1. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Capital Investment Analysis CHAPTER 15

2. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Explain the nature and importance of capital investment analysis Evaluate capital investment proposals using the average rate of return and cash payback methods Evaluate capital investment proposals using the net present value and internal rate of return methods List and describe factors that complicate capital investment analysis Diagram the capital rationing process

3. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Explain the nature and importance of capital investment analysis Learning Objective 1

4. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Capital Investment Analysis Process by which ____________ plans, evaluates, and controls investments in fixed assets Also called _______________ Capital investment decisions are very important for the long-term success of a business

5. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Methods of Evaluating Capital Investment Proposals Methods that do not use present values: __________________ Methods that use present values __________________

6. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Evaluate capital investment proposals, using the average rate of return and cash payback methods Learning Objective 2

7. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Methods That Ignore Present Value Often used to initially _____ proposals Useful for proposals with relatively short useful lives because the _____ of cash flows is less important

8. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Average Rate of Return Measures the average annual income as a percent of the average investment Also called the ________________ Average Investment = Avg. Rate of Return = +

9. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Average Rate of Return $200,000/4 ($500,000 cost + $0 residual)/2 __% = Avg. Rate of Return =

10. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Average Rate of Return If the average rate of return equals or exceeds the company’s __________, the project should be accepted Advantages: Easy to compute ____________________ Disadvantage: ____________________

11. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Payback Method Cash Payback Period: Expected period of time between the date of an investment and _________________________________ ____________: Excess of cash flowing in from revenue over the cash flowing out for expenses Cash Payback Period =

12. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Payback Method $_______ _ years = Cash Payback Period =

13. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Payback Method If annual cash flows are not equal, the payback period is determined by adding the annual net cash flows until the investment is recovered

14. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cash Payback Method Advantages: _____________________ _______ payback period is desirable ____________________ Disadvantages: _____________________

15. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Evaluate capital investment proposals using the net present value and internal rate of return methods Learning Objective 3

16. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Present Value Considerations Uses both the amount and _______ of cash flows to evaluate an investment Present value of an amount – the value of $1 today is worth ____ than $1 received in a future date, because today’s $1 can be invested and earn interest _____________________ – sum of the present values of a series of equal cash flows at fixed time intervals

17. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Time Value of Money

18. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Present Value Method Present value tables help us calculate present values for _________ and ___________

19. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Present Value of an Annuity Calculations Cash Inflow Timeline and Present Value

20. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Present Value of an Annuity Calculations Present value tables help us calculate present values for annuities and single sums

21. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Net Present Value Method Analyzes capital investment proposals by comparing the initial cash investment with the ______________________ Also called _________________ method The return rate is set by management – often called the ______ rate If the net present value expected from an investment equals/exceeds the initial investment, the project is ________

22. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Net Present Value Method Net present value analysis for the purchase of a $200,000 machine with a 5-year useful life. Minimum rate of return is 10%

23. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Present Value Index If multiple proposals are being considered, use of the present value index can help determine which projects to accept Present Value Index =

24. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Internal Rate of Return Uses _____________ concepts to compute the rate of return from the net cash flows expected from capital investment proposals Also called the _________________ method Starts with net cash flows and works backward to determine the _____________ expected from the project

25. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Internal Rate of Return

26. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Internal Rate of Return __________________

27. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Internal Rate of Return Trial-and-error procedures are time-consuming. When ____________________ are expected, the calculation can be simplified

28. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Internal Rate of Return When the internal rate of return __________ a company’s cost of capital, the proposal should be considered for acceptance Advantages: ____________________________ Disadvantages: Computations are more complex ___________________________

29. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. List and describe factors that complicate capital investment analysis Learning Objective 4

30. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Factors That Complicate Capital Investment Analysis Income tax Proposals with ___________ Lease versus ____________ ________________

31. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Diagram the capital rationing process Learning Objective 5

32. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Capital Rationing The process by which management allocates _____ among competing capital investment proposals The proposals that meet all __________ (financial) and __________ tests should be ranked for funding Unfunded proposals may be reconsidered if funds become available later

33. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Continued… Capital Rationing Decision Process

34. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Capital Rationing Decision Process …continued

35. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. End of Chapter 15