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CH 12
CH 12
CH 12
Eighth Edition
Chapter 12
Planning for Capital Investments
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Chapter Outline
Learning Objectives
LO 1 Describe capital budgeting inputs and apply the
cash payback technique.
LO 2 Use the net present value method.
LO 3 Identify capital budgeting challenges and
refinements.
LO 4 Use the internal rate of return method.
LO 5 Use the annual rate of return method.
LEARNING OBJECTIVE 1
Describe capital budgeting inputs and apply the cash
payback technique.
Cumulative net
Cost of
cash flows from
investment
investment
$900,000
Cash payback period = 4.3 years
$210,000
LEARNING OBJECTIVE 2
Proposal is acceptable
when net present value
is zero or positive.
Present Value
at 12%
Discounted factor for 10 periods 5.65022
Present value of net cash flows:
$24,000 × 5.65022 $135,605
9% Discount Present
Cash Flow Factor Value
Present value of net annual cash flows $210,000 4.48592 $942,043
Less: Capital investment 900,000
Net present value $42,043
LEARNING OBJECTIVE 3
Intangible Benefits
Might include increased quality, improved safety, or enhanced
employee loyalty.
To avoid rejecting projects with intangible benefits:
1. Calculate NPV ignoring intangible benefits
2. Project conservative estimates of value of intangible benefits,
and incorporate these values into NPV calculation
Project A Project B
$58,112 divided by $40,000 $110,574 divided by
$58,112 $110,574
1.45 1.23
equals 1.45 $90,000 equals 1.23
$40,000 $90,000
Solar Wind
Present value of annual cash flows $78,580 $168,450
Initial investment $45,500 $125,300
LEARNING OBJECTIVE 4
LEARNING OBJECTIVE 5
Use the annual rate of return method.
Sales $200,000
Less: Costs and expenses
Manufacturing costs (exclusive of depreciation) $132,000
Depreciation expense ($130,000 ÷ 5) 26,000
Selling and administrative expenses 22,000 180,000
Income before income taxes 20,000
Income tax expense 7,000
Net income $ 13,000
$900,000 $0
Average investment $450,000.
2
$60,000
Annual rate of return $13.3%.
$450,000