Hospitality Industry Managerial Accounting HRT 374

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Hospitality Industry Managerial AccountingHRT 374

• Chapter 13
• Capital Budgeting

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Relationship of Capital Budgeting to Operations
Budget

• Operations Budget first
• Capital Budgets for many years

3
Types of Decisions

• Government regulations
• Reduce costs
• Increase sales
• Replacement
• Cosmetic
• New ventures

4
Time Value of Money

• What is the future value of todays money?
• Present value of 1
• Present value of an annuity of 1
• Present Value Future Value (Factor)
• where Factor is a function of
• n number of periods
• I interest rate

5

• FV 100 (1 i)²
• FV 100 (1 .12) ²
• FV 100 (1.2544)
• FV 125.44

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Time Value MoneyUsing your financial calculator
(HP 10BII)

• How much would 100 today be worth in 2 years at
  12 interest?
• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 1 P_Yr (if not 1 shift p/yr)
• 100 - PV (Present Value) should see -100
• 2 N
• 12 I/YR
• FV (Future Value)
• Should get answer of 125.44

7
How much would 300 today be worth in 2 years at
11 interest?

• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 1 P_Yr (if not 1 shift p/yr)
• 300 /- PV (Present Value) should see -300
• 2 N
• 11 I/YR
• FV (Future Value)
• Should get answer of 369.63

8
What if you wanted to have 200 at the end of 2
years with 12 annual compounding interest?

• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 1 P_Yr (if not, 1 shift p/yr)
• 200 /- FV (Future Value) should see -200
• 2 N
• 12 I/YR
• PV (Present Value)
• Should get answer of 159.44

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Compounding--when N is not years

• N is NOT years. It is the number of periods
• To find number of periods, multiply the number of
  years x compounding
• Find the N
• 2 years and annual compounding
• Answer N 1 x 2 2
• 3 years and semi annual compounding?
• Answer N 3 x 2 6
• 1 year and daily compounding?
• N 1 x 365 365

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How much would 100 today be worth in 2 years,12
interest, with semi annual compounding?

• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 2 P_Yr (if not 2 orange p/yr)
• 100 - PV (Present Value) should see -100
• NOT 2N. Should be 4N
• 2 times 2 (twice per year X 2 years)
• 12 I/YR
• FV (Future Value)
• Should get answer of 126.25

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How much would 200 today be worth in 3 years,9
interest, with semi-annual compounding?

• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 2 P_Yr (if not 2 shift p/yr)
• 200 - PV (Present Value) should see -200
• NOT 3N. Should be 6N
• 3 times 2 6 (3 years x twice per year)
• 9 I/YR
• FV (Future Value) Should get answer of 260.45

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What if you wanted to have 200 at the END of 2
years with 12 interest compounding quarterly?

• Check compounding (number of times the bank pays
  interest) by orange C
• Should say 4 P_Yr (if not, 4 shift p/yr)
• 200 /- FV (Future Value) should see -200
• 8 N
• 12 I/YR
• PV (Present Value)
• Should get answer of 157.88

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Annuity

• Most capital investments provide a stream of
  receipts for several years.
• When the amounts are the same and at equal
  intervals, this stream is called an annuity.

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Annuity calculations

• Example p.585
• Page 587, Exhibit 3

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Example of annuity

• If you invest 10,000 each year for 6 years at 8
  interest and compounded annually, what is the
  future value of the investment?
• 10,000 /- PMT (should see -)
• 8 I/YR
• 6 N
• Shift BGN
• FV 79,228

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Annuity problem 2

• If you invest 12,000 each year for 4 years at 9
  interest and compounded annually, what is the
  future value of the investment?
• 59,816
• 12,000 /- PMT (should see -)
• 9 I/YR
• 4 N
• Shift BGN
• FV 59,816

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Cash Flow

• Initial investment
• Investment revenues
• Investment expenses
• Not including depreciation

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Models

• Accounting Rate of Return
• Payback
• Net Present Value
• Internal Rate of Return

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Acct. Rate of Return pros and cons

• Prosinformation easily available
• Consdoes not use time value of money or cash
  flows. Uses book value, not market value

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Payback

• Illustration
• 0 year -50,000
• 1 year 30,000
• 2 year 20,000
• 3 year 10,000
• 4 year-- 5,000
• When would the payback be?

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Payback pros and cons

• Pros Simple, many investments do not need
  complex and costly analysis
• Cons- Ignores time value. Might cause you to
  make investments that are worth less than they
  cost. Biased toward short investments
• Example of payback ruleall investments under
  10,000 must have payback within 2 years.

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NPV illustration

• Buy a run down house for 100,000
• Spend 25,000 to paint, new plumbing, windows,
  etc.
• Put on market and it sells for 150,000
• Your investment of 25,000 created 25,000 of value
• The difference between the market value and its
  cost is called the net present value (NPV)
• Reason to do NPV is to know before you invest the
  money

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Net Present Value

• Pros--Uses Time Value of money over the life of
  the capital project
• Discounts cash flows to their present value
• How? Subtract project cost from the present value
  of the discounted cash flow stream

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Internal Rate of Return

• Illustration A project costs 1,000 today and
  pays 1,100 in a year. What is the rate of
  return on the investment?
• 10
• Good if our target IRR is less than 10,
• Bad if our target IRR is greater than 10

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Mutually exclusive projects

• Select the one with higher NPV unless lives are
  significantly different (page 598)
• If useful lives are different
• Assume shorter life prevails or
• Assume longer life prevails
• Just be consistent

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Capital Rationing

• Limiting funds for capital purposes.
• Select projects with highest NPV until money runs
  out

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Models in the industry

• 74 use IRR
• 66 use payback
• 55 use NPV
• 32 use ARR

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Homework

• Problems
• 1.1
• 2
• 3 (first 2 parts)

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1.1 What amount must be invested today at an
annual interest rate of 12 to yield 100,000 in
10 years?

• 1.1 32,197
• Enter 100,000 /- FV
• Always check to see how many times
  compoundingorange Clear
• To change, number orange p/yr
• Enter number of periods 10 N
• Enter interest rate 12 I/yr
• Enter PV 32,197

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2.1 If invest 100,000 today, what will it be
worth in 5 yrs at 8 interest?

• 1. Answer 146,933
• Clear all and check compounding (orange C)
• If need to change, 1 orange p/yr
• 100,000 PV should see -100,000 (it is a minus
  because you are paying out 100,000)
• 8 I/yr
• 5 N
• FV Should see answer of 146,933

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2.2 If invest 120,000 today, what will it be
worth in 3 yrs at 7 interest?

• Answer 147,005
• Clear all and check compounding (orange C)
• If need to change, 1 orange p/yr
• 120,000 PV should see -120,000 (it is a minus
  because you are paying out 120,000)
• 7 I/yr
• 3 N
• FV Should see answer of 147,005

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2.3 If invest 20,000 at beginning of each year
for 5 yrs at 9 interest, what will it be worth
after 5 yrs?

• Answer130,467
• Clear all and check compounding (orange C)
• If need to change, 1 orange p/yr
• 20,000 /PMT should see -20,000 (it is a minus
  because you are paying out 20,000 each year)
• 9 I/yr
• 5 N
• Shift BEG/End (Want BEG)
• FV Should see answer of 130,467

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3.1 If 100,000 invested today at 12 annual
interest compounded quarterly for 10 years?

• 1. 326,203.78
• 100,000 - PV
• Quarterly compounding 4 shift P/YR
• 12 I/YR
• 40 N (quarterly x 10 40)
• FV 326,204

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3.2 If 15,000 invested annually today at 10
interest and compounded annually for 10 years?

• 15,000 /- PMT should see -15,000
• 10 I/YR
• 10 N
• Shift Beg/end (you are paying in at the beginning
  of the year)
• FV 262,967.51