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Lecture Managerial accounting: Creating value in a dynamic business environment (10/e): Chapter 16 - Ronald W. Hilton, David E. Platt

Chapter 16, capital expenditure decisions. After completing this chapter, you should be able to: Use the net-present-value method and the internal-rate-of-return method to evaluate an investment proposal; compare the net-present-value and internal-rate-of-return methods, and state the assumptions underlying each method; use both the total-cost approach and the incremental-cost approach to evaluate an investment proposal. | Capital Expenditure Decisions Chapter 16 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 16: Capital Expenditure Decisions Net-Present-Value Method 1. Prepare a table showing cash flows for each year, 2. Calculate the present value of each cash flow using a discount rate, 3. Compute net present value, 4. If the net present value (NPV) is zero or positive, accept the investment proposal. Otherwise, reject it. 16- These four steps constitute a net-present-value analysis of an investment proposal: 1. Prepare a table showing the cash flows during each year of the proposed investment. 2. Compute the present value of each cash flow, using a discount rate that reflects the cost of acquiring investment capital. This discount rate is often called the hurdle rate or minimum desired rate of return. 3. Compute the net present value, which is the sum of the present values of the . | Capital Expenditure Decisions Chapter 16 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 16: Capital Expenditure Decisions Net-Present-Value Method 1. Prepare a table showing cash flows for each year, 2. Calculate the present value of each cash flow using a discount rate, 3. Compute net present value, 4. If the net present value (NPV) is zero or positive, accept the investment proposal. Otherwise, reject it. 16- These four steps constitute a net-present-value analysis of an investment proposal: 1. Prepare a table showing the cash flows during each year of the proposed investment. 2. Compute the present value of each cash flow, using a discount rate that reflects the cost of acquiring investment capital. This discount rate is often called the hurdle rate or minimum desired rate of return. 3. Compute the net present value, which is the sum of the present values of the cash flows. 4. If the net present value (NPV) is equal to or greater than zero, accept the investment proposal. Otherwise, reject it. Internal-Rate-of-Return Method The internal rate of return is the true economic return earned by the asset over its life. The internal rate of return is computed by finding the discount rate that will cause the net present value of a project to be zero. 16- An alternative discounted-cash-flow method for analyzing investment proposals is the internal-rate-of-return method. An asset’s internal rate of return, or time-adjusted rate of return is the true economic return earned by the asset over its life. Another way of stating the definition is that an asset’s internal rate of return, IRR, is the discount rate that would be required in a net-present-value analysis in order for the asset’s net present value to be exactly zero. Internal-Rate-of-Return Method Black Co. can purchase a new machine at a cost of $104,320 that will save $20,000 per year in cash .