
• Other account which increase the entries are increases in account
payable, accrued expenses, and deferred income.
• b. Under cash disbursement, out-of-pocket expenses on intangible
assets acquisition are entered. Other account included here are
decreases in account payable, notes payable, bank-drafts payable,
accrued expenses, mortgage bonds payable and long-terms notes
receivable, inventories, and investment. Cash dividends issued and
income tax payments also comprise cash disbursements.
• The beginning cash balance for the period is then added to the net cash
flow to arrive at ending cash balance in the balance sheet. It should be
noted that all accounts entered in the cash budget should tally with the
same account in the income statement and balance sheet.
21/10/2022 ntaldon 13
 Pro-formal cash-flow statements
Years ending 31 December
(in pesos)
CASH RECEIPTS: 1st year 2nd year 3rd year
Common stocks issued 400,000
Preffered stocks issued 90,192
Paid-in surplus
Mortgage bonds payable-increases 11,151
Long-term notes payable-increases 200,000
Total receipts from financing 701,343
Profit before income tax 189,452 243,988 263,839
Add: Depreciation of fixed assest 46,610 46,610 46,610
Amortization of pre-paid expenses
Amortization of deferred charges
Amortization of intangible assets 700 700 700
Other non-out-of-pocket expenses
Accounts payable 6,394
Notes payable-increases 20,000
Bank drafts payable-increases
Accrued expenses-increases
Deferred income-increases
Total inflow from production,
operations and financial accounts 263,156 291,298 311,149
TOTAL ASSUMED CASH RECEIPTS 964,499 291,298 311,149

21/10/2022 ntaldon 14
 TOTAL ASSUMED CASH RECEIPTS 964,499 291,298 311,149

CASH DISBURSEMENTS: 1st year 2nd year 3rd year

Expenses on intangible assets (Out of Pocket)
Good will
Patents 500
Copyrights
Leases
Licenses 500
Franchises 500
Organization and pre-operating expenses 2,000
Acquisitions of fixed assets (out-of-pocket):
Land 200,000
Buildings 60,000
Equipment 77,545
Machinery 100,000
Accounts payable-decreases
Notes payable-decreases
Bank drafts payable-decreases
Accrued expenses-decreases
Treasury stocks-increases
Mortgage bonds payable-decreases 1,394 1,394
Long-term notes payable-decreases 25,000 25,000
Cash dividends issued 98,038 98,038
Marketable securities-increases 85,507 78,196 89,297
Accounts receivable-increases 317,520 16,511 16,511
Notes receivable-increases
Inventories-increases:
Raw materials 5,000 1,000 1,000
Supplies 2,000 1,000 1,000
Goods in process 9,000 1,000 1,000
Finished goods 20,000 1,000 1,000
Income tax payments 56,308 75,396
Investment-increases (pre-paid and deferred charges) 2,000 2,000 2,000
TOTAL CASH DISBURSEMENTS 882,072 281,447 311,636
NET CASH FLOW (Net cash deficit) = receipts - disbursements 82,427 9,851 (487)
Add: balance, beginning 82,427 92,278
CASH BALANCE, ENDING 82,427 92,278 91,791

21/10/2022 ntaldon 15
 BALANCE SHEET
The balance sheet shows the assets derived by the
project from corresponding liabilities and equities
(net worth).It is an overall picture of a film’s financial
condition as of a certain time.
• Comprising the asset portion of the statement are
current asset, fixed asset, and intangible assets.

• Assets = liabilities + owner’s equity

21/10/2022 ntaldon 16
 BALANCE SHEET
Current assets _ to those type with are either cash account or other
account expected to be converted into cash with one year. The item
listed in this division are of course cash, marketable securities,
receivables, inventories, prepaid expense, and deferred change. The
latter two accounts signify cash expenditures for the services of a
creditor not yet received in full by the project in question, such as
pre- paid insurance.

• Fixed assets _ are the tangible assets of an enterprise of an

enterprise, the service life of which usually extends to over one year.
Land, building, machinery, and equipment are typical example of
fixed assets. The balance sheets or book value of these assets are
derived by subtracting their accumulated depreciation from their
cost of acquisition, depreciation being the portion of cost allocated
to one fiscal period.

• Intangible assets _service life, like fixed will, patents, copyrights,

leases, licenses, franchises, and organization and pre-operation
expenses fall under other assets. When an intangible asset is
amortized, the accumulated amortization account is not entered in
the balance sheet, which contains only the net book value of assets
21/10/2022
in this category. ntaldon 17
 • Intangible assets _ have not physical substance.
Examples are, goodwill, leaseholds, copyrights,
patents, franchises, licenses, and trademarks.
Accounting for an intangible asset is rendered
somewhat difficult because the lack of physical
substance makes evidence of its existence more
elusive, may make its value debatable and its useful
life may be questionable.

21/10/2022 ntaldon 18
 LIABILITIES
_ are debts or claims anyone other than the owners
of the property upon the assets of the company.

• Current liabilities:
Accounts payable ,Notes payable, Bank-drafts
payable , Estimated tax liability, Accrued expenses
(Dividends payable):

• Other liabilities:
Mortgage bonds payable ,Long-term notes
payable
21/10/2022 ntaldon 19
 OWNER’S EQUITY
• COMMON STOCK
_. represents the ownership of stockholders who have residual
claim on the assets of the corporation after all other claims have
been settled. No return is guaranteed on the investment of
common stockholders. They have the right to call meetings, to
vote, to elect members of the board of directors, amend charter
and constitution and by-laws, inspect books of the corporation,
receive dividends, share remaining assets if corporation is
dissolved
• PREFERRED STOCK
_ also represent ownership. And it possesses the same rights as
common stock, but in addition, it enjoys certain preferences, not
possessed by common stock. It has priority over common stock
in receipt of dividends, and it is usually guaranteed a fixed
annual dividend, regardless of the amount of the earnings of the
corporation. In case the corporation is dissolved, the owner of
the preferred stock, has priority over the common stockholders.
They may have right to vote in meetings.
21/10/2022 ntaldon 20
 BALANCE SHEET (in pesos)

ASSETS: 1st year 2nd year 3rd year

Current assets
Cash 82,427 92,278 91,791
M arketable securities 85,507 163,703 253,000
Account receivable, net 317,520 334,031 350,542
Notes receivable
Inventories
Raw materials 5,000 6,000 7,000
Supplies 2,000 3,000 4,000
Goods-in-process 9,000 10,000 11,000
Finished goods 20,000 21,000 22,000
Pre- paid expenses 1,000 2,000 3,000
Deferred charges 1,000 2,000 3,000
Tota current assets 523,454 634,012 745,333

Fixed assets:
Land 200,000 200,000 200,000
Building 60,000 60,000 60,000
Equipment 77,545 77,545 77,545
M achinery 100,000 100,000 100,000
Total fixed assets, 437,545 437,545 437,545
Less:accumulated depreciation (46,610) (93,220) (139,830)

21/10/2022 Total fixed assets,

ntaldonnet 390,935 344,325 297,715 21
 1st year 2nd year 3rd year
Other assets:
Investments
Intangible assets, net of amortization:
Goodwill
Patents 400 300 200
Copyrights
Lease
Licenses 400 300 200
Franchises 400 300 200
Organization and pre-operating expenses 1,600 1,200 800
Total other assets 2,800 2,100 1,400

TOTAL ASSETS (current, fixed, other) 917,189 980,437 1,044,448

LIABILITIES AND EQUITY:

Current liabilities
Accounts payable 6,394 6,394 6,394
Notes payable 20,000 20,000 20,000
Bank-drafts payable
Estimated tax liability 56,308 75,396 82,344
Accrued expenses:
Dividends payable 98,038 98,038 98,038
Deferred income
Total current liabilities 180,740 199,828 206,776
Other liabilities:
Mortgage bonds payable 11,151 9,757 8,363
Long-term notes payable 200,000 175,000 150,000
Total other liabilities 211,151 184,757 158,363

TOTAL LIABILITIES 391,891 384,585 365,139

OWNER'S EQUITY:
Common stocks 400,000 400,000 400,000
Preferred stocks 90,192 90,192 90,192
Less: treasury stocks
Paid-in surplus
Retained earnings 35,106 105,660 189,117
TOTAL EQUITIES 525,298 595,852 679,309

TOTAL LIABILITIES AND EQUITY 917,189 980,437 1,044,448

21/10/2022 ntaldon 22
 EBITDA
• EBITDA_ an initialism for earnings before interest, taxes,
depreciation, and amortization. It is a non-GAAP (generally
accepted accounting principles) metric that is measured exactly as
stated. All interest, tax, depreciation and amortization entries in the
income statement are reversed out from the bottom-line net
income. It purports to measure cash earnings without accrual
accounting, canceling tax-jurisdiction effects, and canceling the
effects of different capital structures.
• EBITDA differs from the operating cash flow in a cash flow
statement primarily by excluding payments for taxes or interest as
well as changes in working capital.
• EBITDA also differs from free cash flow because it excludes cash
requirements for replacing capital assets (capex). EBITDA margin
refers to EBITDA divided by total revenue. EBITDA margin measures
the extent to which cash operating expenses use up revenue.
• Use by debtholders_EBITDA is widely used in loan covenants. The
theory is that it measures the cash earnings that can be used to pay
interest and repay the principal. Since interest is paid before income
tax is calculated, the debtholder can ignore taxes. They are not
interested in whether the business can replace its assets when they
wear out, therefore can ignore capital amortization and
depreciation.
21/10/2022 ntaldon 23
 PROFITABILITY ANALYSIS

21/10/2022 ntaldon 24
 Minimum Acceptable Rate of Return (MARR)
• Also known as Minimum Attractive Rate of Return or known as
hurdle rate, the interest rate used in the valuation of
profitability of a project in Present Worth, Future Worth and
Annual Worth Methods.

• It is usually a policy issue by the top management of an

organization in view of the following considerations:
 The amount of money available for investment,
 Number of good projects available for investment,
 The amount of perceived risk associated with investment opportunities
available and
 Type of organization involved.

• In business and engineering, the minimum acceptable rate of

return, often abbreviated MARR, or hurdle rate is the
minimum rate of return on a project a manager or company is
willing to accept before starting a project, given its risk and the
opportunity cost of forgoing other projects.

21/10/2022 ntaldon 25
 Minimum Acceptable Rate of Return (MARR); Hurdle Rate
• The hurdle rate is usually determined by evaluating existing
opportunities in operations expansion, rate of return for
investments, and other factors deemed relevant by
management.
• A risk premium can also be attached to the hurdle rate if
management feels that specific opportunities inherently
contain more risk than others that could be pursued with the
same resources.
• A common method for evaluating a hurdle rate is to apply the
discounted cash flow method to the project, which is used in
net present value models.
• The hurdle rate determines how rapidly the value of the dollar
decreases out in time, which, parenthetically, is a significant
factor in determining the payback period for the capital
project when discounting forecast savings and spending back
to present-day terms.
21/10/2022
• ntaldon 26
 Minimum Acceptable Rate of Return (MARR);
Hurdle Rate
• Most companies use a 12% hurdle rate, which is
based on the fact that the S&P 500 typically yields
returns somewhere between 8% and 11%
(annualized). Companies operating in industries with
more volatile markets might use a slightly higher
rate in order to offset risk and attract investors.

• The hurdle rate is frequently used as synonym of

cutoff rate, benchmark and cost of capital.

21/10/2022 ntaldon 27
 SAMPLE PROBLEMS; ROI

Given: Investment Total Investment Net profit

1 P 100,000 P 23,000

2 P 150,000 P 28,000

3 P 180,000 P 37,000

Required: Select the best alternative if minimum acceptable return on investment

required is 10%
Solution:
ROI based on initial total investment:

ROI1 
 23, 000  100  23%  10%, ok
100, 000
28, 000
ROI 2  100  18.67%  10%, ok
150, 000
37,000
> ROI3= 180,000 = 20.56%?10% ok
21/10/2022 ntaldon 28
 All three investments passed the MARR therefore evaluate the investments using ROI based on
incremental investment:

• Comparing 1 and 2
Additional investment of P50,000 will yield additional
net profit of P5,000)

ROI1 2 
 28, 000  23, 000  100  10%, ok
150, 000  100, 000  investment 2 is better than 1

• Comparing 2 and 3;
Additional investment of P30,000 will yield additional
net profit of P9,000)

ROI 23 
 37, 000  28, 000  100  30%  10%, ok
180, 000  150, 000  Therefore, select # 3

21/10/2022 ntaldon 29
 2. Annual Cost Method
The annual cost of the alternatives including the
minimum return on investment is determined. The
alternative with the least annual cost is chosen. This
method, like the rate of return on investment
method, applies only to alternatives which have a
uniform cost data for each year and a single
investment of capital at the beginning of the project
life.
Typical cost factors
a. Depreciation Costs(usually as sinking fund)
b. Annual Operating Costs
c. Annual Labor Costs
d. Insurance and Taxes
e. Other Costs
f. Return on Investment or Cost of Money
Total Annual Costs
21/10/2022 ntaldon 30
 • A company is considering two types of equipment for its new plant. The
following data are given:
If the minimum return on investment is 15%, which equipment should
be selected using
a. Annual Cost Method?
b. ROI

Equipment A Equipment B
First Cost P 2.0 M P 3.0 M
Annual Operating Cost/yr P 350,000 P 250,000
Annual Labor Cost/yr P 500,000 P 350,000
Insurance and Taxes/yr 3.5% of First Cost 3.5% of First Cost
Other Cost/yr 8% of first Cost 8% of First Cost
Salvage Value P200,000 P300,000
Estimated life 10 years 10 years

ntaldon 21/10/2022 31
21/10/2022 ntaldon 32
 3. Discounted Cash Flow,
Minimum Internal Rate of Return (MIRR)
• The method of approach for discounted cash flow takes into account the time value
of money and is based on the amount of the investment that is unreturned at the
end of each year during the estimated life of the equipment.

• Thus, the rate of return by this method is equivalent to the maximum interest rate
(normally after taxes) at which money could be borrowed to finance the project over
its life that would just be sufficient to pay all principal and interest accumulated on
the outstanding principal.

• The discount rate reflects two things:

1. The time value of money - investors would rather have cash immediately than
having to wait and must therefore be compensated by paying for the delay.
2. A risk premium - reflects the extra return investors demand because they want
to be compensated for the risk that the cash flow might not materialize after
all.

21/10/2022 ntaldon 33
 3. Discounted Cash Flow,
Minimum Internal Rate of Return (MIRR)
• Internal Rate of Return is the most widely used rate of return method for
performing engineering economic analyses. It is sometimes called by
several names, such as the investor’s method, the discounted cash flow
method, and the profitability index. Also means that the value of this
measure depends only on the cash flows from an investment and not on
any assumptions about reinvestment rates.

• The internal rate of return (IRR) is a rate of return used in capital budgeting
to measure and compare the profitability of investments. It is also called
the discounted cash flow rate of return (DCFROR) or simply the rate of
return (ROR). In the context of savings and loans the IRR is also called the
effective interest rate. The term internal refers to the fact that its
calculation does not incorporate environmental factors (e.g. the interest
rate).
• The internal rate of return is the rate of return promised by an investment
project over its useful life. It is some time referred to simply as yield on
project. The internal rate of return is computed by finding the discount rate
that equates the present value of a project's cash out flow with the present
value of its cash inflow In other words, the internal rate of return is that
discount rate that will cause the net present value of a project to be equal
to zero.
CF1 CF2 CFn
Total Capital Investment    ... 
1  i  1  i 
1 2
1  i n
21/10/2022 ntaldon 34
 Sample Problem: Discounted Cash Flow
• Compute for the IRR given by the sequence of cash
flows Year Cash Flow
0 -100
1 40
2 59
3 36
4 55
5 20
SOLUTION:

40 59 36 55 20
0  100     
1  i 1 1  i 2 1  i 3 1  i 4 1  i 5
40 59 36 55 20
100     
1  i 1 1  i 2 1  i 3 1  i 4 1  i 5
i  33.63%
21/10/2022 ntaldon 35
 SAMPLE PROBLEM : Discounted Cash-flow, IRR

Given: Initial Fixed-Capital Investment = P100,000

Working capital Investment = P10,000
Service life = 5 years
Salvage value @ the end of service life = P10,000

Required: Internal Rate of Return (IRR)

Solution:
YEAR Cash-flow, P

1 30,000
2 31,000
3 36,000
4 40,000
5 43,000

30,000 31,000 36,000 40,000 43,000 10,000  10,000

110,000      
1  i  1  i  1  i  1  i  1  i 
1 2 3 4 5
1  i 5
i  20.72%

21/10/2022 ntaldon 36
 Present Worth (Net Present Worth)

The difference between the present value of the annual cash flows (CF)
and the total initial investment (TCI). If the present worth of the net cash flow is
equal to or greater than zero, the project is justified economically.
CF1 CF2 CFn
NPW    ..   TCI
1  i  1  i 2
1  i n

SAMPLE PROBLEM

GIVEN:
Total Fixed Working Salvage Value Service Annual
Capital capital life, years Cash flow
P 100,000 P 11,000 P10,000 6 P 36,000

Required: Net Present Value,

i=12% CF1 CF2 CFn
Solution: Net Pr esent Worth    ..   FC
1  i  1  i 2 1  i 
n

 1  0.12 6  1  11, 000  10, 000 

 36, 000    100, 000  11, 000   47, 650
  0.12 1  0.12   1  0.12 
6 6

21/10/2022 ntaldon 37
 Future Worth Method
This method is comparable to the present worth method except that
all cash inflows and outflows are compounded forward to a reference point in
time called the future. If the future worth of the net cash flow is equal or greater
than zero, the project is justified economically.

NFW  CF1 1  i   CF2 1  i   ..  CFn  TCI 1  i 

n 1 n2 n

21/10/2022 ntaldon 38
 GIVEN:

Total Fixed Working Salvage Value Service Annual

Capital capital life, years Cash flow
P 100,000 P 11,000 P10,000 6 P 36,000

Required: Net Future Value, i=12%

Solution:


NFW  36,000  1.12  1
6

 21,000  111,0001.12
6
 94,052.49
0.12

21/10/2022 ntaldon 39
 Pay-out Period, N
This method determines the number of years within which the invested capital can be
recovered out of the expected cash flow. It does not consider the possible earnings of the
reinvested capital during the pay-put period.

A. Without Interest Depreciable Fixed Capital Investment

N
AverageCashFlow / yr

Fixed Capital Investment  SalvageValue

N
AverageNet Pr ofit / yr  AverageDepreciation/ yr

Depreciable Fixed Capital Investment  Interest On Total Investment

N
Average CashFlow / yr
B. With Interest

N

DFCI  TCI 1  i   1
n

AverageNet Pr ofit / yr  AverageDepreciation / yr as annuity

Note: Depreciable Fixed Capital Investment= Fixed Capital Investment- Salvage Value
21/10/2022 TCI=Total capital Investment=Fixed Capital
ntaldon Investment +Working Capital 40
 SAMPLE PROBLEM: PAY-OUT PERIOD

Given:
Total fixed Working Salvage Value Service Life, Net Profit/yr
capital capital years

P 100,000 P 11,000 P 10,000 6 P21,000

Required: Pay-out Period, N, without interest

Solution: Depreciable Fixed Capital Investment

N=
 Net Profit+ Depreciation ave
year

100,000  10,000
Annual Dep   15,000
6

N
100,000  10,000  2.5 years
21,000 15,000

21/10/2022 ntaldon 41
 SAMPLE PROBLEM: PAY-OUT PERIOD

• Given:
Total fixed Working Salvage Service Life, Net Profit
capital capital Value years

P 100,000 P 11,000 P 10,000 6 P21,000

Required: Pay-out Period, N, with interest; i = 10% pa

Solution: Depreciable Fixed Capital Investment  Interest On Total Investment

N
Average CashFlow / yr
 
d  FC  SV 
i

 1  i   1
L

 0.10 
 100,000  10,000   11,664.66
 1.10 6
 1 

100, 000  10, 000   100, 000  11, 000  1.10   1

6

N   5.4 years
21, 000  11, 664.66

21/10/2022 ntaldon 42
 SAMPLE PROBLEM: PAY-OUT PERIOD

• Given:
Total Fixed Working Salvage Value Service Annual
Capital capital life, years Cash flow
P 100,000 P 11,000 P10,000 6 P 36,000

Required: Pay-out Period, N, with interest; i = 10% pa

Solution:
Depreciable Fixed Capital Investment  Interest On Total Investment
N
Average CashFlow / yr

N
 
100,000  10,000  100,000  11,000 1.10  1
6
 4.88 years
36,000

21/10/2022 ntaldon 43
 Capitalized Cost, K (Perpetuity)
The total amount of money that must be available initially to purchase the equipment and
simultaneously provide funds for interest accumulation to permit perpetual replacement of the
equipment.
In perpetuity, the amount required for replacement must be earned as compounded
interest over a given length of time. Let P be the amount of present principal or present worth
which can accumulate to an amount F during the interest periods at periodic interest i. Then,
F = P(1+i)n
If perpetuation is to occur, the amount F accumulated after n periods minus cost for the
replacement must equal the present worth P. If we let CR represent the replacement cost,
I  CR  F  P  P1  i   P  P[1  i   1]
n n

CR
P
1  i n  1

K  FC  P
CR
K  FC 
where: 1  i n  1
FC = First Cost of the equipment
CR = Replacement/Maintenance Cost of the equipment after certain period ,n
K = Capitalized Costs
P = additional investment which interest will take care of the perpetual replacement of the equipment

21/10/2022 ntaldon 44
 Sample Problem
What is the capitalized cost of an equipment which has an
initial fixed capital investment of P25M, annual maintenance
cost of P2M and P4M every 2 years, service life of 10 years
with salvage value of P0.5M. i=12%.

CR
K  FC 
1  i   1
n

25  0.5 2 4
 25     P69.02M
1  0.12  1 0.12 1  0.12  1
10 2

21/10/2022 ntaldon 45
 Sample Problem:
Given:
The initial cost of the equipment is P100,000, a salvage value of
P20,000 after 5 years and a maintenance cost of P10,000 per 1 year,
and cost of money of 10% pa.

Required: Capitalized Cost

CR
K  FC 
Solution: 1  i n  1
100,000  20,000 10,000
 100,000    P331,037.98
1  0.10  1 1  0.10  1
5 1

0 _ 331,037.98  100,000  231,037.98

1 _ 231,037.98 x1.1  10,000  244,241.778
2 _ 244,241.778 x1.1  10,000  258,555.9558
3 _ 258,555.9558 x1.1  10,000  274,411.5514
4 _ 274,411.5514 x1.1  10,000  291,852.7065
5 _ 291,852.7065 x1.1  10,000  20,000  331,037.98
21/10/2022 ntaldon 46
 Capital Recovery, CR
The minimum income that must be earned by the
investor in order to recover the cost of depreciation of the
equipment plus the interest earned by the initial investment
made. L
 1  i   1
FL  FC 1  i   CR    SV
L

 i 

FC1  i   SV
L
CR   FC A/P,i%, n   SV  A/F,i%, n 
1  i   1
L

i
where:
FC = First cost of the equipment
SV = salvage value at the end of service life
L = service life,
i = periodic interest

21/10/2022 ntaldon 47
 Sample Problem: Capital Recovery
Given: Installed cost of Equipment = P400,000
Service life = 5 years
Salvage value = P40,000
Cost of money = 10% p.a.
Required: Capital Recovery, CR
Solution:

FC 1  i   SV 400, 000 1.1  40, 000

L 5

CR    P 98,969
1  i  1.1
L
1
5
1
i 0.1
Explanation:

   0.10 
d  FC  SV   
i
  400,000  40,000  1.105  1  58,967.09
 1  i   1
L
 
I  400,0000.10  40,000
d  I  58,967.09  40,000  98,967.09

21/10/2022 ntaldon 48
 Sample Problem: Capital Recovery
Given: Installed cost of Equipment = P400,000
Working capital = 100,000
Service life = 5 years
Salvage value = P40,000
Cost of money = 10% p.a.
Required: Capital Recovery, CR
Solution:

CR 
400,000  100,000(1.1)  (100,000  40,000)  108,967.09
5

 1.1  1
5

 0.10 
 

d
400,000  40,000  58,967.09
Explanation:
 1.1  1
5

 0.10 
 
I  500,0000.10  50,000
CR  58,967.09  50,000  108,967.09

21/10/2022 ntaldon 49
 SAMPLE PROBLEM:

A company requires an initial fixed capital investment of P100,000 and a working

capital of P10,000. The fixed capital investment has a salvage value of P10,000 after 5
years, The projected annual cash flow is P36,000 and annual expenses is P44,000.
Assume a minimum yield on investment of 15% pa. Determine the ff.
a. ROI
b. Minimum pay-out period, w/o and w/ interest
c. Net Present worth
d. Capitalized costs
e. Capital Recovery

SOLUTION:
a. ROI
Profit = Cash flow – Annual depreciation
Total Investment = FCI + working capital
Annual depreciation = (100,000 – 10,000)/ 5 = P18,000
Total investment = 100,000 + 10,000 = P110,000
Profit = 36,000 – 18,000 = 18,000

Profit 18, 000

ROI   100%  16.36%
Investment 110, 000
21/10/2022 ntaldon 50
 a. Minimum pay-out period, without interest

Depreciable Fixed Capital Investment

N
Cash Flow
100, 000  10, 000
  2.5 years
36, 000

b. Minimum pay-out period, with interest

Depreciable Fixed Capital Investment  Interest on Total Investment

N
Cash Flow
100, 000  10, 000  110, 000 1  0.15   1
5

    5.6 years
36, 000

21/10/2022 ntaldon 51
 c. Net Present Worth

CF1 CFn
NPW    TCI
1  i  1  i 
1 n

 1  0.15 5  1  10, 000  10, 000 

 36, 000    110, 000  P20, 622
 1  0.15  0.15   1  0.15
5 5

d. Capitalized Costs

CR
K  FC  WC 
1  i n  1
44, 000 100, 000  10, 000 
 110, 000    P 492,322
 
5
0.15 1  0.15  1
21/10/2022 ntaldon 52
 e. Capital Recovery

CR 
100,000  10,000(1.15)  (10,000  10,000)  29,848.40
5

 1.15  1
5

 
 0.15 

Explanation:

d
100,000  10,000  13,348.40
 1.15  1
5

 0.15 
 
I  110,0000.15  16,500
d  I  29,848.40

21/10/2022 ntaldon 53