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Lecture Survey of accounting (4/e) - Chapter 16: Planning for capital investments

After studying this chapter you will be able to: Explain the time value of money concept, determine and interpret the net present value of an investment opportunity, determine and interpret the internal rate of return of an investment opportunity, evaluate investment opportunities using the payback method and the unadjusted rate of return. | Chapter Sixteen Planning for Capital Investments © 2015 McGraw-Hill Education. 1 Capital Investment Decisions Purchases of long-term operational assets are capital investments. Once a company purchases operational assets, it is committed to these investments for an extended period of time. Understanding the time value of money concept will help you make rational capital investment decisions. 16-2 2 Time Value of Money This concept recognizes that the value of a dollar received in the future is less than today’s dollar. The further into the future the receipt is expected to occur, the smaller its present value. When a company invests in capital assets, it sacrifices present dollars in exchange for the opportunity to receive future dollars. 16-3 3 Minimum Rate of Return Most companies consider the cost of capital to be the minimum expected return on investment opportunities. Creditors expect interest payments; in most companies, owners expect dividends and increased stock value. The . | Chapter Sixteen Planning for Capital Investments © 2015 McGraw-Hill Education. 1 Capital Investment Decisions Purchases of long-term operational assets are capital investments. Once a company purchases operational assets, it is committed to these investments for an extended period of time. Understanding the time value of money concept will help you make rational capital investment decisions. 16-2 2 Time Value of Money This concept recognizes that the value of a dollar received in the future is less than today’s dollar. The further into the future the receipt is expected to occur, the smaller its present value. When a company invests in capital assets, it sacrifices present dollars in exchange for the opportunity to receive future dollars. 16-3 3 Minimum Rate of Return Most companies consider the cost of capital to be the minimum expected return on investment opportunities. Creditors expect interest payments; in most companies, owners expect dividends and increased stock value. The blend of creditor and owner costs is considered the cost of capital for an organization. 16-4 4 Converting Future Cash Inflows to Their Equivalent Present Values EZ Rentals wants to add LCD projectors to its product line. If EZ invests $178,571 on January 1 and requires a rate of return of 12%, the company will expect a $200,000 cash inflow at the end of the first year. Investment + (0.12 × Investment) = Future cash inflow 1.12 (Investment) = $200,000 Investment = $178,571 16-5 5 Present Value Table for Single-Amount Cash Inflows Table 1 in the Appendix $200,000 × 0.892857 = $178,571 (rounded) 16-6 6 Present Value Table for Annuities Let’s assume that EZ Rentals is going to receive $200,000 at the end of each of the next 4 years. The company uses an interest rate for present value calculations of 12%. An annuity is a series of equal periodic payments. Rent on your apartment or home, or insurance on your automobile is probably paid in the form an equal periodic payment. How do we .