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Click to edit Master title style,Click to edit Master text styles,Second Level,Third Level,Fourth Level,Fifth Level,8-,1,2001,Prentice Hall Business Publishing,Management Accounting,3/E,Atkinson,Banker,Kaplan,and Young,Capital Budgeting,Chapter 8,Learning Objective 1,Describe the nature and importance of long-term assets.,Long-Term(Capital)Assets,What are long-term capital assets?,Long-term capital assets are equipment or facilities that provide productive services to the organization for more than one accounting period.,Long-Term(Capital)Assets,Organizations have developed specific tools to control the acquisition and use of long-term assets for three reasons:,Organizations commit to long-term assets for extended periods of time.,The amount of capital committed is usually very large.,The long-term nature of capital assets creates technological risk for organizations.,Long-Term(Capital)Assets,What is capital budgeting?,It is a systematic approach to evaluating an investment in long-term assets.,Learning Objective 2,Use the basic tools and concepts of financial analysis:investment,return,future value,present value,annuities,and required rate of return.,Investment and Return,Investment,is the monetary value of the assets that the organization gives up to acquire a long-term asset.,Return,is the increased cash inflows in the future that are attributable to the long-term asset.,Investment and,return,are the foundations of capital budgeting analysis.,Time Value of Money,A central concept in capital budgeting is the,time value of money,.,Because money can earn a return,its value depends on the time period in which it is received.,Amounts of money received at different periods of time must be converted to their value on a common date to be compared.,Time Value of Money,The,future value,of money is the value that an amount invested today will be after a stated number of periods at a given rate of return.,How much would an initial amount of$100 accumulate over five years when the rate of return is 5%per year?,Time Value of Money,Today,Year 5,5%,5%,5%,5%,5%,$100.00,$127.63,FV=PV,(1+r),n,Time Value of Money,Compound Growth of Investment,5 periods at 5%,Year 0:$1.00,Year 1:$1.05,Year 2:$1.1025,Year 3:$1.1576,Year 4:$1.2155,Year 5:$1.2763,Present Value,What is the present value of money?,It is the current monetary worth of an amount to be paid in the future under stated conditions of interest and compounding.,Analysts call a future cash flows value at time zero its present value.,The process of computing present value is called discounting.,Present Value,What is the present value of$127.63 to be received 5 years from now when the rate of return is 5%per year?,$100.00,PV=FV (1+r),n,Time Value of Money,Today,Year 5,5%,5%,5%,5%,5%,$127.63,$100.00,Present value of$127.63 in 5,years at a 5%annual rate of return,Present Value and Future Value of Annuities,What is an annuity?,It is a contract involving a series of constant payments or receipts to be paid or received for a stated number of periods at a specified rate.,Present Value and Future Value of Annuities,What is the future value of an annuity?,It is the sum of payments plus accumulated interest.,What is the present value of an annuity?,It is the value today of a series of future payments or receipts.,Present Value and Future Value of Annuities,Future,value of an annuity of$1,5 periods at 5%,Periods,Future Value,1$1.000,2$2.050,3$3.153,4$4.310,5$5.526,Present Value and Future Value of Annuities,Present,value of an annuity of$1,5 periods at 5%,Periods,Present Value,1$0.952,2$1.859,3$2.723,4$3.546,5$4.329,Cost of Capital,What is the cost of capital?,It is the interest rate organizations use in computing the time value of money.,It equals the return that the organization must earn on its investments to meet its investors return requirements.,The cost of capital is the benchmark the organization uses to evaluate investment proposals.,Learning Objective 3,Demonstrate how capital budgeting is used to evaluate investment proposals and how the concepts of payback,accounting rate of return,net present value,internal rate of return,and economic value added relate to capital budgeting.,Approaches to Capital Budgeting,Payback,Accounting rate of return,Net present value,Internal rate of return,Profitability index,Economic value added,Approaches to Capital Budgeting,Shirleys Doughnut Hole is considering the purchase of a new machine that will cost$70,000 and last five years.,Its salvage value is$10,000.,The machine will increase profits by$20,000 per year.,The cost of capital is 10%.,Is this investment worthwhile?,Payback Criterion,The,payback period,or payback criterion,computes the number of periods needed to recover a projects initial investment.,Payback time=70,000 20,000,=3.5 years,Accounting Rate of Return Criterion,The,accounting rate of return,approximates the return of investment.,Accounting Rate of Return,=,Average Income Average Investment,Accounting Rate of Return Criterion
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