Budget chapter 3 capital budgeting Planning for Capital Investments Chapter 3 Planning for Capital

Since most of the cash flows in Project B are at the end of the time, they are not greatly affected by the reinvestment rate assumption. We know that this problem is due to reinvestment and not size as the initial investments are the same, but the timing of cash flows is different. Net Present Value, Internal Rate of Return, and Payback Period Analyses; Ethical Issues. Tower CD Stores would like to open a retail store in Houston. The initial investment to purchase the building is $420,000, and an additional $50,000 in working capital is required. Since this store will be operating for many years, the working capital will not be returned in the near future.

• Ii) the average rate of return on initial investment, to one decimal place.
• It does this by examining the techniques of net present value, internal rate of return and annuities.
• The second location, Kenton, is not as close to the ocean, and much further from desirable vacation destinations.
• Is any available alternative to purchase, build, lease, or renovate buildings, equipment, or other long-range major items of property.
• PP – increase T for low risk projects and decrease T for high risk projects.

The Internal Rate of Return calculates the average annualized rate of return that we can earn over the lifetime of the project. It is reasonable to argue that capital budgeting is the most important factor in maximizing shareholder wealth. Good capital budgeting decisions can generate hundreds of millions of dollars for shareholders as often a successful project lays the foundation for many more on top of the original. Poor capital budgeting decisions can destroy wealth almost as quickly . While we will focus only on a small portion of the process , it is worthwhile to look at the process as a whole.

QUIZ.GG.Chapter5.docx

If Ch Capital Budgeting And Cash Flow s are mutually exclusive, accept the one with the highest IRR . The payback period refers to the amount of time it takes to recover the cost of an investment or how long it takes for an investor to hit breakeven.

• The IRR decision rule states that if the IRR is greater than or equal to the company’s required rate of return , the investment is accepted; otherwise, the investment is rejected.
• However, capital budgeting methods include adjustments for the time value of money (discussed in AgDM File C5-96, Understanding the Time Value of Money).
• Also, the decision rule is arbitrary – what is an acceptable payback period?
• Car Repair, Inc., would like to purchase a new machine for $400,000.

The machine will have a life of 5 years with no salvage value, and is expected to generate annual cash revenue of $50,000. Annual cash expenses, excluding depreciation, will total $24,000. The company uses the straight-line depreciation method, has a tax rate of 40 percent, and requires a 12 percent rate of return. Car Repair, Inc., would like to purchase a new machine for $400,000. The machine will have a life of 4 years with no salvage value, and is expected to generate annual cash revenue of $180,000.

What Are the Types of Project Appraisal Methodologies?

The second is a new order placement system for the drive-thru. McBurger could choose to take the new deep fryer or the new order placement, or it could choose both. Taking one project does not influence the other, so they are independent. When we have independent projects, our decision rule does not need to rank which project is the best, but merely identify if the project is good or bad. Mutually exclusive projects are any set of projects in which choosing one makes the other projects no longer possible. For example, we are considering upgrading our printing press and have the choice of two alternatives.

However, there is a cash benefit related to depreciation since income taxes paid are reduced as a result of recording depreciation expense. We explore the impact of income taxes on NPV and IRR calculations later in the chapter. Our goal now is to determine the exact return—that is, to determine the IRR. We know from Figure 8.4 «Alternative NPV Calculation for Jackson’s Quality Copies» that the copy machine investment generates a return greater than 10 percent. Figure 8.5 «Finding the IRR for Jackson’s Quality Copies» summarizes this calculation with the 2 columns under the 10 percent heading. Present value calculations tell us the value of cash flows in today’s dollars.

Gathering information and making cash flow estimates

The bias is smaller for projects that are back loaded . If projects are mutually exclusive, the IRR can provide invalid rankings due to two problems. First, if the projects are of different sizes . This is referred to as the reinvestment rate problem.

Should the company purchase the production equipment? Based on your findings in requirements a, b, and c, should the company purchase the production equipment? Should the company purchase the blueprint machine? $250,000 will be received at the end of each year for 4 years. $10,000 will be received at the end of each year for 6 years. $1,000 will be received at the end of each year for 6 years.

The https://intuit-payroll.org/ is currently considering expanding by adding a second retail store. The second store is expected to become profitable three years after opening.