Beruflich Dokumente
Kultur Dokumente
McGrawHill/Irwin
TheMcGrawHillCompanies,Inc.2006
Capital Investment
Capital Investment - Purchases of longterm operational asset
Once purchased, co is committed to
these investments for an extended
period of time.
Capital Investment
Decisions
A decision to exchange current cash
outflows for the expectation of
receiving future cash inflows
Understanding the time value of
money concept will help you make
a rational capital investment
decision.
today
today at
at aa 12%
12%
return
return is
is equivalent
equivalent
to
to receiving
receiving
$200,000
$200,000 each
each
year
year for
for the
the next
next
four
four years.
years.
Example
Wald Corp is considering
purchasing a new machine that
costs $50,000. Wald expects the
machine to increase annual net
cash flow by $12,500 for each of
the next five years. The machine
has a $2,000 salvage value.
What is the present value of the
future cash flows?
Capital Investment
Proposals
Net Present Value
Subtracting the cost of the investment from the
present value of future cash inflows determines
the net present value of the investment
opportunity.
A positive net present value indicates the
investment will yield a rate of return higher than
the required return. A negative net present value
means the return is less than the required return.
Capital Investment
Proposals
EZ Rentals mgmt is willing to pay
$607,470 today to obtain $200,000
per year over the next four years.
Cost = $582,742
To determine whether EZ Rentals
should invest, mgmt must compare
the present value of the future cash
inflows to the cost of the projectors.
Capital Investment
Proposals
Net Present Value =
PV of Future Cash Flows Cost of
Investment
$607,470 582,742 = $24,728
Example
Wald Corp is considering
purchasing a new machine that
costs $50,000. Wald expects the
machine to increase annual net
cash flow by $12,500 for each of
the next five years. The machine
has a $2,000 salvage value.
What is the net present value of
the investment?
Example
The management team at Savage
Corp. is evaluating two alternative
capital investment opportunities.
First Alt. modernize the co.s
current machinery cost =
$45,000; modernization will reduce
annual net cash outflows by
$12,500 per year
Comparing Alternative
Capital Investment
OpportunitiesPV of cash inflows
PV index =
PV of cash
outflows
$47,385
Alternative 1 =
= 1.053
$45,500
$59,346
Alternative 2 =
= 1.050
$56,500
Alternative 1 yields a higher return than Alternative 2.
Cost
Savings
Release of
Working Capital
Cash
Inflows
Salvage
Value
Increases in
Operating
Expenses
Cash
Outflows
IRR - Example
Medina Manufacturing Co. has an
opportunity to purchase some
technologically advanced equipment that
will reduce the companys cash outflow
for operating expenses by $68,641 per
year. The cost of the equipment is
$200,000. Medina expects it to have a 4year useful life and zero salvage value.
The company has established an
investment hurdle rate of 12%.
Project 1
Cash Inflow
$
3,500
$
3,000
$
1,000
$
500
Project 2
$
2,000
PV Factor
0.909091
0.826446
0.751315
0.683013
=
=
=
=
PV
$ 3,182
2,479
751
342
$ 6,754
(6,000)
$ 754
3.169865 = $ 6,340
(6,000)
$ 340
Tax Considerations
Taxes affect the amount of cash flows
generated by investments. In the following
example, Wu Company purchases an asset for
$240,000. The asset has a four-year useful
life, no salvage value, and straight-line
depreciation is used. The asset is expected to
generate incremental revenues of $90,000
per year. Wus income tax rate is 40%, and
the company has a desired after tax return of
10%.
Tax Considerations
Net cost of
investment
Annual net cash
inflows
Payback Method
Winston Cleaners can purchase a piece of
equipment for $100,000 that will reduce
labor costs by $40,000 per year over a fouryear useful life. Lets calculate the payback
period.
Net cost of
investment
Annual net cash
inflows
Payback
$100,000
=
= 2.5 years
period
$40,000
Payback
=
period
Year
2006
2007
2008
Annual
Amount
$
3,000
$
1,000
$
2,000
Cumulative
Amount
$
3,000
$
4,000
$
6,000
Payback
=
period
$6,000
$1,500
= 4 years
Post Audits
A post audit is conducted at the
completion of a capital investment
project, using the same analytical
technique that was used to justify the
original investment. The focus should
be on continuous improvement in the
capital expenditure process.