Post on 19-Dec-2015
Prof. W. Bentz A&MIS 212 1
Introduction to Accounting
FINAL EXAM REVIEW
Chapters 10,11,12, 13, 14, & 15
Prof. W. Bentz A&MIS 212 2
Standard Cost Card – Variable Production Cost
A standard cost card for one unit of product might look like this:
A A x BStandard Standard StandardQuantity Price Cost
Inputs or Hours or Rate per Unit
Direct materials 3.0 lbs. 4.00$ per lb. 12.00$ Direct labor 2.5 hours 14.00 per hour 35.00 Variable mfg. overhead 2.5 hours 3.00 per hour 7.50 Total standard unit cost 54.50$
B
Prof. W. Bentz A&MIS 212 3
Are standards the same as budgets?
A standard is the expected cost for one
unit.
A budget is the expected cost for all
units.
Standards vs. Budgets
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A General Model of Variances
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance Quantity Variance
Standard price is the amount that should have been paid for the resources acquired.
Prof. W. Bentz A&MIS 212 5
Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
A General Model of Variances
Standard quantity is the quantity allowed for the actual good output.
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A General Model of Variances
AQP(ap - sp) sp(AQU - SQ)
AQP = Actual Quantity sp = Standard Price ap = Actual Price SQ = Standard Quantity
Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × actual price standard price standard price
Prof. W. Bentz A&MIS 212 7
Hanson Inc. has the following direct material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were purchased for $3.90 per pound, at total cost of $6,630, and used to make 1,000 Zippies.
Material Variances Example Zippy
Prof. W. Bentz A&MIS 212 8
Material Price Variance
Based on purchases:
AQP(ap - sp)
= 1,700 lbs. ($3.90 - $4.00)
= - $170 Favorable Based on usage:
AQU(ap - sp)
= 1,700 lbs. ($3.90 - $4.00)
= - $170 Favorable
Prof. W. Bentz A&MIS 212 9
Material Quantity Variance
Standard quantity = output sq per unit
= 1,000 units 1.5 lbs./unit
= 1,500 lbs.
Quantity variance = (AQ – SQ) sp
= (1,700 -1,500 lbs.) $4
= $800 Unfavorable
Prof. W. Bentz A&MIS 212 10
1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb.
= $6,630 = $ 6,800 = $6,000
Price variance$170 favorable
Quantity variance$800 unfavorable
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Material Variances Summary Zippy
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Material Variances
Hanson purchased and used 1,700 pounds.
How are the variances computed if the amount purchased differs from
the amount used?
The price variance is computed on the entire
quantity purchased.
The quantity variance is computed only on the
quantity used.
Prof. W. Bentz A&MIS 212 12
Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies. Compute the price variance.
Material Variances ContinuedZippy
Prof. W. Bentz A&MIS 212 13
Material Variances Continued
Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb.
= $10,920 = $11,200
Price variance$280 favorable
Price variance increases because quantity
purchased increases.
Zippy
Prof. W. Bentz A&MIS 212 14
Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb.
= $6,800 = $6,000
Quantity variance$800 unfavorable
Quantity variance is unchanged because actual and standard
quantities are unchanged.
Material Variances Continued
Zippy
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Hanson Inc. has the following direct labor standard to manufacture one Zippy:
1.5 standard hours per finished Zippy at $6.00 per direct labor hour
Last week 1,550 direct labor hours were worked at an average cost of $6.20 per hour, for a total labor cost of $9,610, to make 1,000 Zippies.
Labor Variances ExampleZippy
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Labor Rate Variance
Based on labor usage:
AQ (ar - sr)
= 1,550 hrs.($6.20 - $6.00)
= $310 Unfavorable
Zippy
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Labor Quantity Variance
Standard quantity = output sq per unit
= 1,000 units 1.5 hrs./unit
= 1,500 hrs.
Quantity variance = (AQ – SQ) sp
= (1,550 -1,500 hrs.) $6
= $300 UnfavorableZippy
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Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
Labor Variances Summary
Rate variance$310 unfavorable
Efficiency variance$300 unfavorable
1,550 hours 1,550 hours 1,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour
= $9,610 = $9,300 = $9,000
Zippy
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Labor Efficiency Variance –A Closer Look
UnfavorableEfficiencyVariance
Poorlytrainedworkers
Poorquality
materials
Poorlymaintainedequipment
Poorsupervisionof workers
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Hanson Inc. has the following variable manufacturing overhead standard tomanufacture one Zippy
1.5 standard hours per Zippy at $3.00 perdirect labor hour
Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent forvariable manufacturing overhead.
Variable Overhead Variances (VOH) Example
Zippy
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VOH Spending Variance
Based on labor usage:
AQ (ar - sr)
= 1,550 hrs. ($3.30 - $3.00)
= $465 Unfavorable
Zippy
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Variable Efficiency Variance
Standard quantity = output sq per unit
= 1,000 units 1.5 hrs./unit
= 1,500 hrs.
Efficiency variance = (AQ – SQ) sp
= (1,550 -1,500 hrs.) $3
= $150 UnfavorableZippy
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Spending variance$465 unfavorable
Efficiency variance$150 unfavorable
1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour
= $5,115 = $4,650 = $4,500
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
Variable ManufacturingOverhead Variances Zippy
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Fixed Manufacturing Overhead
Suppose budgeted fixed overhead associated with the production of Zippys is $9,000 and the budgeted labor hours at standard total 1,800 hours per period. The standard fixed overhead cost per unit is determined as follows:
POR = $9,000/1,800 standard hours (DQ)
= $5 per standard labor hour
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Unit FOH Standard
The standard fixed overhead cost per unit is computed as
= sq POR
= 1.5 hours $5 per standard hour
= $7.50 per complete unit
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Fixed Overhead Variances
Assume the fixed overhead cost incurred (actual) was $9,350.
Fixed overhead budget variance (BV)
= Actual – Budgeted fixed overhead
= $9,350 - $9,000
= $350, Unfavorable
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Fixed Overhead Variances
Fixed overhead volume variance (VV)
= Budgeted FOH – Applied FOH
= $9,000 – 1,000 units @ $7.50
= $9,000 - $7,500
= $1,500, Unfavorable
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Volume Variance Check
What was the production level used to find the denominator quantity (DQ)?
1,800 standard hours/1.5 hours per unit
= 1,200 units
Volume variance in unit = 1,000 – 1,200 U
Volume variance in $ = 200 units @ $7.50
= $1,500, Unfavorable
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Per Unit Standard Cost
Direct material (1.5 lbs. @ $5) $ 7.50
Direct labor (1.5 hrs. @ $6) 9.00
Variable overhead (1.5 hrs. @ $3) 4.50
Fixed overhead (1.5 hrs. @ $5) 7.50 Total standard cost per unit $28.50
Zippy
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Chapter 12 Topics
Segment margin Report format Omission of costs Treatment of traceable costs Treatment of common costs Telescoping of segments
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E12-2
Parts 1 & 2
Sales 500,000$ 100.0% 200,000$ 100.0% 300,000$ 100.0%Variable expenses 240,000 48.0% 60,000 30.0% 180,000 60.0%Contribution margin 260,000$ 52.0% 140,000$ 70.0% 120,000$ 40.0%Traceable fixed costs 126,000 25.2% 78,000 39.0% 48,000 16.0%Office segment margin 134,000$ 26.8% 62,000$ 31.0% 72,000$ 24.0%
Common expenses 63,000 12.6%Net income 71,000$ 14.2%
Raner, Harris & Chan
Total Company Chicago Minneapolis
Income StatementFor the Year Ending December 31, 2001
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E12-2E12-2
Sales 300,000$ 100.0% 200,000$ 100.0% 100,000$ 100.0%Variable expenses 180,000 60.0% 128,000 64.0% 52,000 52.0%Contribution margin 120,000$ 40.0% 72,000$ 36.0% 48,000$ 48.0%Traceable fixed costs 33,000 11.0% 12,000 6.0% 21,000 21.0%Office segment margin 87,000$ 29.0% 60,000$ 30.0% 27,000$ 27.0%
Common expenses 15,000 5.0%Net income 72,000$ 24.0%
Minneapolis Medical Dental
Raner, Harris & ChanIncome Statement
For the Year Ending December 31, 2001
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Chapter 12 Topics
Return on investment ROI = Net income from operations
Average Operating Assets ROI = Margin Turnover ROI = NIO/Sales Sales/Avg. Op. Assets
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Chapter 12 Topics
Residual income RI = NIO – (Cost of Capital Average
Operating Assets Instead of the cost of capital, a problem
might refer to the rate of return required by management, or the minimum rate of return expected
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Example
Sales$25,000,000
Net operating income $ 3,000,000
Average operating assets$10,000,000
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Example
ROI = $3,000,000/$10,000,000
= 30%
Or
Margin = $3M/$25M = 12%
Turnover = $25M/$10M = 2.5
ROI = 12% 2.5 = 30%
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Points Regarding ROI & RI
Both start with net income from operations (aka, operating income)
Both utilize average operating assets as their measures of investment
Both would exclude non-operating items from consideration because the purpose is to monitor operations.
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Other Comments
The discussion of ROI in chapter 12 is in the context or evaluations the accounting return on investment earned by an entity (division or investment center), not a project being evaluated. In chapters 13, 14, and 15, we sometimes talk about the incremental ROI of a project, which is somewhat different, yet similar.
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Overview of Ch. 13
In chapter 13, we consider the use of accounting information to analyze the impact of decisions on the profitability of an organization. In general, profitability is a function of the income and cash flow generated by a business. Specific projects or options about which a decision must be made are the subject of this chapter.
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Chapter 13 - Assumptions
The approach to decisions outlined in chapter 13 is based on some key assumptions
◈The incremental investment is too small to affect the decision under consideration
◈Revenues, variable costs and fixed costs can be adequately modeled with linear models.
Prof. W. Bentz A&MIS 212 42
Chapter 13 - Assumptions
◈Total fixed costs will not change unless a problem or case specifies otherwise.
◈As in chapter 6, any changes in per-unit prices or variable costs will be made explicit. Otherwise, assume no changes in the per-unit amounts
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Maximizing Income
Given the above assumptions, one can focus on the impact of decision options on the income from operations and ignore changes in investment. Also, since the incremental investment is small, we can ignore the time value of money (chapter 14).
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Decisions Mentioned in Ch. 13
Replace equipment (or not) Adding or dropping product lines Make or buy component parts Accept or reject special order Utilizing constrained resources Sell or process further
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Incremental Perspective
The first four categories of decisions mentioned above can be approached by looking at changes in contribution margin less any change in fixed costs incurred to determine the impact on income from operations. If you are not told of any specific change in total fixed cost, then assume that it is indeed fixed.
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Resource Environments
Unconstrained – If there are no important constraints, then we will evaluate the effects of the decision options on contribution margin or income from operations. If fixed costs do not change, then we can focus on the effects on contribution margin. If fixed costs do change, then evaluate the effects on income from operations.
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Resource Environments
Single constraint – If there is a single binding constraint, we must determine the contribution margin per unit of the constrained resource. Then we use this information to determine how best to use the constrained resource to maximize contribution margin and income from operations.
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Example of a Single Constraint
Unit Information X Y ZSelling price 40$ 30$ 35$ Variable cost 24 16 20 Contribution margin 16$ 14$ 15$
Capacity (labor hours) 60,000 Maximum demand for X (units) 10,000 Maximum demand for Y (units) 8,000 Maximum demand for Z (units) 9,000
Product
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Unconstrained Production
Product Unit cm Units CMX 16.00$ 10,000 160,000$ Y 14.00$ 8,000 112,000 Z 15.00$ 9,000 135,000
Total 15.07$ 27,000 407,000$
Production capacity unconstrained
Sales With No Constraint on Production
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Constrained Labor Case
Unit Information X Y ZSelling price 40$ 30$ 35$ Variable cost 24 16 20 Contribution margin 16$ 14$ 15$ Direct labor hours 4 2 3 Contribution margin per labor hour 4$ 7$ 5$
Product
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Constrained Labor Case
Product Labor Hrs. Units Hrs. Req.X ($4**) 4.00 4,250 17,000 Y ($7) 2.00 8,000 16,000 Z ($5) 3.00 9,000 27,000 Total 2.82 21,250 60,000
*Constrained to 60,000 labor hours
**cm per labor hour
Sales With Constrained* Labor Hours
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Constrained Labor Case
Product cm/hour Units CMX 16.00$ 4,250 68,000$ Y 14.00$ 8,000 112,000 Z 15.00$ 9,000 135,000
Total 14.82$ 21,250 315,000$
Constrained to 60,000 direct labor hours
Sales With Constraint on Direct Labor
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Constrained Machine Hours
Unit Information X Y ZSelling price 40$ 30$ 35$ Variable cost 24 16 20 Contribution margin 16$ 14$ 15$ Machine hours 5 7 4 Contribution margin per machine hour 3$ 2$ 4$
Product
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Constrained Machine Hours
Product Mach. Hrs. Units Hrs. Req.X ($3**) 5.00 10,000 50,000 Y ($2) 7.00 2,000 14,000 Z ($4) 4.00 9,000 36,000 Total 4.76 21,000 100,000
*Constrained to 100,000 machine hours
**cm per machine hour
Sales With Constrained* Machine Hours
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CM - Constrained Mach. Hrs.
Product Unit cm Units CMX 16.00$ 10,000 160,000$ Y 14.00$ 2,000 28,000 Z 15.00$ 9,000 135,000
Total 15.38$ 21,000 323,000$
*Constrained to 100,000 machine hours
Sales With Constrained* Machine Hours
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Recapitulation
Recap: CMUnconstained case 407,000$ Constrained labor case 315,000$ Constrained machine hours 323,000$
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Resource Environments
Multiple constraints – In the case of multiple constraints in a complex environment, we would maximize an objective function subject to a set of constraints (in Mgt. Sci. 331 & A&MIS 525).
Prof. W. Bentz A&MIS 212 58
Sell or Process Further
A B CSales value at split-off 120$ 150$ 60$ Sales value after further processing 160 240 90 Allocated joint costs 80 100 40 Separable cost of processing 50 60 10
Pp. 636-9 of text
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Sell or Process Further
Analysis of Sell or Process FurtherA B C
Incremetal revenue:Sales value after further processing 160$ 240$ 90$ Sales value at split-off point 120 150 60 Incremental revenue 40$ 90$ 30$ Cost of further processing 50 60 10 Incremental operating income (10)$ 30$ 20$
Pp. 636-9 of text
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Objective
To initiate and maintain projects and activities that earn an adequate rate of return on the required investment. To be adequate, the returns must be consistent with investor expectations, management plans, and business opportunities.
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Capital Budgeting
Capital budgeting concerns the analysis and evaluation of projects that require investment in working capital or property, plant & equipment. These tend to be large projects that involve significant cash inflows and outflows over several fiscal years. However, the methods covered are applicable to investment decisions made by individuals as well as organizations.
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Internal rate of return
The internal rate of return (IRR) is that interest return, positive or negative, that equates the present value of the investment with the present value of the cash inflows. In cases where there are multiple investments over time, it is that rate that equates the present value of the cash inflows with the present value of the cash outflows.
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Internal rate of return
Thus, it as the discounted rate of return for which the net present value is zero.
Prof. W. Bentz A&MIS 212 65
Internal rate of return
Symbolically,
PV = i =0
CFi (1+r)-i
To find the internal rate of return, find that value of r such that
0.0 = i=0
CFi (1+r)-i
N
Prof. W. Bentz A&MIS 212 66
Internal Rate of Return (IRR)
Alternatively, one can write out the terms of the above expression as follows:
0 = CF0 + CF1(1+r)-I + CF2(1+r)-2 +… + CFN(1+r)-N
Again, the objective is to find a rate r such the above expression is satisfied.
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Internal rate of return
Next we illustrate use of the annuity table to find IRR when the cash flows are uniform from one period to the next
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Interpolation Example (p. 676)
Investment required $6,000
Annual cost savings $1,500
Life of project 15 years
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Table method (equal cash flow)
PV = CF [1 – (1 + r)-N] / r
$6,000 = $1,500 PVOA (10 periods, r %)
PVOA (10, r %) = $6,000 = 4.000$1,500
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Factor Interpolation
20% factor (table) 4.1924.192
Project factor (computed) 4.000
22% factor (table) 3.923
Difference 0.1920.269
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For example one
Investment of $6,000 and annual cash flows of $1,500 for 10 years:
0.0 = - $6,000 + $1,500(1+ r)-1 +
$1,500(1+ r)-2 + + $1,500(1+ r)-10
IRR (r) = 21.406% (using Excel worksheet)
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IRR Interpolation
IRR = 20% + (0.192 / 0.269) (2%)
IRR = 20% + 0.7137 (2%)
IRR = 20% + 1.4247%
IRR = 21.4247%
Note that the true IRR was 21.406%
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Example 2
PV = CF [1 – (1 + r)-N] / r
$10,000 = $2,432.50 [1 – (1 + r)-N] / r
$10,000 = $2,432.50
PVOA (6 years, r %)
PVOA (6 years, r %) = $10,000.00
$ 2,432.50
= 4.111
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Example 2
From Exhibit 14C-4, we see that in row 6 (6 periods) we find the PVOA factor 4.111 in the column 12%. What luck! The internal rate of return on this project is exactly 12% per year.
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Example 3
Investment is $10,000 Annual cash flows are $3,000 per year for
six years
0.0 = -$10,000 + $3,000(1+ r)-1 +
$3,000(1+ r)-2 + + $3,000(1+ r)-6
IRR (r) = 19.905% (using Excel worksheet)
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Example 3
PV = CF [1 – (1 + r)-N] / r
$10,000 = $3,000 [1 – (1 + r)-N] / r
$10,000 = $3,000 PVOA (6 years, r %)
PVOA (6 years, r %) = $10,000/$ 3,000
= 3.333
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Example 3
From Exhibit 14C-4, we see that in row 6 (6 periods) we find the PVOA factor 3.333 is between the columns for 18 and 20%. What rotten luck! The internal rate of return on this project has to be estimated by interpolation!
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Factor Interpolation
18% factor (table) 3.498 3.498
Project factor (computed) 3.333
20% factor (table) 3.326
Difference 0.165 0.172
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IRR Interpolation
IRR = 18% + (0.165 / 0.172) (2%)
IRR = 18% + 0.9593 (2%)
IRR = 18% + 1.9186%
IRR = 19.9186%
Notice that this is very close to the true IRR of 19.905%
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IRR Summary
The internal rate of return is a method that recognizes the time-value of money through determining the interest return earned by investments.
If cash flows are constant from period to period, we can use the annuity table to approximate the IRR.
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IRR Summary
If the cash flows vary from period to period, the best way to determine an IRR is to use a financial calculator or a computer program such as Excel to compute an exact rate.
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Project ROI
Project ROI (Simple rate of return) =
Incremental income from operations Incremental investment
Incremental revenue –incremental expenses Incremental investment
OR
ΔROI = Incremental IOIncremental investment
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Payback period
Payback period is the number of periods it takes to recover the cash investment in a project without regard to any income on that investment.
Payback period = Project investment
Annual net cash inflow
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Payback for Example 3 Above
Payback = $10,000/$3,000
= 3.33 years or
3 years, 4 months
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Payback for Example 4
Period Investment Cash inflow
Unrecovered Investment
1 $10,000 $2,000 $8,000
2 $4,000 $4,000
3 $6,000
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Payback: Uneven Cash Flows
Payback = 2 + (4,000 / 6,000)
= 2 2/3 years or 2 years, 8 mo.
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Assumptions for Chapter 14
When working with discounted cash flow, assume cash inflows come at period end. (p. 672)
Assume all cash flows generated by an investment are immediately reinvested at the project discount rate.
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Discount rate for NPV
Cost of capital Target rate of return set by financial
managers for this purpose The opportunity cost of capital
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Chapter 15
Chapter 15 brings the issue of taxes into our study of capital budgeting.
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Taxable Events
The following events affect income taxes and should be analyzed on an after-tax basis on the exam for capital budgeting questions.
1. Revenue from operations2. Operating expenses (other than
depreciation)3. Income tax savings due to the
reduction in income for depreciation
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Taxable Events
4. Disposal of an asset for gain or loss5. Disposal of a fully-depreciated asset
(tax methods) for its salvage value6. Special expenses usually described as
repairs, overhaul, or renovation, which represent tax-deductible items
7. Dividend income, interest income, and interest expense
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Non-taxable Events
The following events do not affect income taxes when they occur and should be analyzed on a pre-tax basis on the exam for capital budgeting purposes.
1. Deposits made for possible damages or the return of equipment if the deposits are returnable.
2. Increases and decreases in working capital