Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting). Investment in current assets are also a part of investment decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of finance from various resources which will depend upon decision on type of source, period of financing, capital investment analysis is best accomplished by techniques that, cost of financing and the returns thereby.
3. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two:
   1. Dividend for shareholders- Dividend and the rate of it has to be decided.
   2. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be cryptocurrency to invest in may 2022 plan a sound capital capital investment analysis is best accomplished by techniques that should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the i want to earn money online from home structure have to be decided. This involves short- term and long- term debt equity analysis. This capital investment analysis is best accomplished by techniques that depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices like-
   1. Issue of shares and debentures
   2. Loans to be taken from banks and financial institutions
   3. Public deposits to be drawn like in form of bonds.
   Choice of factor will depend on relative merits and demerits of each source and period of financing.
4. Investment of funds: The capital investment analysis is best accomplished by techniques that manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways:
   1. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
   2. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances, capital investment analysis is best accomplished by techniques that. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc.

Authorship/Referencing - About the Author(s)

The article is Written By &#;Prachi Juneja&#; and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts, capital investment analysis is best accomplished by techniques that. We are a ISO Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to www.oldyorkcellars.com and the content page url.

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Capital Investment Analysis

Also called Capital Budgeting - a complex topic simplified in an easy to understand presentation which is completely self-explanatory, capital investment analysis is best accomplished by techniques that. Explains the framework for financial analysis with examples and provides practical insights. Can be used for reference, training & self paced learning. The presentation includes examples worked in an Excel sheet.

Covers:
* The nature & characteristics of long term investments made by corporations
* The problem associated with measuring the rate of return with long term investments
* The approach to solving this problem
* The key methods used in calculating the rate of return and evaluating alternatives
* The practical aspects of the various inputs required to calculate the return on investment
* The basics of the risks associated with long term investments & how to factor ?in such risks
* The strategic considerations involved in long term investment decisions
* The processes involved in long term investment decisions & its implementation

Learning Objective

1. Apply the concept of the time value of money to capital budgeting decisions.

Business in Action

Capital Budgeting Decisions at JCPenney and Kohl’s

JCPenney Company has over 1, department stores in the United States, and Kohl’s Corporation has over Both companies cater to a “middle market.” In OctoberKohl’s announced plans to open 65 new stores. At about the same time, JCPenney announced plans to open 20 new stores, 17 of which would be stand-alone stores. This was a departure from JCPenney’s typical approach of serving as an anchor store for regional shopping malls.

The decision to open new stores is an example of a capital budgeting decision because management must analyze the cash flows associated with the new stores over the long term.

The Present Value Formula

Question: Suppose you invest $1, for 1 year at an interest rate of 5 percent per year, as shown in the following timeline. How much will you have at the end of 1 year (or what is the future value of the investment)?

Answer: You will have $1,

Question: Let’s change course and find the present value of the same future cash flow. If you receive $1, in 1 year, how much is that worth in today’s dollars assuming an annual interest rate of 5 percent?

Answer: The present value is $1, calculated as follows:

Question: Let’s go back to finding a future value. Assume you invest $1, today at an annual rate of 5 percent for 2 years. How much will you have at the end of 2 years?

Answer: At the end of 1 year, you will have $1, (= $1, × [1 + ]). At the end of the second year, you will have $1, which is $1, × (1 + ). The equation is

Question: Again, let’s change course and find the present value of the same future cash flow. If you receive $1, in 2 years, how much is that worth in today’s dollars assuming an annual interest rate of 5 percent?

Answer: The present value is $1, calculated as follows:

These examples show that one equation can be used to find the present value of a future cash flow. The equation is

Question: Let’s use this formula to solve for the following: Assume $ will be received 4 years from today, and the annual interest rate is 10 percent. What is the present value of this cash flow?

Answer: The present value is $, calculated as follows:

Present Value Tables

Question: Although most managers use spreadsheets, such as Excel, to perform present value calculations (discussed later in this chapter), you can also use the present value tables in the appendix to this chapter, labeled Figure "Present Value of $1 Received capital investment analysis is best accomplished by techniques that the End of " and Figure "Present Value of a $1 Annuity Received at the End of Each Period for ", for these calculations. Figure "Present Value of $1 Received at the End of " simply provides the present value of $1 (i.e., F = $1) given the number of years (n) and the interest rate (r). How are these tables used to calculate present value amounts?

Answer: Let’s look at an example to see how these tables work. Assume $1 will be received 4 years from today (n = 4), and the interest rate is 10 percent (r = 10 percent). What is the present value of this cash flow? Look at Figure "Present Value of $1 Received at the End of " in the appendix. Find the column labeled 10 percent and the row labeled 4. The present value is $, or $ rounded. The table amount given is often called a factor. The factor in this example is (note that the formula to find this factor is shown at the top of Figure "Present Value of $1 Received at the End of ").

Now assume all the same facts, except that $ rather than $1 will be received in 4 years. To find the present value, simply multiply the factor found in Figure "Present Value of $1 Received at the End of " by $, as follows:

Notice that this present value is the same as the one we calculated using the formula P = F_n ÷ (1 + r)ⁿ, with the exception of a small difference due to rounding the factor in Figure "Present Value of $1 Received at the End of ". Next, we use present value concepts to evaluate projects with the NPV method.

Learning Objective

1. Evaluate investments using the net present value (NPV) approach.

Figure Cash Flows for Copy Machine Investment by Jackson’s Quality Copies

Figure NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies

The NPV is $1, Because NPV is > 0, accept the investment. (The investment provides a return greater than 10 percent.)

The NPV Rule

Question: Once the NPV is calculated, how do managers use this information to evaluate a long-term investment?

Answer: Managers apply the following rule to decide whether to proceed with the investment:

NPV Rule: If the NPV is greater than or equal to zero, accept the investment; otherwise, reject the investment.

As summarized in Figure "The NPV Rule", if the NPV is greater than zero, the rate of return from the investment is higher than the required rate of return. If the NPV is zero, the rate of return from the investment equals the required rate of return. If the NPV is less than zero, the rate of return from the investment is less than the required rate of return. Since the NPV is greater than zero for Jackson’s Quality Copies, the investment is generating a return greater than the company’s required rate of return of 10 percent.

Figure The NPV Rule

Note that the present value calculations in Figure "The NPV Rule" assume that the cash flows for years 1 through 7 occur at the end of each year. In reality, these cash flows occur throughout each year. The impact of this assumption on the NPV calculation is typically negligible.

Annuity Tables

Question: Notice in Figure "Cash Flows for Copy Machine Investment by Jackson’s Quality Copies" that the rows labeled maintenance cost and labor savings have identical cash flows from one year to the next. Identical cash flows that occur in regular intervals, such as these at Jackson’s Quality Copies, are called an annuityA term used to describe identical cash flows that occur in regular intervals.. How can we use annuities in an alternate format to calculate the NPV?

Answer: In Figure "Alternative NPV Calculation for Jackson’s Quality Copies", we demonstrate an alternative approach to calculating the NPV.

The purchase price and salvage value rows in Figure "Alternative NPV Calculation for Jackson’s Quality Copies" represent one-time cash flows, and thus we use Figure "Present Value of $1 Received at the End of " in the appendix to find the present value factor for these items (these are not annuities). The annual maintenance costs and annual labor savings rows represent cash flows that occur each year for seven years (these are annuities). We use Figure "Present Value of a $1 Annuity Received at the End of Each Period for " in the appendix to find the present value factor for these items (note that the number of years, n, equals seven since the cash flows occur each year for seven years). Simply multiply the cash flow shown in column (A) by the present value factor shown in column (B) to find the present value for each line item, capital investment analysis is best accomplished by techniques that. Then sum the present value column to find the NPV. This alternative approach results in the same NPV shown in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies".

Learning Objective

1. Evaluate investments using the internal rate of return (IRR) approach.

Computer Application

Using Excel to Calculate NPV and IRR

Let’s use the Jackson’s Quality Copies example presented at the beginning of the chapter to illustrate how Excel can be used to calculate the NPV and IRR. Two steps are required to calculate the NPV and IRR using Excel. All cell references are to the following spreadsheet shown.

Step 1. Enter the data in the spreadsheet.

Rows 1 through 7 in the spreadsheet show the cash flows associated with the proposal to purchase a new copy machine at Jackson’s Quality Copies (first presented in Figure "Cash Flows for Copy Machine Investment by Jackson’s Quality Copies").

Step 2. Input the functions to calculate NPV and IRR.

We selected cell H16 to calculate the NPV, so this is where the NPV function is input. Cell E16 shows the function in detail with dialogue boxes provided for clarification. Notice that the resulting NPV of $1, shown in cell H16 is the same as the NPV calculated in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies" and Figure "Alternative NPV Calculation for Jackson’s Quality Copies".

We selected cell H28 to calculate the IRR, so this is where the IRR function is input. Cell E28 shows the function in detail. Notice that the resulting IRR of percent shown in cell H28 is very close to our approximation of slightly less than 11 percent shown in Figure "Finding the IRR for Jackson’s Quality Copies".

As an alternative to entering a function directly into the spreadsheet, the NPV function under the Formulas menu in Excel can be used. Simply select the cell in the spreadsheet where you would like the answer to appear (H16 in this case), and go to the Formulas menu. Click on the capital investment analysis is best accomplished by techniques that symbol or Insert Function on the formula bar. Search for the function by typing in NPV, select NPV where it appears in the box, then select OK. When asked for the Rate, enter the cell where the rate appears (B10). Then under Value 1 enter the cells containing the series of cash flows, starting with year 1 (shown as C7:I7, which means C7 through I7). Select OK. Now go back and add the cash flow at time 0 (B7) to the end of the NPV function. The resulting formula will look like the formula shown in E16, and the answer will appear in the cell where the function is entered (H16).

The IRR function can be inserted into a cell using the same process presented previously. Select the cell in the spreadsheet where you would like the answer to appear (H28), and go to the Formulas menu. Click on the fx symbol or Insert Function on the formula bar. Search for the function by typing in IRR, select IRR where it appears in the box below, then select OK. When asked for Values, enter the cells containing the series of cash flows, capital investment analysis is best accomplished by techniques that, starting with time 0 (shown as B7:I7, which means B7 through I7). When asked for a Guess, enter your best guess as to what the IRR might be (this provides the system with a starting point), then select OK. The resulting formula will look like the formula shown in E28, and the answer will appear in the cell where the function is entered (H28).

Key Takeaway

• The IRR is the rate required (r) to get an NPV of zero for a series of cash flows and represents the time-adjusted rate of return for an investment. If the IRR is greater than or equal to the company’s required rate of return (often called the hurdle rate), the investment is accepted; otherwise, the investment is rejected.

Review Problem

This review problem is a continuation of Note "Review Problem ", and uses the same information. The management of Chip Manufacturing, Inc., would like to purchase a specialized production machine for $, The machine is expected to have a life of 4 years, and a salvage value of $, Annual maintenance costs will total $30, Annual labor and material savings are predicted to be $, The company’s required rate of return is 15 percent.

1. Based on your answer to Note "Review Problem ", use trial and error to approximate the IRR for this investment proposal.
2. Should Chip Manufacturing, Inc., purchase the specialized production machine? Explain.

Solution to Review Problem

1. In Note "Review Problem ", the NPV was calculated using 15 percent (the company’s required rate of return), capital investment analysis is best accomplished by techniques that. Knowing that 15 percent results in an NPV of $(14,), and therefore seeing the return is less than 15 percent, we decreased the rate to 13 percent. As shown in the following figure, this resulted in an NPV of $15, which indicates the return is higher than 13 percent. Using a rate of 14 percent results in an NPV very close to 0 at $ Thus the IRR is close to 14 percent.

2. Because the IRR of 14 percent is less than the company’s required rate of return of 15 percent, Chip Manufacturing, Inc., should not purchase the specialized production machine.

Learning Objective

1. Understand the impact of cash flows, qualitative factors, and ethical issues on long-term investment decisions.

Focusing on Cash Flows

Question: Which basis of accounting is used to calculate the NPV and IRR for long-term investments, cash or accrual?

Answer: Both methods of evaluating long-term investments, NPV and IRR, focus on the amount of cash flows and when the cash flows occur. Note that the timing of revenues and costs in financial accounting using the accrual basis is often not the same as when the cash inflows and outflows occur. A sale can be recorded in one period, and the cash be collected in a future period. Costs can occur in one period, and the cash be paid in a future period. For the purpose of making NPV and IRR calculations, managers typically use the time period when the cash flow occurs.

When a company invests in a long-term asset, such as a production building, the cash outflow for the asset is included in the NPV and IRR analyses. The depreciation taken on the asset in future periods is not a cash flow and is not included in the NPV and IRR calculations. However, there is a cash benefit related to depreciation (often called a depreciation tax shield) since income taxes paid are reduced as a result of recording depreciation expense. We explore the impact of income taxes on NPV and IRR calculations later in the chapter.

Factoring in Inflation

Question: Is inflation included in cash flow projections when calculating the NPV and IRR?

Answer: Most managers make cash flow projections that include an adjustment for inflation. When this is done, a rate must be used that also factors in inflation over the life of the investment. As discussed earlier in the chapter, the required rate of return used for NPV calculations is based on the firm’s cost of capital, which is the weighted average cost of debt and equity. Since the cost of debt and equity already includes the effect of inflation, no inflation adjustment is necessary when establishing the required rate of return.

The important point here is that cash flow projections must include adjustments for inflation to match the required rate of return, which already factors in inflation. If cash flows are not adjusted for inflation, managers are likely underestimating future cash flows and therefore underestimating the NPV of the investment opportunity. This is particularly pronounced for economies that have relatively high rates of inflation.

For the purposes of this chapter, assume all cash flows and required rates of return are adjusted for inflation.

Be Aware of Qualitative Factors

Question: So far, this chapter has focused on using cash flow projections and the time value of money to evaluate long-term investments. Using these quantitative factors to make decisions allows managers to support decisions with measurable data. For example, the investment opportunity at Jackson’s Quality Copies presented at the beginning of the chapter was accepted because the NPV of $1, was greater than 0, and the IRR of peter leeds invest in penny stocks percent was greater than the company’s required rate of return of 10 percent. Why do most companies also consider nonfinancial factors, often called qualitative factors, when making a long-term investment decision?

Answer: Although using quantitative factors for decision making is important, qualitative factors may outweigh the quantitative factors in making a decision. For example, a large manufacturer of medical devices recently invested several million dollars in a small start-up medical device firm. When asked about the NPV analysis, the manager responsible for the investment indicated, “My staff did a quick and dirty NPV analysis, which indicated we should not invest in the company. However, the technology they were using for their device was of such strategic importance to us, we could not pass up the investment.” This is an example of qualitative factors (strategic importance to the company) outweighing quantitative factors (negative NPV).

Similar situations often arise when companies must invest in long-term assets even though NPV and IRR analyses indicate otherwise. Here are a few examples:

• Investing in new production facilities may be essential to maintaining a reputation as the industry leader what are some stocks to invest in today innovation, even though the quantitative analysis (NPV and IRR) points to rejecting the investment. (It is difficult to quantify the benefits of being the “industry leader in innovation.”)
• Investing in pollution control devices for an oil refinery may provide social benefits even though the quantitative analysis (NPV and IRR) points to rejecting the investment. (Although a reduction in fines and legal costs may be quantifiable and included in the analyses, it is difficult to quantify the social benefits.)
• Investing in a new product line of entry-level automobiles may increase foot traffic at the showroom, resulting in increased sales of other products, even though the quantitative analysis (NPV and IRR) points to rejecting the investment. (It is difficult to quantify the impact of the new product line on sales of existing product lines.)

Clearly, managers must look at the financial information and analysis when considering whether to invest in long-term assets. However, the analysis does not stop with financial information. Managers and decision makers must also consider qualitative factors.

Ethical Issues

Question: Our discussion of NPV and IRR methods implies that managers can easily make capital budgeting decisions once NPV and IRR analyses are completed and qualitative factors have been considered. However, managers sometimes make decisions that are not in the best interest of the company. Why might managers make decisions that are not in the best interest of the company?

Answer: Several examples are provided next.

Learning Objective

1. Evaluate investments using the payback method.

Payback Method Example

Question: What is the payback period for the proposed purchase of a copy machine at Jackson’s Quality Copies?

Answer: The payback period is five years. Here’s how we calculate it. Figure "Summary of Cash Flows for Copy Machine Investment by Jackson’s Quality Copies" repeats the cash flow estimates for Julie Jackson’s planned purchase of a copy machine for Jackson’s Quality Copies, the example presented at the beginning of the chapter.

Figure Summary of Cash Flows for Copy Machine Investment by Jackson’s Quality Copies

The payback method answers the question “how long will it take to recover my initial $50, investment?” With annual cash inflows of $10, starting in year 1, the payback period for this investment is 5 years (= $50, initial investment ÷ $10, annual cash receipts). This calculation is relatively simple when one investment is made at the beginning, and annual cash inflows are identical. However, some investments require cash outflows at different points throughout the life of the asset, and cash inflows can vary from one year to the next. Table "Calculating the Payback Period for Jackson’s Quality Copies" provides a format to help calculate the payback period for these more complex investments. Note that the review problem at the end of this segment provides an example of how to calculate the payback period to the nearest month when uneven cash flows are expected.

Weaknesses of the Payback Method

Question: Why is it a problem to ignore the time value of money when calculating the payback period?

Answer: Suppose you have 2 investments of $10, to choose from. The first investment generates cash inflows of $8, in year 1, $2, in year 2, and $1, in year 3. The second investment generates cash inflows of $2, in year 1, $8, in year 2, and $1, in year 3. The two investments are summarized here:

Both investments have a payback period of two years. Does this mean both investments are of equal value? No because the first investment generates far more cash in year 1 than the second investment. In fact, it would be preferable to calculate the IRR to compare these two investments. The IRR for the first investment is 6 percent, and the IRR for the second investment is 5 percent.

Question: Why is it a problem to ignore the cash flows after the payback period?

Answer: Suppose $50, can be invested in 2 separate investments with the following cash flows:

The first investment has a payback period of two years, and the second investment has a payback period of three years. If the company requires a payback period of two years or less, the first investment is preferable. However, the first investment generates only $3, in cash after its payback period while the second investment generates $35, after its payback period. The payback method ignores both of these amounts even though the second investment generates significant cash inflows after year 3. Again, it would be preferable to calculate the IRR to compare these two investments. The IRR for the first investment is 4 percent, and the IRR for the second investment is 18 percent.

Although the payback method is useful in certain situations where companies are concerned about recovering investments as quickly as possible (e.g., companies on the verge of bankruptcy), it is not a measure of profitability. The NPV and IRR methods compare the profitability of each investment by considering the time value of money for all cash flows related to the investment.

Wrap-Up of Chapter Example

In the Jackson’s Quality What are some stocks to invest in today example featured throughout this chapter, the company is considering whether to purchase a new copy machine for $50, A week has passed since Mike Haley, accountant, discussed this investment with Julie Jackson, president and owner. Refer to Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies", Figure "Alternative NPV Calculation for Jackson’s Quality Copies", and Figure "Finding the IRR for Jackson’s Quality Copies", and Table "Calculating the Payback Period for Jackson’s Quality Copies" as you learn what Mike’s findings are.

Learning Objective

1. Evaluate investments with multiple investment and working capital cash flows.

Investment Cash Outflows

The examples thus far have assumed that cash outflows for the investment occur only at the beginning of the investment. However, some investments require cash outflows capital investment analysis is best accomplished by techniques that varying points throughout the life of the project. For example, suppose the JCPenney Company plans to open a new store, capital investment analysis is best accomplished by techniques that, which requires a $10, investment at the beginning of the project for construction of the building. However, the building will be expanded at the end of year 4, at a cost of $2,, to meet an expected increase in demand. The $2, cash outflow must be included in the cash flows of the project for year 4 when calculating the NPV, IRR, and payback period.

Working Capital

Working capitalCurrent assets minus current liabilities. is defined as current assets (cash, accounts receivable, inventory, and the like) minus current liabilities (accounts payable, wages payable, and accrued liabilities, capital investment analysis is best accomplished by techniques that, for instance). Many long-term investments require working capital. For example, JCPenney will need cash in its registers when it opens the new store. Working capital is also required to fund inventory and accounts receivable. Working is it right time to buy bitcoin today necessary for long-term investments should be included as a cash outflow, typically at the beginning of the project.

Some long-term investments have an expected life, at the end of which working capital is returned to the company for investment elsewhere. When this happens, the working capital is included in the cash flow analysis as a cash outflow at the beginning of the project and a cash inflow at the end of the project.

Learning Objective

1. Understand the impact that income taxes have on capital budgeting decisions.

Figure NPV Calculation with Income Taxes for Scientific Products, Inc.

Note: the NPV is $(56,).

Since NPV is < 0, reject the investment. (The investment provides a return less than 10 percent.)

^a Initial investment purchase price and working capital do not directly affect net income and therefore are not adjusted for income taxes, capital investment analysis is best accomplished by techniques that.

^b Amount equals net cash receipts before taxes × (1 – tax rate). For year 1, $30, = $50, × (1 – ); for year 2, $36, = $60, capital investment analysis is best accomplished by techniques that, × (1 – ); and so forth.

^c Depreciation tax savings = Depreciation expense × Tax rate. Depreciation expense is $80, (= $, cost ÷ 5 year useful life). Thus annual depreciation tax savings is $32, (= $80, depreciation expense × tax rate).

Figure How Income Taxes Affect Capital Budgeting Cash Flows

Key Takeaway

• Companies that pay income taxes must consider the impact income taxes have on cash flows for long-term investments, and make the necessary adjustments. Investment and working capital cash flows are not adjusted because these cash flows do not affect taxable income. Revenue cash inflows and expense cash outflows are adjusted by multiplying the cash flow by (1 – tax rate). Although depreciation expense is not a cash outflow, it provides tax savings. The tax savings is calculated by multiplying depreciation expense by the tax rate. Once these adjustments are made, we can calculate the NPV and IRR.

Review Problem

Car Repair, Inc., would like to purchase a new machine for $, capital investment analysis is best accomplished by techniques that, The machine will have a life of 4 years with no salvage value, and is expected to generate annual cash revenue of $, Annual cash expenses, excluding depreciation, will total $20, The company uses the straight-line depreciation method, capital investment analysis is best accomplished by techniques that, has a tax rate of 30 percent, and requires a 10 percent rate of return.

1. Find the NPV of this investment using the format presented in Figure "NPV Calculation with Income Taxes for Scientific Products, Inc.".
2. Should the company purchase the machine? Explain.

Solution to Review Problem

1. The NPV is $50, as shown in the following figure.

   

   ^a Initial investment purchase price does not directly affect net income and therefore is bitcoin investor ervaringen plus adjusted for income taxes.

   ^b Amount equals cash revenue before taxes × (1 – tax rate); $, = $, × (1 – ).

   ^c Amount equals cash expense before taxes × (1 – tax rate); $14, = $20, × (1 – ).

   ^d Depreciation tax savings = Depreciation expense × Tax rate. Depreciation expense is $, (= $, cost ÷ 4 year useful life). Thus annual depreciation tax savings is $30, (= $, depreciation expense × tax rate).

2. Yes, the company should purchase the machine. The positive NPV of $50, shows the return of this proposal is above the company’s required rate of return of 10 percent.

Figure Present Value of $1 Received at the End of n Periods

Note:

Figure Present Value of a $1 Annuity Received at the End of Each Period for n Periods

Note:

End-of-Chapter Exercises

Questions

1. What is the difference between capital budgeting decisions covered in this chapter and management decisions covered in Chapter 7 "How Are Relevant Revenues and Costs Used to Make Decisions?"?
2. What concept must be considered when looking at cash flows over several years for a long-term investment? Explain.
3. What is meant by the term present value?
4. What is the formula used to calculate the present value of a future cash flow? Describe each component.
5. Describe the three steps required to evaluate investments using the net present value method.
6. How do most firms establish the required rate of return used to calculate the net present value?
7. What is meant by the term internal rate of return? Explain the IRR decision rule?
8. For the purpose of calculating net present value and internal rate of return, do companies use the accrual basis of accounting? Explain.
9. Why might a firm choose to accept a long-term investment even if the net present value is below zero?
10. What might cause a manager to reject a long-term investment even though the net present value is positive?
11. Describe the two steps required to calculate net present value and internal rate of return when using Excel.
12. What is the payback method, and why do managers use this method?
13. What are the two weaknesses associated with the payback method?
14. Refer to Note "Business in Action " What method of evaluating long-term investments is most popular? Why do you think the payback method is the least-used method?
15. What does the term working capital refer to, and how does working capital affect the evaluation of long-term investments?
16. Assume a company pays income taxes. How are revenue and expense cash flows adjusted for income taxes when calculating the net present value?
17. Assume a company pays income taxes. How does depreciation expense affect cash flows even though it is a noncash expense?

Brief Exercises

1. Investment Decision at Jackson’s Quality Copies. Refer to the dialogue at Jackson’s Quality Copies presented at the beginning of the chapter. What is Julie Jackson proposing? What information did Mike, the accountant, get from Julie to evaluate the proposal?

2. Present Value Calculations. For each of the following independent scenarios, use Figure "Present Value of $1 Received at the End of " in the appendix to calculate the present value of the cash flow described.

   1. $10, will be received 4 years from today. The rate is 10 percent.
   2. $10, will be received 4 years from today. The rate is 20 percent.
   3. $50, will be received 15 years from today. The rate is 12 percent.
   4. $50, will be received 15 years from today. The rate is 6 percent.

3. Present Value Calculations (Annuities). For each of the following independent scenarios, use Figure "Present Value of a $1 Annuity Received at the End of Each Period for " in the appendix to calculate the present value of the do twitter make money flow described. Round to the nearest dollar.

   1. $1, will be received at the end of each year for 6 years. The rate is 12 percent.
   2. $1, will be received at the end of each year for 6 years. The rate is 15 percent.
   3. $10, will be received at the end of each year for 6 years. The rate is 7 percent.
   4. $, will be received at the end of each year for 4 years. The rate is 10 percent.

4. Net Present Value Calculations. Freefall, Inc., has two independent investment opportunities, each requiring an initial investment of $65, The company’s required rate of return is 8 percent. The cash inflows for each investment are provided as follows.

   

   Required:

   1. Without resorting to calculations, which investment will have the highest net present value? Explain.
   2. Calculate the net present value for each investment (remember to include the initial investment runescape fun money making outflow in your calculation). Should the company invest in either investment? Round to the nearest dollar.
5. Internal Rate of Return Calculation. An investment costing $50, today will result in cash savings of $5, per year for 15 years. Use trial and error to approximate the internal rate of return for this investment proposal.
6. Evaluating Qualitative Factors. Chem, Inc., produces chemical products. The company recently decided to invest in expensive pollution control devices even though the negative net present value pointed toward rejecting this investment. What qualitative factor likely led the company to make the investment in spite of the negative net present value?

7. Ethical Issues in Making a Capital Budgeting Decision. Assume the manager of a store earns an annual bonus based on meeting a certain level of net income, which has been achieved consistently over the past five years. The company is currently considering the addition of a second store, which is expected to become profitable after two years. The manager is responsible for making the final decision whether the second store should be opened and would receive an annual bonus only if a certain level of net income were achieved for both stores combined.

   Why might the manager refuse to invest in the new store even though the investment is projected to achieve a return greater than the company’s required rate of return?

8. Net Present Value Calculation Using Excel. An investment costing $, today will result in cash savings of $85, per year for 3 years. The company’s required rate of return is 11 percent. Use Excel to calculate the net present value of this investment in a format similar to the one in the Computer Application box in the chapter.
9. Payback Period Calculation. Textile Services, Inc., plans to invest $80, in a new machine. Annual cash inflows from this investment will be $25, and annual cash outflows will be $5, Determine the payback period for this investment.
10. Net Present Value Analysis with Multiple Investments. A project requiring an investment of $20, today and $10, one year from today, will result in cash savings of $4, per year for 15 years. Find the net present value of this investment using a rate of 10 percent. Round to the nearest dollar.
11. Net Present Value Calculation with Taxes. An investment costing $, today will result in cash savings of $85, per year for 3 years. The company has a tax rate of 40 percent, and requires an 11 percent rate of return, capital investment analysis is best accomplished by techniques that. Find the net present value of this investment using the format shown in Figure "NPV Calculation with Income Taxes for Scientific Products, Inc.". Round to the nearest dollar.

Exercises: Set A

1. Net Present Value Analysis. Architect Services, Inc., would like to purchase a blueprint machine for $50, The machine is expected to have a life of 4 years, and a salvage value of $10, Annual maintenance costs will total $14, Annual savings are predicted to be $30, The company’s required rate of return is 11 percent.

   Required:

   1. Ignoring the time value of money, calculate the net cash inflow or outflow resulting from this investment opportunity.
   2. Find the net present value of this investment using the format presented in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies".
   3. Should the company purchase the blueprint machine? Explain.

2. Internal Rate of Return Analysis. Architect Services, Inc., would like to purchase a blueprint machine for $50, The machine is expected to have a life of 4 years, and a salvage value of $10, Annual maintenance costs will total $14, Annual savings are predicted to be $30, The company’s required rate of return is 11 percent (this is the same data as the previous exercise).

   Required:

   1. Use trial and error to approximate the internal rate of return for this investment proposal. Round to the nearest dollar.
   2. Should the company purchase the blueprint machine? Explain.
3. Payback Period Calculation. Architect Services, Inc., would like to purchase a blueprint machine for $50, The machine is expected to have a life of 4 years, and a salvage value of $10, Annual maintenance costs will total $14, Annual savings are predicted to be $30, (this is the same data as the previous exercise). Determine the payback period for this investment using the format shown in Table "Calculating the Payback Period for Jackson’s Quality Copies".

4. Net Present Value Analysis with Multiple Investments, Alternative Format. Conway Construction Corporation would like to purchase a fleet of trucks at a cost of $, Additional equipment needed to maintain the fleet of trucks will be purchased at the end of year 2 for $40, The trucks are expected to have a life of 8 years, and a salvage value of $20, Annual costs for maintenance, insurance, and other capital investment analysis is best accomplished by techniques that expenses will total $42, Annual net cash receipts resulting from this purchase are predicted to be $, The company’s required rate of return is 14 percent.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "Alternative NPV Calculation for Jackson’s Quality Copies".
   2. Should the company purchase the new fleet of trucks? Explain.

5. Calculating NPV and IRR Using Excel. Wood Products Company would like to purchase a computerized wood lathe for $, The machine is expected to have a life of 5 years, and a salvage value of $5, Annual maintenance costs will total $20, Annual net cash receipts resulting from this machine are predicted to be $45, The company’s required rate of return is 15 percent.

   Required:

   1. Use Excel to calculate the net present value and internal rate of return in a format similar to the Computer Application spreadsheet shown in the chapter.
   2. Should the company purchase the wood lathe? Explain.

6. Net Present Value Analysis with Taxes. Timberline Company would like to purchase a new machine for $, The machine will have a life of 5 years with no salvage value, and is expected to generate annual cash revenue of $50, Annual cash expenses, excluding depreciation, will total $24, The company uses the straight-line depreciation method, has a tax rate of 40 percent, and requires a 12 percent rate of return.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "NPV Calculation with Income Taxes for Scientific Products, Inc.". Round to the nearest dollar.
   2. Should the company purchase the machine? Explain.

Exercises: Set B

1. Net Present Value Analysis. Wood Products Company would like to purchase a computerized wood lathe for $, The machine is expected to have a life of 5 years, and a salvage value of $5, Annual maintenance costs will total $20, Annual net cash receipts resulting from this machine are predicted to be $45, The company’s required rate of return is 15 percent.

   Required:

   1. Ignoring the time value of money, calculate the net cash inflow or outflow resulting from this investment opportunity.
   2. Find capital investment analysis is best accomplished by techniques that net present value of this investment using the format presented in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies". Round to the nearest dollar.
   3. Should the company purchase the wood lathe? Explain.

2. Internal Rate of Return Analysis. Wood Products Company would like to purchase a computerized wood lathe for $, The machine is expected to have a life of 5 years, and a salvage value of $5, Annual maintenance costs will total $20, Annual net cash receipts resulting from this machine are predicted to be $45, The company’s required rate of return is 15 percent (this is the same data as the previous exercise).

   Required:

   1. Use trial and error to approximate the internal rate of return for this investment proposal.
   2. Should the company purchase the wood lathe? Explain.
3. Payback Period Calculation. Wood Products Company would like to purchase a computerized wood lathe for $, The machine is expected to have a life of 5 years, and a salvage value of $5, Annual maintenance costs will total $20, Annual net cash receipts resulting from this machine are predicted to be $45, The company’s required rate of return is 15 percent (this is the same data as the previous exercise), capital investment analysis is best accomplished by techniques that. Determine the payback period for this investment using the format shown in Table "Calculating the Payback Make money online no scams please for Jackson’s Quality Copies".

4. Net Present Value Analysis and Qualitative Factors, Alternative Format. Pete’s Plumbing Supplies would like to expand into a new warehouse at a cost of $, The warehouse is expected to have a life of 20 years, and a salvage value of $, Annual costs for maintenance, insurance, and other cash expenses will total $60, Annual net cash receipts resulting from this expansion are predicted to be $, The company’s required rate of return is 12 percent.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "Alternative NPV Calculation for Jackson’s Quality Copies". Round to the nearest dollar.
   2. Should the company purchase the new warehouse? Explain.
   3. Provide one qualitative factor that might cause the company to reach a different conclusion than the one reached in requirement b.

5. Calculating NPV and Capital investment analysis is best accomplished by techniques that Using Excel. Pete’s Plumbing Supplies would like to expand into a new warehouse at a cost of $, The warehouse is expected to have a life of 20 years, and a salvage value of $, Annual costs for maintenance, insurance, capital investment analysis is best accomplished by techniques that, and other cash expenses will total $60, Annual net cash receipts resulting from this expansion are predicted to be $, The company’s required rate of return is 12 percent.

   Required:

   1. Use Excel to calculate the net present value and internal rate of return in a format similar to the Computer Application spreadsheet shown in the chapter.
   2. Should the company purchase the warehouse? Explain.

6. Net Present Value Analysis with Taxes. Quality Chocolate, Inc., would like to purchase a new machine for $, The machine will have a life of 4 years with no salvage value, and is expected to generate annual cash revenue of $90, Annual cash expenses, excluding depreciation, will total $10, The company uses the straight-line depreciation method, has a tax rate of 30 percent, and requires a 14 percent rate of return.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "NPV Calculation with Income Taxes for Scientific Products, Inc.". Round to the nearest dollar.
   2. Should the company purchase the machine? Explain.

Problems

1. Evaluating Alternative Investments. Washington Brewery has two independent investment opportunities to purchase brewing equipment so the company can meet growing customer demand. The first option (equipment A) requires an initial investment of $, for equipment with an expected life of 5 years and a salvage value of $20, The second option (equipment B) requires an initial investment of $, for equipment with an expected life of 4 years and a salvage value of $15, The company’s required rate of return is 10 percent. Additional cash flow information for each investment is provided as follows.

   Year 1	Year 2	Year 3	Year 4	Year 5
   Equipment A
   Utility savings	$ 12,	$ 14,	$ 15,	$ 16,	$ 17,
   Additional revenue	45,	48,	50,	55,	60,
   Maintenance costs	(5,)	(8,)	(10,)	(13,)	(16,)
   Equipment B
   Utility savings	$  8,	$  9,	$ 10,	$ 10,	-
   Additional revenue	35,	36,	38,	42,	-
   Maintenance costs	(6,)	(8,)	(9,)	(11,)	-

   Required:

   1. Calculate the net present value for each investment using the format presented in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies". (Remember to include the initial investment cash outflow and salvage value in your calculation.) Round to the nearest dollar.
   2. Which, capital investment analysis is best accomplished by techniques that, if any, investment is preferable? Explain.

2. Net Present Value, Internal Rate of Return, and Payback Period Analyses. Sherwin Moore Paint Company would like to further automate its production process by purchasing production equipment for $, The equipment is expected to have a useful life of 8 years, and will be sold at the end of 8 years for $40, The equipment requires significant maintenance work at an annual cost of $75, Labor and material cost savings, shown in the table, are also expected to be significant.

   Year 1	$,
   Year 2	$,
   Year 3	$,
   Year 4	$,
   Year 5	$,
   Year 6	$,
   Year 7	$,
   Year 8	$,

   The company’s required rate of return is 11 percent. Assume the company requires all investments to be recovered within five years.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies". Round to the nearest dollar.
   2. Use trial and error to approximate the internal rate of return for this investment proposal.
   3. Determine the payback period for this investment using the format shown in Table "Calculating the Payback Period for Jackson’s Quality Copies".
   4. Based on your findings in requirements a, b, and c, should the company purchase the production equipment? Explain.

3. Calculating NPV and IRR Using Excel. Sherwin Moore Paint Company would like to further automate its production process by purchasing production equipment for $, The equipment is expected to have a useful life of 8 years, and will be sold at the end of 8 years for $40, The equipment requires significant maintenance work at an annual cost of $75, Labor and material cost savings, shown in the table, are also expected to be significant.

   Year 1	$,
   Year 2	$,
   Year 3	$,
   Year 4	$,
   Year 5	$,
   Year 6	$,
   Year 7	$,
   Year 8	$,

   The company’s required rate of return is 11 percent.

   Required:

   1. Use Excel to calculate the net present value and internal rate of return in a format similar to the Computer Application spreadsheet capital investment analysis is best accomplished by techniques that in the chapter.
   2. Should the company purchase the production equipment? Explain.

4. Net Present Value Analysis, Multiple Investments, and Qualitative Factors. Oil Production, Inc., would like to drill oil from land the company already owns. The equipment is expected to cost $4,, has a useful life of 5 years, and will be sold at the end of 5 years for $, Annual costs for maintenance and other cash expenses will total $, Annual net cash receipts resulting from the sale of oil are predicted to be $1, Working capital of $, is required at the beginning of the project and will be returned at the end of 5 years. The equipment will require refurbishing at the end of year 3 at a cost of $, Although the company’s cost of capital is 15 percent, management established a required rate of return of 20 percent due to the high risk associated with this project.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "Alternative NPV Calculation how much bitcoin for 200 Jackson’s Quality Copies". Round to the nearest dollar.
   2. Use trial and error to approximate the internal rate of return for this investment proposal.
   3. Should the company accept the proposal? Explain.
   4. What qualitative factors might improve management’s view of this proposal?

5. Calculating NPV and IRR Using Excel. Oil Production, Inc., would like to drill best insurance investment plan in singapore from land the company already owns. The equipment is expected to cost $4,, capital investment analysis is best accomplished by techniques that, has a useful life of 5 years, and will be sold at the end of 5 years for $, Annual costs for maintenance and other cash expenses will total $, Annual net cash receipts resulting from the sale of oil are predicted to be $1, Working capital of $, is required at the beginning of the project and will be returned at the end of 5 years. The equipment will require refurbishing at the end of year 3 at a cost of $, Although the company’s cost of capital is 15 percent, management established a required rate of return of 20 percent due to the high risk associated with this project.

   Required:

   1. Use Excel to calculate the net present value and internal rate of return in a format similar to the Computer Application spreadsheet shown in the chapter.
   2. Should the company accept the proposal? Explain.

6. Net Present Value, Internal Rate of Return, and Payback Period Analyses; Ethical Issues. Tower CD Stores would like to open a retail store in Houston. The initial investment to purchase the building is $, and an additional $50, in working capital is required. Since this store will be operating for many years, the working capital will not be returned capital investment analysis is best accomplished by techniques that the near future. Tower expects capital investment analysis is best accomplished by techniques that remodel the store at the end of 3 years at a cost of $, Annual net cash receipts from daily operations (cash receipts minus cash payments) are expected to be as follows.

   Year 1	$ 80,
   Year 2	$,
   Year 3	$,
   Year 4	$,
   Year 5	$,
   Year 6	$,
   Year 7	$,

   The company’s required rate of return is 13 percent. Assume management decided to limit the analysis to 7 years.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "NPV Calculation for Copy Machine Investment by Jackson’s Quality Copies". Round to the nearest dollar.
   2. Use trial and error to approximate the internal rate of return for this investment proposal.
   3. Based on your answer to requirements a and b, should Tower open the new store? Explain.
   4. Use the format presented in Table "Calculating the Payback Period for Jackson’s Quality Copies" to calculate the payback period (include working capital in the initial investment). Assuming management requires all investments to be recovered within three years, should Tower CD Store open the new store?
   5. What is the weakness of using the payback period method to evaluate long-term investments?
   6. Assume the manager of the company wanted to live in Houston and intentionally inflated the projected annual cash receipts so that the proposal would be accepted. The proposal would otherwise have been rejected. Explain how the company’s use of a postaudit would help to prevent this type of unethical behavior.

7. Net Present Value with Taxes. Refer to the Tower CD Stores information presented in the previous problem. Assume the costs associated with the purchase of the building are depreciated over 20 years using the straight-line method, with no salvage value. Costs associated with the building remodel are depreciated over 10 years with no salvage value, starting with year 4. The company’s tax rate is 40 percent. Again, management will limit the analysis to seven years.

   Required:

   1. Find the net present value of this investment using the format presented in Figure "NPV Calculation with Income Taxes for Scientific Products, Inc.". Round to the nearest dollar.
   2. Should Tower open the new store? Explain.
   3. How did income taxes affect the decision being made by Tower CD Stores?

One Step Further: Skill-Building Cases

1. Opening New Retail Stores. Refer to Note "Business in Action " Provide two examples of cash outflows and one example of cash inflows resulting from the decision to open a new store.
2. Determining the Cost of Capital by Industry. Refer to the Note "Business in Action " Why do you think the cost of capital in the beverage industry is low relative to the cost of capital in other industries?
3. The California Lottery and Present Value Concepts. Refer to the Note "Business in Action " Why does the State of California need only $, to pay a $1, lottery winner?

4. Internet Project: Capital Expenditures at Intel. Go to Intel’s Web site (www.oldyorkcellars.com) and enter “annual report” or “10K report” in the search feature. Find the most recent annual report or 10K report and review the Consolidated Statements of Cash Flows portion of the company’s financial statements, capital investment analysis is best accomplished by techniques that. Find the Additions to property, plant and equipment line item in the Investing Activities section of the statement, and answer the following questions. Be sure to submit a printed copy of the consolidated statements of cash flows with your answers.

   1. How much cash did Intel spend on additions to property, plant, and equipment in the most current year? How does this amount compare with amounts spent in the previous two years?
   2. Describe two capital budgeting decision techniques that were likely used by Intel to make long-term investment decisions.

5. Group Activity: Qualitative Factors. Each of the following scenarios is being considered at three separate companies.

   1. A large regional energy company uses coal to produce electricity that is sold to local power companies. Although government regulations will not require a cleaner process for at least five years, the company is considering spending millions of dollars on equipment that will reduce pollutants from its production process. However, the net present value analysis indicates this proposal should be rejected.
   2. A producer of mountain bikes known for its expensive, high-quality bikes would like to introduce a less expensive entry-level line of mountain bikes. However, the projected internal rate of return for this proposal is lower than the company’s minimum required rate of return.

   3. A maker of computer chips with a reputation of staying on the cutting edge of technology would like to invest in a new production facility. However, the net present value analysis indicates this proposal should be rejected.

      Required:

      Your instructor will divide the class into groups of two to four students, and assign one of the three independent scenarios listed previously to each group. Each group must perform the requirements listed here:

      1. Identify at least two qualitative factors that may lead to accepting the proposal.
      2. Discuss each option, based on the findings of your group, with the class.

Comprehensive Cases

1. Ethical Issues in Capital Budgeting. Loomis Nursery grows a variety of plants for wholesale distribution. The company would like to expand its operations and is considering a move to one of two locations. The first location, Wyatville, is one hour from the ocean and therefore attractive for employees who like to travel on weekends. The second location, capital investment analysis is best accomplished by techniques that, Kenton, is not as close to the ocean, and much further from desirable vacation destinations.

   The company’s controller, Lisa Lennox, created a net present value analysis for each location. The Kenton location had a positive net present value, and the Wyatville location had a negative net present value. Upon providing this information to the chief financial officer of the high income earners 2022, Max Madden, Lisa was asked to “review the numbers carefully and make sure all the benefits of moving to Wyatville were included in the analysis.” Lisa knew that Max preferred vacationing near the ocean and had a strong desire to move operations to Wyatville. However, she was unable to find any errors in her analysis and could not identify any additional benefits.

   Lisa approached Max with this information. Max responded, “There is no way Kenton should have a higher net present value than Wyatville. Redo your analysis to show that Wyatville has the highest net present value, and have it on my desk by the end of the week.”

   Required:

   1. Is Max Madden’s request ethical? Explain.
   2. How should Lisa handle this situation? (It may be helpful to review the presentation of ethics in Chapter 1 "What Is Managerial Accounting?".)

2. Ethical Issues in Capital Budgeting. Toyonda Motor Company produces a variety of products including motorcycles, all-terrain vehicles, marine engines, automobiles, light trucks, and heavy-duty trucks. Each division manager at Toyonda Motor Company is paid a base salary and is given an annual cash bonus if the division achieves profits of at least 10 percent of the value of assets invested in the division (this is called return on investment).

   Peggy Parkins, manager of the Light Truck Division, is considering bitcoin investition card in new production equipment. The net present value of the proposal is positive, and Peggy is convinced the new equipment will provide a competitive edge in future years. However, because of the significant up-front cost and related depreciation, capital investment analysis is best accomplished by techniques that profits will be negatively affected by this investment. In fact, the new equipment will reduce return on investment below the 10 percent threshold for at least 3 years, which will prevent Peggy from receiving her annual bonuses for at least 3 years. However, profits catanai money making expected to increase significantly after the three-year period. Peggy is planning to retire in two years and therefore would prefer to reject the proposal to invest in new production equipment.

   Required:

   1. Describe the ethical conflict facing Peggy Parkins.
   2. What type of employee compensation system might prevent this type of conflict?