Slide 1 ___________________________________ 8.6 Othe r Capital - - PDF document

Slide 1

8.6 Othe r Capital Budge ting Appr

• a c he s

Othe r Ca pita l budg e ting me thods

• Inte r

nal r ate of r e tur n

• Paybac k pe r

iod

• Simple rate of r

e turn

2005 K D Ha the wa y-Dia l

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Inte rna l Ra te of Re turn

• Simply the yie ld on a pr
• je c t
• Re turn ra te on a proje c t whe n

ne t pr e se nt va lue is ze ro

• Whe re disc ounte d inflows e qua l

disc ounte d outflows

2005 K D Ha the wa y-Dia l

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Inte rna l Ra te of Re turn

Ca lc ula ting the Inte rna l Ra te of Re turn

• F

ina nc ial c alc ulator

• Spr

e adshe e t softwa re

• By ha nd – not re c omme nde d

2005 K D Ha the wa y-Dia l

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Slide 4

Pa yba c k Pe riod Me thod

• Pa yba c k pe riod is the time

re quire d to r e c oup the initia l inve stme nt fr

• m c a sh r

e c e ipts

• Not a true me a sure of profita bility
• Doe s not ta ke into a c c ount future

c a sh flows

• Pa yba c k Pe riod Me thod E

qua tion

2005 K D Ha the wa y-Dia l

Pa yba c k Pe riod Me thod Inve stme nt Require d Ne t Annua l Ca sh Inflows

=

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Payba c k Pe riod Me thod Exa mple

Cosmos Inte r na tional ha s de c ide d to upda te e quipme nt. Upon r e vie w of the spe c s on a numbe r of bids, two bids have be e n ide ntifie d as having the ne c e ssary attr ibute s to re plac e the antiqua te d e quipme nt.

• Bid 172a is ba r

e bone s. Howe ve r , be c a use this e quipme nt will not r e quir e c onstant r e pa ir a nd ma inte na nc e it is c a lc ula te d tha t pr

• duc tivity should

inc r e a se by 25%

• Bid 274b ha s some time saving fe atur

e s but is mor e e xpe nsive

2005 K D Ha the wa y-Dia l

CO COSMOS I INTL

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Payba c k Pe riod Me thod Exa mple

Base d upon the paybac k me thod the bare bone s mode l is the be st de c ision. It will pay for itse lf almost

• ne ye a r

e a r lie r than the fanc y mode l.

2005 K D Ha the wa y-Dia l

4.9 yr s 4.0 yr s Payba c k pe r iod in yr s $52,500 $43,750 Ne t c ash inflows $258,000 $175,000 Inve stme nt r e quir e d Bid 274b Bid 172a Inve stme nt

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Slide 7

Simple Ra te of Re turn

• Doe s not involve disc ounting c a sh

flows a nd thus doe s not c onside r the time va lue of mone y

• AKA:
• Ac c ounting r

ate of re tur n

• Una djuste d r

a te of re tur n

• F
• c us on inc re me nta l ne t ope ra ting

inc ome

• Inc r

e me ntal r e ve nue s – inc r e me nta l e xpe nse s

2005 K D Ha the wa y-Dia l

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Simple Ra te of Re turn

T wo e qua tion va r ia tions:

2005 K D Ha the wa y-Dia l

Simple Ra te of Re turn Simple R a te of Re tur n Initia l Inve stme nt Initia l Inve stme nt Annua l Cost Sa ving s Annua l De pr e c ia tion on Ne w E quipme nt Annua l Inc r e me nta l Re ve nue s Annua l Inc reme nta l E xpe nse s inc luding De pre c ia tion

= =

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Simple Ra te of Re turn E xa mple 1

Sc ott Inc . ma ke s widg e ts a nd is c onside ring the a ddition of a ne w proc e ssing line . T he proc e ssing line would inc re a se r e ve nue by $650,000 with a ssoc iate d e xpe nse s

• f

$475,000. T he ne w proc e ssing line would c ost $900,000 a nd ha ve a use ful life of 10 ye ar s with no sa lvage value

2005 K D Ha the wa y-Dia l

Simple Ra te of Re turn $900,000 $650,000 ($475,000 + $85,000 de pre c ia tion) (850,000 – 0)/ 10 Assume str a ig ht line depre c ia tion (Cost – sa lva g e va lue ) / useful life

= = 10%

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Slide 10

Simple Ra te of Re turn E xa mple 2

Da lla s John Corp ha s be g un to re vie w a utoma ting the pac kag ing division of the ir wa re house . Curr e ntly a ll Doodads are pac ke d for shipping by ha nd. T he ne w e quipme nt c ould save the c ompany $79,000 e ac h ye ar in labor c osts. T he ne w e quipme nt c osts $360,000. It ha s a use ful life of 15 ye a rs with no salva ge va lue .

2005 K D Ha the wa y-Dia l

Simple R a te of Re tur n $300,000 $80,000 $20,000

= = 20.0%

(300,000 – 0)/ 15 Assume str a ig ht line depre c ia tion (Cost – sa lva g e va lue ) / useful life

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