1. Financial and Managerial Accounting
Wild, Shaw, and Chiappetta
Fifth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 1

2. Capital Budgeting & Investment Analysis
Chapter 24
Capital Budgeting & Investment Analysis
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3. Conceptual Learning Objectives
C1: Describe the selection of a hurdle rate for an investment.
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4. Analytical Learning Objectives
A1: Analyze a capital investment project using break-even time.
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5. Procedural Learning Objectives
P1: Compute payback period and describe its use.
P2: Compute accounting rate of return and explain its use.
P3: Compute net present value and describe its use.
P4: Compute internal rate of return and explain its use.
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6. Capital Budgeting Large amounts of money are usually involved.
Outcome is uncertain.
Large amounts of money are usually involved.
Investment involves a long-term commitment.
Decision may be difficult or impossible to reverse.
Capital budgeting: Analyzing alternative long- term investments and deciding which assets to acquire or sell.
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7. Payback Period P1
The payback period of an investment is the time expected to recover the initial investment amount.
Payback
period =
Cost of investment
Annual net cash flow
Click to add notes
Net cash flow = Cash inflows – Cash outflows.
Managers prefer investing in projects with shorter payback periods.
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8. Using the Payback Period
Ignores the
time value
of money.
Unacceptable for projects with long lives where time value of money effects are major.
Ignores cash
flows after
the payback
period.
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9. Accounting Rate of Return (Return on Average Investments)P2
The accounting rate of return focuses on annual income instead of cash flows.
Accounting Annual after-tax net income rate of return Annual average investment =
Beginning book value + Ending book value 2
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10. Net Present Value Decision Rule
When an asset’s expected cash flows are discounted at the required rate and yield a positive net present value, then the asset should be acquired.
Accept project
If >0$
Present value of net cash flows
($)
Amount invested
($)
Net present value
($)
Reject project
If < 0$
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11. Using Net Present ValueC1
General decision rule . . .
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12. Internal Rate of Return (IRR)P4
The interest rate that makes . . .
Present value of cash inflows
Present value of cash outflows = 
The net present value equal zero.
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13. Internal Rate of Return (IRR) (Exhibit 24.9)P4
1. Determine the present value factor $12,000 ÷ $5,000 per year =
2. Using present value of annuity table . . .
IRR is approximately 12%.
IRR is the interest rate of the column in which the present value factor is found.
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14. Using Internal Rate of ReturnP4
Compare the internal rate of return on a project to a predetermined hurdle rate, which is a minimum acceptable rate of return.
To be acceptable, a project’s rate of return cannot be less than the hurdle rate.
If >0%
Accept project
Internal rate of return
(%)
Hurdle rate
(%)
Reject project
If < 0%
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15. Comparing Methods C1
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16. Break-Even Time A1
Break-even time incorporates time value of money into the payback period method of evaluating capital investments.
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17. End of Chapter 24
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