1. ©2012 McGraw-Hill Ryerson Limited 1 of 45 Learning Objectives 1.Define capital budgeting decisions as long-run investment decisions. (LO1) 2.Explain that cash flows rather than accounting earnings are evaluated in the capital budgeting decision. (LO2) 3.Evaluate investments by the average accounting return, the payback period, the internal rate of return, the net present value and the profitability index. (LO3)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 45 What is Capital Budgeting?  represents a long-term investment decision  for example, buy a new computer system or build a new plant  emphasizes amounts and timing of cash flows as well as opportunity costs and benefits  investment usually requires a large initial cash outflow with the expectation of future cash inflows  considers only those cash flows that will occur as a result of the investment (resultant cash flows)  all cash flows are calculated aftertax LO1

3. ©2012 McGraw-Hill Ryerson Limited 3 of 45 Figure 12-1 Capital budgeting procedures LO1

4. ©2012 McGraw-Hill Ryerson Limited 4 of 45 Average Accounting Return: An Example Earnings Aftertax Amortized Capital Cost Capital Cost $30,000* Year 1 $2,000 22,500 Year 2 4,000 15,000 Year 3 8,000 7,500 Year 4 2,000 0 Average $16,000/4 = $4,000 $75,000/5 = $15,000** Average Accounting Return $4,000/$15,000 = 26.7% *Straight-line depreciation **Also, Average Book Value = ($15,000 + $0)/2 = $15,000 LO1