1. ©2012 McGraw-Hill Ryerson Limited 1 of 45 Learning Objectives 4.Appraise the use of the cost of capital as the discount rate in capital budgeting analysis. (LO4) 5.Integrate the cash flows that result from an investment decision, including the after tax operating benefits and the tax shield benefits of capital cost allowance (amortization). (LO5) 6.Perform NPV analysis to assist in the decision- making process concerning long-run investments. (LO6)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 45 Table 12-5 Internal rate of return and net present value ($10,000 investment) LO4 Investment A (11.16% IRR)Investment A YearCash FlowYearCash Flow 1$5,0001 10% 2 5,0002 11% 3 2,000Discounted at 11.16% 3 2,00012% Discounted at various rates if desired NPV = 0NPV = $27

3. ©2012 McGraw-Hill Ryerson Limited 3 of 45 Net Present Value Profile – a graph of the NPV of a project at 3 different discount rates: a zero discount rate the normal discount rate (or cost of capital) the IRR for the investment – allows an easy way to visualize whether or not an investment should be undertaken LO4

4. ©2012 McGraw-Hill Ryerson Limited 4 of 45 6,000 4,000 2,000 0 Net present value ($) 5%10%15%20%25% IRR B = 14.33% IRR A = 11.16% Discount rate (percent) Investment B Investment A Figure 12-2 Net Present Value Profile B B A A LO4 Investment AInvestment B Discount Rate NPV Discount Rate NPV 0 %$2,000 0 %$6,000 51,025 53,433 10180101,414 11.16014.330 15-55615-195

5. ©2012 McGraw-Hill Ryerson Limited 5 of 45 6,000 4,000 2,000 0 Net present value ($) 5% 10% 15% 20%25% IRR C = 22.49% IRR B = 14.33% Discount rate (percent) Crossover point Investment C Investment B Investment C Investment B Figure 12-3 Net Present Value Profile With Crossover B B C C LO4 Investment C Discount Rate NPV 0 %$3,200 52,381 101,563 151,002 20417 22.490 25-112 8.7%