Planning for Cap Investments.ppt

LO 3 Explain the net present value method. Illustration 26-13 Net Present Value Method Comprehensive Example Compute the net annual cash flow. LO 3 Explain the net present value method. Illustration 26-14 Net Present Value Method Comprehensive Example Compute the net present value. Intangible Benefits LO 4 Identify the challenges presented by intangible benefits in capital budgeting. Intangible benefits might include increased quality, improved safety, or enhanced employee loyalty. To avoid rejecting projects with intangible benefits: Calculate net present value ignoring intangible benefits. Project rough, conservative estimates of the value of the intangible benefits, and incorporate these values into the NPV calculation. Additional Considerations Example - Berg Company is considering the purchase of a new mechanical robot. LO 4 Illustration 26-15 Based on the negative net present value of $30,493, the proposed project is not acceptable. Additional Considerations Example - Berg estimates that sales will increase cash inflows by $10,000 annually as a result of an increase in quality. Berg also estimates that annual cost outflows would be reduced by $5,000 as a result of lower warranty claims, reduced injury claims, and missed work. LO 4 Illustration 26-16 Berg would accept the project. Additional Considerations Profitability Index for Mutually Exclusive Projects LO 5 Describe the profitability index. Proposals are often mutually exclusive. Managers often must choose between various positive-NPV projects because of limited resources. Tempting to choose the project with the higher NPV. Additional Considerations Profitability Index for Mutually Exclusive Projects LO 5 Illustration: Two mutually exclusive projects, each assumed to have a 10-year life and a 12% discount rate. Illustration 26-17 Illustration 26-18 Additional Considerations Profitability Index for Mutually Exclusive Projects Illustration: One method of comparing alternative projects is the profitab