CAPITAL

BUDGETING
(CAPITAL Investment Analysis)
COST VARIABLES IN CAPITAL
INVESTMENT
FIXED COSTS
VARIABLE COSTS
EXPECTED LIFE OF EQUIPMENT
OBSOLESCENCE
SALVAGE VALUE
SUNK COSTS
OPPORTUNITY COSTS
THE IMPACT OF
DEPRECIATION ON
INVESTMENT
STRAIGHT-LINE METHOD
DECLINING BALANCE METHOD OR
Ddbm
SUM OF THE YEARS DIGITS METHOD
DEPRECIATION BASED ON USAGE
METHOD
ASCERTAINING THE
VALUE OF Assets
Book value and market value
Interest rates, present value and
annuities
Methods of evaluating
alternative investments
The payback method
The average rate of return
Present-value method
The profitability index
The internal rate of return
Mutually exclusive projects
Capital rationing
Risk and the investment decision
Nonfinancial
considerations in
evaluating
Human resources
alternative
investments
The impact of government regulations
Pollutes the environment (ISO 9000; 14000)
Technological considerations
Risk with changing technology
The impact of layout, scheduling, volume,
customer serv.
The installation and operational considerations
The payback method
The payback period or an investment tells the
number of years required to recover the initial
investment. The payback period is calculated
by adding the cashflows up until they are equal
to the initial fixed investment
Although this measure does, in fact, deal with
cash flows and is easy to calculate and
understand, it ignores any cash flows that
occur after the payback period and does not
consider the time value of money within the
payback period
Present value methods
The net present value of an investment project is the present value of the
cash inflows less the present value of the cash outflows. By assigning
negative values to cash outflows, it becomes :

n
ACFt
NPV I0
1 1 k
t

Where :
ACFt = the annual after-tax cash flow in time period t (this can take on
either positive or negative values)
k = the required rate of return or appropriate discount rate or cost of
capital
I0 = the initial cash outlay
n = the project`s expected life
Present value methods
(cont)
a. The acceptance criteria are
Accept if NPV > 0
Reject if NPV < 0
b. The advantage of this approach is that it
takes the time value of money in to
consideration in addition to dealing with
cash flows
Present value methods
(cont)
2. The profitability index is the ratio of the
resent value of the expected future net cash

flows to the initial cash outlay, or
n
ACFt
(1 k ) t
t 1

Profitability index I0
Present value methods
(cont)
a. The acceptance criteria are :
accept if PI > 1.0
reject if PI < 1.0
b. The advantages of this method are the
same as those for the net present value
c. Either of these present value methods
will give the same accept reject
decisions to a project
D. The internal rate of return is the discount rate that
equates the present value of the project`s future
net cash flow with the project`s initial outlay. Thus,
the internal rate of return is represented by IRR in
the equation below :

n
ACFt
I0
t 1 (1 IRR )
t
1. The acceptance rejection criteria are :
accept if IRR > required rate of return
reject if IRR < required rate of return
the required rate of return is often taken
to be the firm`s cost of capital which will
be discussed in chapter 13
2. The advantages of this method are that it
deals with cash flows and recognized the
time value of money ; how ever, the
procedure is rather complicated and time
consuming.
V. Mutually axclusive project : although the IRR and
the present value methods will, in general give
consistent accept reject decision, they may not
rank project`s identically. This becomes important
in the case of mutually exclusive project
A. a project mutually exclusive if acceptance of it
precludes the acceptance of one or more projects.
In this case, the project`s relative ranking becomes
important.
B. Ranking conflicts come as a result of the different
asumptions on the reinvestment rate of funs
released from the proposals
C. Thus, when conflicting ranking of mutually
exclusive projects results from the different
reinvestment assumptions, the decision boils
down to with assumption is best.
D. In general the net present value method is
considered to be theoretically superior.
VI. Capital rationing is the situation in which
a budget ceiling or constraint is placed
upon the amount of funds that can be
invested during a time period.
A. theoretically, a firm should never reject
a project that yields more that required rate
of return. although there are circumstances
that may create complicated situations, in
general, an investment policy limited by
capital rationing is less than optimal.
 Methods for evaluating
projects
A. Average rate of return is
Average rate n annual profit after tax
of return = n
t=1 investment + salvage value
2
1. This formula assumes straight-line
descreption; thus, the average
investment in the project is equal to
the sum of the investment plus the
salvage value divided by 2.
2. Although this measure has the
advantages of being easy to calculate
and of having familiar terms, it uses
profit rather than cash flows in its
calculations and does not consider
the time value of money.
 AKUISISI PERALATAN
PT. SAUS sedang mempertimbangkan pembelian
seperangkat mesin otomatis seharga pembelian
seperangkat mesin otomatis seharga $2.000.000 guna
menggantikan empat mesin lama. Mesin lama
dijalankan tiga shifts sehari, lima hari seminggu;
mesin baru dijalankan dua shifts sehari, lima hari
seminggu dan memproduksi output yang sama.
Mesin baru diharapkan mengurangi biaya tenaga kerja
melalui pengurangan jumlah pekerja dari sepuluh
menjadi enam per shift dan menjadikan kecelakaan
shift tengah malam. Pengawas tengah malam akan
dipindah ke bagian lain mengganti seseorang yang
pensiun.
Para pekerja shift gaji rata-rata adalah $15.000 per
tahun (plus $5.000 dana kesejah- teraan), dan gaji
pengawas setahun $22.000 (plus $7.000 dana
kesejahteraan).
Mesin baru akan meningkatkan tingkat kebisingan
sebesar 20%, tetapi bisa menurunkan kecelakaan
fisik sebanyak 70%.
Usia mesin baru diharapkan 10 tahun, nilai sisa
$80.000. mesin baru layak memperoleh kredit pajak
investasi sebesar 10%. Penyusutan garis lurus.
Nilai buku mesin lama $200.000 per mesin, dan nilai
sisa $25.000 per mesin dalam 10 tahun, dimana bisa
dijual sekarang pada pasar mesin bekas $100.000
per mesin. PPH 60%, dan tingkat perolehan yang
dipersyaratkan setelah pajak 14%.
DIMINTA:
a. Hitung investasi bersih semula
b. Hitung penghematan setelah pajak
dalam gaji
c. Hitung penghematan setelah pajak dari
kenaikan PH
d. Hitung pengurangan nilai sisa dari
mesin lama ke mesin baru
e. Terapkan faktor nilai sekarang dari a
sampai d
f. BUATLAH KEPUTUSAN
 SOLUTION
Description year Cash Flow PV Factor Present Value
IN (OUT)
INVESTMENT:
Price of new line $(2.000.000)
Investment Tax
credit 10% 200.000
Sale of old lines 400.000
Tax loss on old lines
($200.000-$100.000)X
4 X 60 240.000

(a)Net Investment 0 $(1.160.000) 1.000 $(1.160.000)

ANNUAL FLOWS:
Shift workers
(4+4+10) X $20.000 $360.000
Foreman 29.000
Operating margin $389.000
Change before tax
Income tax 60% (233.400)

(b) Operating Margin

Change After Tax $155.600
Operating margin change $155.600
After tax
DEPRECIATION INCREAS
New line $2.000.000 - $80.000
10
$192.000
Old lines $800.000 - $100.000
10
$70.000
Difference times tax rate
($192.000 - $70.000)X60% 73.200

(c) annual net cash flow 1-10 $228.800 5.216 1.193.421

 TERMINAL VALUE
annual net cash flow 1-10 $228.800 5.216 1.193.421

(d) Salvage Value Difference

($80.000-$100.000) 10 $(20.000) .270 (5.400)

(e) Net Present Value 28.021

(f) Decision: purchase the new line and sell the

old lines
Based on a positive net present value