Kế toán, kiểm toán - Chapter 9: Capital budgeting and other long - Run decisions

Slide 9-2CHAPTER 9Capital Budgeting and Other Long-Run DecisionsSlide 9-3Capital Budgeting DecisionsCompanies, like individuals, make investments in long-lived assetsExamples includeDuke Energy invests in 400 roof-top solar panel installationsPfizer invests in a $294 million biotechnology factory in IrelandNordstrom invests in a new store in New JerseyStarbucks invests in a new product: instant coffeeLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-4Capital Budgeting DecisionsInvestment decisions are important because they have a long run impact on a firm’s operationsDecisions involving the acquisition of long-lived assets are referred to as capital expenditure decisionsThey often require that capital (company funds) be expended to acquire additional resourcesAlso called capital budgeting decisionsSlide 9-5Capital Budgeting DecisionsMost firms carefully analyze the potential projects in which they may investThe process of evaluating the investment opportunities is referred to as capital budgetingThe final list of approved projects is referred to as the capital budgetLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-6Which of the following is not a capital expenditure decision?Building a new factoryPurchasing a new piece of equipmentPurchasing inventoryPurchasing another companyAnswer: cPurchasing inventoryTest Your Knowledge 1Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-7The Time Value of MoneyIn evaluating an investment opportunity, a company must not only know how much but also when cash is received or paidTime value of money recognizes that it is better to receive a dollar today than in the futureThis is because a dollar received today can be invested so that it amounts to more than a dollar in the futureLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-8Evaluating Opportunities: Time Value of Money ApproachesCompanies invest money today hoping to receive more money in the futureBy how much must the future cash flows exceed the cost of the investment?Money in the future is not equivalent to money todayA company needs to convert future dollars into their equivalent current , or present valueLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-9Basic Time Value of Money Calculations Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-10Basic Time Value of Money Calculations - Example Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-11Present Value Tables Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-12 Test Your Knowledge 2Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-13The Net Present Value MethodThe only relevant cash flows are those that are incrementalThe cash flows that will be incurred if the project is undertakenCash flows that have already been incurred are sunkThey have no bearing on a current investment decisionLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-14The Net Present Value MethodSteps in the NPV method1. Identify the amount and time period of each cash flow associated with a potential investment2. Discount the cash flows to their present values using a required rate of return3. Evaluate the net present value, which is the sum of the present value of all cash inflows and outflowsLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-15The Net Present Value MethodEvaluate the investment opportunityIf the NPV is zero, the investment earns the required rate of returnThe investment should be undertakenIf the NPV is positiveIt should also be undertaken because it earns more than the required rateInvestments that have a negative NPV are not accepted because they earn less than the required rateLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-16Net Present Value ApproachLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-17If the net present value of a project is zero, the project is earning a return equal to:ZeroThe rate of inflationThe accounting rate of returnThe required rate of returnAnswer: dThe required rate of returnTest Your Knowledge 3Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-18Net Present Value ExampleAn auto repair shop is considering the purchase of an automated paint spraying machine. The machine will last five years.Following information is available:Each year $2,000 will be saved on paintIt will reduce labor costs by $20,000 each yearIt will require maintenance costs of $1,000 each yearThe machine costs $70,000The expected residual value is $5,000The required rate of return is 12%Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-19Net Present Value ExampleSince the NPV > 0, the company should buy the equipmentLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-20Comparing Alternatives with NPVCalculate the NPV of each alternative and choose the alternative with the highest NPVThe difference between the NPVs of any two alternatives is the incremental value of the highest NPV investmentAnother method to evaluate alternatives is to compute the present value of their incremental cash flowsLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-21Comparing Alternatives with NPVLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-22The Internal Rate of Return (IRR) MethodThe internal rate of return is that rate of return that equates the present value of the future cash flows to the investment outlayThe rate of return that makes the net present value equal to zeroIf the IRR of a potential investment is equal to or greater than the required rate of return, the investment should be undertakenLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-23The Internal Rate of Return MethodLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-24An investment should be undertaken if:The IRR is equal to or greater than the required rate of returnThe IRR is equal to or greater than zeroThe IRR is greater than the accounting rate of returnThe IRR is greater than the present value factorAnswer: aThe IRR is equal to or greater than the required rate of returnTest Your Knowledge 4Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-25The Internal Rate of Return with Equal Cash FlowsEqual cash flows are called an annuityFor an annuity,PV = PV factor x AnnuityTherefore: Use the table to find the closest PV factor for the same number of yearsLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-26Internal Rate of Return ExampleInvestment = $100Cash flow $60 per year for two yearsPV factor = 100 / 60 = 1.667Check PV annuity table, row 2Closest factor is in 13% columnLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-27Investment costs = $79,100Returns $14,000 a year for 10 yearsRequired return is 18%Calculate IRR and evaluatePV Factor = 79,100 / 14,000 = 5.65Test Your Knowledge 5Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-28Internal Rate of ReturnLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-29Internal Rate of Return With Unequal Cash FlowsUtilized when annual cash flows are not equal amountsUse trial and errorMust estimate IRRUse estimated IRR to calculate the NPV of the projectIf NPV > 0, increase estimated IRRIf NPV < 0, decrease estimated IRRRecalculate until NPV is equal to or close to zeroLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-30Internal Rate of Return With Unequal Cash FlowsThe IRR is approximately 16%Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-31Use of NPV and IRRLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-32Considering “Soft” Benefits in Investment DecisionsIt is important that managers consider “soft” benefits in addition to a project’s NPV or IRR“Soft” benefits are difficult to quantifyIgnoring soft benefits may lead firms to pass up investments that are of strategic importanceEspecially investments in advanced manufacturing technologyLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-33“Soft” BenefitsLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-34Calculating the Value of “Soft” BenefitsExampleDynamic Medical Equipment is considering production of a high tech wheelchairSuppose the finance department fails to consider that production of the wheelchair will improve the firm’s reputation as an industry leaderThe reputation is difficult to quantifyNew construction techniques will be developed for producing future productsLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-35Calculating the Value of “Soft” BenefitsSuppose the project has a negative NPV of $80,000With a required return of 15%, benefits of $15,989 per year would make NPV zeroLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-36Estimating the Required Rate of ReturnIn previous examples the required rate of return was simply statedIn practice, management must estimate the required rate of returnIn some cases, the required rate of return should equal cost of capitalThe cost of capital is the weighted average of debt and equity financing usedLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-37The cost of capital is:The cost of debt financingThe cost of equity financingThe weighted average of the costs of debt and equity financingThe internal rate of returnAnswer: cThe weighted average of the costs of debt and equity financingTest Your Knowledge 6Learning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Slide 9-38Additional Cash Flow ConsiderationsBoth NPV and IRR consider cash inflows and outflows, not revenues and expensesOnly cash inflows and outflows are discounted back to present value:Must consider the timing of collection of revenues Depreciation does not require cash outflow in the period it is recordedLearning objective 1: Define capital expenditure decisions and capital budgets and evaluate investment opportunities using the net present value approach and the internal rate of return approach.Learning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-39Cash Flows, Taxes, and the Depreciation Tax Shield In the previous examples we ignored the effect of taxes on cash flowTax considerations play a major role in capital budgetingIf a project generates taxable revenue, cash inflows will be reduced by taxes paid on the revenueIf a project generates tax deductible expenses, cash inflows will be increased by the tax savings generatedSlide 9-40Cash Flows, Taxes, and the Depreciation Tax Shield We stated that depreciation is not relevant in present value analysisDepreciation affects cash flows indirectlyDepreciation reduces the amount of tax a company must payThe term depreciation tax shield refers to the tax savings from depreciationLearning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-41Example of theDepreciation Tax Shield Learning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-42Adjusting Cash Flows for InflationIt may be important to consider inflation when estimating the cash flows associated with investment opportunitiesInflation can be taken into account by multiplying the current cash flows by the expected rate of inflationLearning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-43Adjusting Cash Flows for InflationIf inflation is ignored in net present value analysis, worthwhile opportunities might be rejectedThis is because current rates of return for debt and equity financing already include estimates of future inflationCash flows will be lowRequired rates of return will be highLearning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-44Other Long-Run DecisionsTime value of money techniques are also applicable to the analysis of other long-run decisionsExamples of these decisions include:Decision to outsource grounds maintenanceDecision to drop a product lineDecision to buy rather than make a subcomponent of a productLearning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Slide 9-45Other Long-Run DecisionsEvaluation of decision to sponsor a golf tournamentLearning objective 2: Calculate the depreciation tax shield and evaluate long-run decisions, other than investment decisions, using time value of money techniques.Learning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-46Simplified Approaches to Capital BudgetingMany companies continue to use simpler approachesTwo of these arePayback period methodAccounting rate of returnBoth methods have significant limitations in comparison to NPV and IRRSlide 9-47Payback Period MethodThe payback period is the length of time it takes to recover the initial cost of an investmentAn investment which costs $1,000 and yields cash flows of $500 per year has a payback period of 2 years ($1,000 / $500)If an investment costs $1,000 and yields cash flows of $300 per year it has a payback period of 3 1/3 yearsLearning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-48Payback Period MethodOne approach is to accept projects that have a payback period less than some specified requirementThis can lead to poor decisionsThe payback method does not take into account the total cash flowsIt only considers the stream of cash flows up until the investment is repaidIt does not consider the time value of moneyLearning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-49Which of the following methods ignores the time value of money (present and future values) in its calculation?Net present valueInternal rate of returnPayback periodExternal rate of returnAnswer: cPayback periodTest Your Knowledge 7Learning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-50Accounting Rate of Return (ARR)Accounting Rate of Return Formula: ARR = Average Net Income Average InvestmentAverage investment is the initial investment divided by 2Like the payback period method, the accounting rate of return ignores the time value of moneyLearning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-51Conflict Between Performance Evaluation and Capital BudgetingManagers may be discouraged from using PV techniques for evaluating investments depending on how their performance is evaluatedAn investment may have high depreciation in the early years, or revenue may be lowManagers need to be assured that if they approve projects with long run positive NPV their compensation will take the expected benefits into accountLearning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-52Short-Run Accounting ProfitLearning objective 3: Use the payback period and the accounting rate of return methods to evaluate investment opportunities. And explain why managers may concentrate erroneously on the short-run profitability of investments rather than their net present values.Slide 9-53Copyright© 2016 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.