Capital%20Investment%20Analysis

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Capital Investment Analysis

• CHAPTER 15

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Learning Objectives

• After studying this chapter, you should be able
  to
• Explain the nature and importance of capital
  investment analysis
• Evaluate capital investment proposals using the
  average rate of return and cash payback methods
• Evaluate capital investment proposals using the
  net present value and internal rate of return
  methods
• List and describe factors that complicate capital
  investment analysis
• Diagram the capital rationing process

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• Learning Objective 1

• Explain the nature and importance of capital
  investment analysis

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Capital Investment Analysis

• Process by which ____________ plans, evaluates,
  and controls investments in fixed assets
• Also called _______________
• Capital investment decisions are very important
  for the long-term success of a business

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Methods of Evaluating Capital Investment Proposals

• Methods that do not use present values
• __________________
• __________________
• Methods that use present values
• __________________
• __________________

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• Learning Objective 2

• Evaluate capital investment proposals, using the
  average rate of return and cash payback methods

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Methods That Ignore Present Value

• Often used to initially _____ proposals
• Useful for proposals with relatively short useful
  lives because the _____ of cash flows is less
  important

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Average Rate of Return

• Measures the average annual income as a percent
  of the average investment
• Also called the ________________

Average Investment
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Average Rate of Return

Avg. Rate of Return
200,000/4
__
(500,000 cost 0 residual)/2
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Average Rate of Return

• If the average rate of return equals or exceeds
  the companys __________, the project should be
  accepted
• Advantages
• Easy to compute
• ____________________
• ____________________
• Disadvantage
• ____________________

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Cash Payback Method

• Cash Payback Period Expected period of time
  between the date of an investment and
  _________________________________
• ____________ Excess of cash flowing in from
  revenue over the cash flowing out for expenses

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Cash Payback Method
_______
_ years
_______
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Cash Payback Method

• If annual cash flows are not equal, the payback
  period is determined by adding the annual net
  cash flows until the investment is recovered

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Cash Payback Method

• Advantages
• _____________________
• _______ payback period is desirable
• ____________________
• ____________________
• Disadvantages
• _____________________
• _____________________

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• Learning Objective 3

• Evaluate capital investment proposals using the
  net present value and internal rate of return
  methods

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Present Value Considerations

• Uses both the amount and _______ of cash flows to
  evaluate an investment
• Present value of an amount the value of 1
  today is worth ____ than 1 received in a future
  date, because todays 1 can be invested and earn
  interest
• _____________________ sum of the present values
  of a series of equal cash flows at fixed time
  intervals

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Time Value of Money
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Present Value Method

• Present value tables help us calculate present
  values for _________ and ___________

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Present Value of an Annuity Calculations

• Cash Inflow Timeline and Present Value

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Present Value of an Annuity Calculations

• Present value tables help us calculate present
  values for annuities and single sums

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Net Present Value Method

• Analyzes capital investment proposals by
  comparing the initial cash investment with the
  ______________________
• Also called _________________ method
• The return rate is set by management often
  called the ______ rate
• If the net present value expected from an
  investment equals/exceeds the initial investment,
  the project is ________

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Net Present Value Method

• Net present value analysis for the purchase of a
  200,000 machine with a 5-year useful life.
  Minimum rate of return is 10

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Present Value Index

• If multiple proposals are being considered, use
  of the present value index can help determine
  which projects to accept

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Internal Rate of Return

• Uses _____________ concepts to compute the rate
  of return from the net cash flows expected from
  capital investment proposals
• Also called the _________________ method
• Starts with net cash flows and works backward to
  determine the _____________ expected from the
  project

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Internal Rate of Return
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Internal Rate of Return
__________________
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Internal Rate of Return

• Trial-and-error procedures are time-consuming.
  When ____________________ are expected, the
  calculation can be simplified

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Internal Rate of Return

• When the internal rate of return __________ a
  companys cost of capital, the proposal should be
  considered for acceptance
• Advantages
• ____________________________
• ____________________________
• Disadvantages
• Computations are more complex
• ___________________________
• ___________________________

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• Learning Objective 4

• List and describe factors that complicate capital
  investment analysis

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Factors That Complicate Capital Investment
Analysis

• Income tax
• Proposals with ___________
• Lease versus ____________
• ________________
• ________________
• ________________

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• Learning Objective 5

• Diagram the capital rationing process

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Capital Rationing

• The process by which management allocates _____
  among competing capital investment proposals
• The proposals that meet all __________
  (financial) and __________ tests should be ranked
  for funding
• Unfunded proposals may be reconsidered if funds
  become available later

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Capital Rationing Decision Process
Continued
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Capital Rationing Decision Process continued
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End of Chapter 15