Cash flows are the final objective of capital budgeting investments just as cash flows are the final objective of any investment.. The NPV of a project is the present value of all cash i
Trang 11 Capital assets are the longlived assets that are acquired by
a firm. Capital assets provide the essential production and distributional capabilities required by all organizations
2 Each criterion provides different information about projects.
By using multiple criteria, more dimensions of competing
projects can be compared as a basis for allocating scarce capital to new investment
3 Cash flows are the final objective of capital budgeting
investments just as cash flows are the final objective of any investment. Accounting income ultimately becomes cash flow but
is reported based on accruals and other accounting assumptionsand conventions. These accounting practices and assumptions detract from the purity of cash flows and are, therefore, not used in capital budgeting
4 Analysts separate the act of financing a business's many
integrated investments and the related financing cash flows from the selection of capital projects and the cash flows related to such selections because of the virtual
impossibility of convincingly assigning dollars obtained from the many general financing sources to the particular projects being selected during a given year
5 Timelines provide clear visual models of the expected cash
inflows and outflows for each point in time for a project. They provide an efficient and effective means to help organizethe information needed to perform capital budgeting analyses
Trang 27 The time value of money is important because having a sum of
money now allows a company to earn a return on it; if the sameamount were not received until some time in the future, a return could not be earned on it between now and the time it
is received. All else being equal, managers prefer to have cash receipts now rather than in the future and would prefer
to make cash disbursements in the future rather than now. Future values can be converted into equivalent present values
by the process of discounting. The following methods use the time value of money concept: net present value, internal rate
of return, and the profitability index. The accounting rate ofreturn and payback period do not use the time value of money concept
8 Return of capital means the investor is receiving the
principal that was originally invested. Return on capital means the investor is receiving an amount earned on the
investment
9 The NPV of a project is the present value of all cash inflows
less the present values of all outflows associated with a project. If the NPV is zero, it is acceptable because, in that case, the project will exactly earn the required cost of capital rate of return. Also, when NPV equals zero, the
of working capital that is needed at the beginning of the project life
11 The NPV method subtracts the initial investment from the
discounted net cash inflows to arrive at the net present
value. The PI divides the discounted cash inflows by the
initial investment to arrive at the profitability index. Thus,each computation uses the same set of amounts in different ways. The PI model attempts to measure the planned efficiency
of the use of the money (i.e., output/input) in that it
reflects the expected dollars of discounted cash inflows per dollar of investment in the project
12 The PI will exceed 1 only in instances where the net present
value exceeds 0. This is because the NPV is positive only if the present value of cash inflows exceeds the present value ofcash outflows. Similarly, the present value of cash inflows must exceed the present value of cash outflows if the
numerator of the PI formula is to exceed the denominator
Trang 413 The IRR is the rate that would cause the NPV of a project to
equal zero. A project is considered potentially successful (all other factors being acceptable) if the calculated IRR exceeds the company's cost of capital
14 On any prospective project, when the NPV exceeds zero, the
project's IRR will exceed the firm's discount rate that was used to find the NPV. If the IRR equals the firm's discount rate, the NPV will equal zero. If the IRR is less than the firm's discount rate, the NPV will be negative. This
relationship holds true because, ultimately, under either method the calculations for project selection are designed to hinge on the project's cash flows in relation to the firm's discount rate
16 The tax shield is the amount of revenue on which the
depreciation prevents taxation. The tax benefit is the tax that is saved because of the depreciation and is found by multiplying the company's tax rate by the tax shield provided
4 Of the best investments for all worthwhile activities, in which ones should the company invest?
constraints, the net present value of the firm
Trang 520 Capital rationing exists because a firm often finds that it
has the opportunity to invest in more acceptable projects than
it has money available. Projects are first screened as to desirability and then ranked as to impact on company
objectives
21 Risk is defined as the likely variability of the future
returns of an asset. Aspects of a project for which risk is involved are:
significantly affected. This process gives the decision maker
an indication of how much room there is for error in estimatesfor input variables and which input variables need special attention
23 Postinvestment audits are performed for two reasons: to
obtain feedback on past projects and to make certain that the champions of proposed projects submit realistic numbers
knowing their estimates will ultimately be compared to actual numbers. These audits can provide information to correct
problems and to assess how well the capital investment
selection process is working. The larger the capital
expenditure, the more important it is to perform
postinvestment audits. Postinvestment audits are performed atthe completion of a project
24 The time value of money refers to the concept that money has
timebased earnings power. Money can be loaned or invested toearn an expected rate of return. Present value is always lessthan future value because of the time value of money. A
future value must be discounted to determine its equivalent (but smaller) present value. The discounting process strips away the imputed rate of return in future values, thus
resulting in smaller present values.
25 An annuity is a cash flow that is repeated in successive
periods. Single cash flows occur only in one period
Trang 626 ARR = Average annual profits ÷ Average investment
Unlike the rate used to discount cash flows or to compare
to the cost of capital rate, the ARR is not a discount rate toapply to cash flows. It is measured from accrualbased
accounting information and is not intended to be associated with cash flows
Trang 730 a Year Amount Cumulative Amount
b Yes. Bach’s should also use a discounted cash flow
technique for two reasons: (1) to take into account the time value of money and (2) to consider those cash flows that occur after the payback period
b Based on the NPV, this is a very acceptable investment
Trang 8c Other considerations would include whether the company
has the necessary capacity to produce the additional output, the possibility that the customer would decide topurchase elsewhere or would no longer have need for the parts after Machado Industrial has made its investment, and whether the company has considered all of the costs that would be affected by the decision to produce the newpart—especially labor and overhead.
Trang 9c PI = ($52,000 + $2,978) $52,000 = 1.06
Trang 10c PI = $1,948,530 ÷ $2,300,000 = 0.85
d PV = discount factor annual cash inflow
$2,300,000 = discount factor $300,000 discount factor = $2,300,000 ÷ $300,000 = 7.6667
discount factor of 7.6667 corresponds to an IRR ≈ 7%
38 a Straightline method
Annual depreciation = $1,000,000 ÷ 5 years = $200,000 per year
*In the final year, the remaining undepreciated cost is expensed
c The depreciation benefit computed in part (b). exceeds that
computed in part (a). solely because of the time value of money. The depreciation method in part (b). allows for faster recapture of the cost; therefore, there is less discounting of the future cash flows
Trang 12c Recomputation of part (a):
Beforetax CF $8,400,000 Less depreciation 5,000,000
40 a Tax: $25,000 $8,000 = $17,000
Financial accounting: $25,000 $15,000 = $10,000
b CFAT = Market value now minus taxes
= $17,000 (($17,000 $8,000) .40) = $13,400
c CFAT = $4,000 (($4,000 $8,000) .40) = $5,600
Trang 1341 a Find the rate that will cause the NPVs of the two
projects to be equal. By trial and error, the indifference rate is just above 4%. At a 4% rate the NPV
of each project is computed as follows:
Project 1:
NPV = (8.1109 $85,000) $400,000NPV = $289,427
Project 2:
NPV = (8.1109 $110,000) $600,000NPV = $292,199
b This rate is known as the Fisher rate
c Project 1:
NPV = (5.6502 $85,000) $400,000NPV = $80,267
Project 2:
NPV = (5.6502 $110,000) $600,000NPV = $21,522
Project 1 would be preferred due to its higher NPV,
42 a cash flow annuity factor = $30,000
cash flow 3.6048 = $30,000cash flow = $8,322
44 a cash flow discount factor = investment
cash flow 7.1607 = $1,200,000cash flow = $167,581
b cash flow discount factor = investment
$193,723 discount factor = $1,200,000
discount factor = 6.1944This PV factor for 12 periods corresponds to 12%
Trang 14e Year 1 receipt: $ 30,000 .9259 = $ 27,777
Year 2 receipt: $ 50,000 .8573 = 42,865 Year 3 receipt: $ 60,000 .7938 = 47,628 Year 4 receipt: $100,000 .7350 = 73,500 Year 5 receipt: $100,000 .6806 = 68,060 Year 6 receipt: $100,000 .6302 = 63,020 Year 7 receipt: $100,000 .5835 = 58,350 Year 8 receipt: $100,000 .5403 = 54,030 Year 9 receipt: $ 70,000 .5003 = 35,021 Year 10 receipt: $ 45,000 .4632 = 20,844 Present value $491,095
f No. Using any discount rate above 0, the present value
of the future annual cash flows is well below $1,000,000
Only if the friend has substantial other assets would she
Trang 15be a millionaire.
Trang 1649 a Annual cash receipts $16,000
Cash expenses (2,000)Net cash flow before taxes $14,000Depreciation 8,333Income before tax $ 5,667Taxes (1,983)Net income $ 3,684Depreciation 8,333Annual aftertax cash flow $12,017
c From part a. accounting income = $9,360
d ARR = $9,360 ÷ (($60,000 + $0) ÷ 2) = 31.2%
Payback = $60,000 $21,360 = 2.81 years
Trang 1751 a Payback = $750,000 $250,000 annually = 3 years
b One of the other cost savings may come in the form of
improved quality. By adopting the higher technology, fewer defects should occur. Additionally, the company may be able to lower its costs because of its enhanced flexibility to switch production from one job to another.Additional costs may come in the form of maintenance and repairs as well as training costs to upgrade skills of workers to operate the new equipment
52 Some of the factors that would weigh in favor of proceeding with the investment as planned include these:
The cost savings will be received now instead of later
Any learning curve effects will be enjoyed earlier
Any quality effects on operations will be recognized sooner
The reduced maintenance cost benefit will occur now rather than later
Demand for services may accelerate unexpectedly
Delays in installing the equipment may result in price hikes that could be avoided if the equipment is installed on schedule
The factors that might weigh in favor of delaying investmentinclude these:
Risk associated with the new investment may increase because
of the likelihood that demand will not pick up in the near future
Possible price reductions might be realized by delaying acquisition of the equipment. Price reductions are more likely on computerized equipment
Trang 1853 A company’s R&D program is the major source of distant, future
cash flows. It is from the R&D effort that new products are identified and developed. Without a successful R&D program,the stream of future cash flows will dry up. Similarly, thepresent products and services offered by a firm are
attributable to past R&D programs. Hence, the linkage is
established between R&D activity, and present and future cashflows
It is not surprising that much longterm planning should
be concentrated on the R&D activity. Managing the investment
in R&D activities is the main method available to managers to
balance current and present cash flows, as well as present andfuture growth. R&D is expensed when incurred and this reducescurrent earnings. This often tends to depress stock prices
54. The capital budget interacts with the cash budget in that
acquisition of capital items represents a use of cash. The capital budget also interacts with the statement of cash flowsinvesting activities section. Further, the capital budget impacts depreciation expense on the budgeted income statement,and assets on the budgeted balance sheet. Indirectly, the capital budget interacts with other lines on the income
statement because the various projects included in the capitalbudget will influence a variety of expenses including labor, overhead, administration and marketing
55. No response provided
56 The market must be expecting an enormous increase in future
cash flows relative to current cash flows. If the total value
of the shares is viewed as the present value of the future cash flows accruing to the equity holders, the only possible explanation for the incredibly high value of the stock is thatinvestors expect future cash flows to be many times the level
of current cash flows
57 If the value of a share of stock is viewed as the present
value of the future cash flows that will accrue to that share
of stock, then any change in the discount rate applied by investors would affect the share price. If interest rates move up and down, it is reasonable to expect stock prices to move inversely to the change in interest rates because the change in the prevailing interest rates represents a change inthe discount rate applied by investors
Trang 1958 The capital budget is a key control tool for a .com firm. Few
.com firms have turned a profit yet. They are very early in the process of developing products and services to deliver
over the Internet and this process requires substantial
capital investment. Consequently, their investing activities,managed by the capital budgeting process, are the focus of
much managerial time and talent. Only if these firms invest
in the right projects will the eventual success of the firm berealized.
Problems
59 a. ($000s omitted)
t0 t1 t2 t3 t4 t5 t6 t7 t8 Investment 90.0
New CM 24.00 24.0 24.0 24.0 24.00 24.00 24.00 24.00 Oper. costs 0.0 6.50 7.2 7.2 7.2 7.95 9.45 10.00 11.25 Ann. savings 90.0 17.50 16.8 16.8 16.8 16.05 14.55 14.00 12.75
b Year Cash Savings Cumulative Savings
Payback = 4 years + (($31,000$28,200)$7,000) = 4.40 years