1. Chapter 22 Further aspects of capital expenditure decisions
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

2. Income taxes and capital expenditure analysis
In profit-seeking enterprises, income taxes are usually payable
Taxation payments are cash flows
Taxation payments and tax deductions must be considered in any cash flows used in a capital expenditure proposal
Taxation implications may dominate other aspects in the analysis of capital expenditure decisions
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

3. After-tax cash flows After-tax cash flows
Cash flows after all the tax implications have been taken into account
Tax effect of an increase in sales
Consider incremental revenue and costs arising from a capital expenditure decision
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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4. After-tax cash flows Tax effect of additional expenses
= incremental expense × (1 – tax rate)
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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5. After-tax cash flows Non-cash expenses Such as depreciation
Are not cash flows
Can produce tax savings and, hence, savings in cash outflows
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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6. After-tax cash flows
Some cash flows do not appear on the profit statement in the same period in which they occur
Purchase of a depreciable asset is a cash outflow in the period of purchase, but not an expense of the current period
Cash outflows from purchase have no direct tax consequences
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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7. continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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8. After-tax cash flows Timing of tax payments Timing of cash flows
Cash flows resulting from income taxes do not occur in the same year as the before-tax cash flows
Timing of cash flows
Cash flows from a proposal are not always recognised as revenue or expenses in the same year
Slight timing differences are difficult to include in a capital expenditure analysis
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

9. Depreciation methods
Australian tax laws allow two methods of depreciation
Straight line (or prime cost)
Diminishing value, based on written-down value of the asset
The method used will affect the after-tax cash flow projections
Taxation versus accounting depreciation
The impact of a capital expenditure project on cash flows will result from taxation depreciation, not accounting depreciation
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

10. Profit and loss on disposal
Profits or losses on disposal of assets have tax effects and, therefore, affect cash flows
Use the book value resulting from taxation deprecation to calculate profit/loss on disposal
The book value is an asset’s acquisition cost minus the accumulated depreciation
A profit on disposal can arise if proceeds are greater than the book value
A loss on disposal can arise if the proceeds are less than the book value
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

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12. Profit and loss on disposal
Investment allowances also affect cash flows
One-off taxation deductions that businesses receive in the year of purchase of an asset
Introduced into the taxation legislation from time to time to encourage business to invest in new assets
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

13. Investment in working capital
The excess of current assets over current liabilities
Often increases as a result of higher balances in accounts receivable or inventory necessary to support a capital investment project
Such increases are cash outflows and should be included in an analysis or cash flows in capital expenditure analyses
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

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15. Using after-tax profit for other capital expenditure analysis techniques
Payback period
= Initial investment ÷ annual after-tax cash inflow
Accounting rate of return
= Average annual profit after tax from project ÷ initial investment
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

16. Ranking investment projects
Most firms have limited resources to invest in potentially profitable projects
NPV and IRR may yield a different ranking for alternative proposals
Cannot always compare the NPVs from different projects, as projects may not have the same life
IRR includes the reinvestment assumption
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

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18. Profitability index
Profitability index (or excess present value index)
Another method for comparing investment proposals
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

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20. Justification of investments in advanced technologies
High-technology projects may yield negative NPVs, even when managers know they will provide a competitive edge
Difficult to quantify strategic impact of investments
Relevant benefits and costs arising from investing in advanced technologies
Strategic implications for such investments
Intangible benefits derived from the investment
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

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22. The limitations of conventional capital expenditure analysis
Use of unrealistic status quo
Do not assume that the current cash flow situation will be maintained if the project does not go ahead
Compare the cash flows of the new proposal to the reduction in cash flows that will occur if the project does not go ahead
Hurdle rates too high
To encourage capital rationing or to hedge against uncertainty
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
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23. The limitations of conventional capital expenditure analysis
Time horizons too short
Need to include benefits over all future years to prevent bias against unfavourable projects
Difficulty in gaining approval for large projects
Creates an incentive for managers to promote small incremental projects rather than requesting large technology projects
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

24. The limitations of conventional capital expenditure analysis
Greater uncertainty about operating cash flows
The complexities of new software and hardware create uncertainty
Inexperience with using new technologies may create difficulties in estimating cash flows
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

25. The limitations of conventional capital expenditure analysis
Exclusion of benefits that are difficult to quantify
Synergistic effects of adopting multiple capital expenditure proposals
Greater flexibility in the production process
Shorter cycle times and reduced lead times
Reduction of non-value-added costs
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith