Docstoc

Zippy

Document Sample
Zippy Powered By Docstoc
					   Introduction to Accounting


           FINAL EXAM REVIEW

 Chapters 10,11,12, 13, 14, & 15



Prof. W. Bentz    A&MIS 212        1
            Standard Cost Card –
           Variable Production Cost
A standard cost card for one unit of product
           might look like this:

                                   A             B             AxB
                               Standard      Standard     Standard
                               Quantity        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
  Prof. W. Bentz               A&MIS 212                        2
             Standards vs. Budgets




                                        A standard is the
                                      expected cost for one
      Are standards the                       unit.
      same as budgets?                   A budget is the
                                       expected cost for all
                                              units.

Prof. W. Bentz            A&MIS 212                       3
 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                   4
 A General Model of Variances

Actual Quantity     Actual Quantity      Standard Quantity
     ×                     ×                     ×
 Actual Price       Standard Price        Standard Price



         Price Variance           Quantity Variance

  Standard quantity is the quantity allowed for
            the actual good output.

 Prof. W. Bentz           A&MIS 212                   5
 A General Model of Variances

Actual Quantity        Actual Quantity        Standard Quantity
     ×                        ×                       ×
 actual price          standard price         standard price



         Price Variance             Quantity Variance

             AQP(ap - sp)                  sp(AQU - SQ)
  AQP = Actual Quantity                 sp = Standard Price
  ap = Actual Price                     SQ = Standard Quantity
 Prof. W. Bentz             A&MIS 212                      6
  Material Variances Example                 Zippy




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.


  Prof. W. Bentz      A&MIS 212               7
            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        8
       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               9
Material Variances Summary                                          Zippy




Actual Quantity             Actual Quantity           Standard Quantity
     ×                             ×                          ×
 Actual Price               Standard Price             Standard Price
  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               Quantity variance
                  $170 favorable               $800 unfavorable
 Prof. W. Bentz                    A&MIS 212                           10
                 Material Variances




                                     The price variance is
 Hanson purchased and               computed on the entire
   used 1,700 pounds.                quantity purchased.
  How are the variances
 computed if the amount             The quantity variance is
 purchased differs from              computed only on the
    the amount used?                    quantity used.
Prof. W. Bentz          A&MIS 212                        11
Material Variances Continued                   Zippy




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.
Prof. W. Bentz        A&MIS 212                12
 Material Variances Continued
Actual Quantity              Actual Quantity
 Purchased                      Purchased                        Zippy
     ×                              ×
 Actual Price                Standard Price
  2,800 lbs.                    2,800 lbs.
     ×                             ×
 $3.90 per lb.                 $4.00 per lb.
  = $10,920                     = $11,200

                                                Price variance increases
                   Price variance                   because quantity
                   $280 favorable                purchased increases.
  Prof. W. Bentz                    A&MIS 212                      13
 Material Variances Continued
                   Actual Quantity
   Zippy               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 is
  unchanged because
  actual and standard               Quantity variance
quantities are unchanged.           $800 unfavorable
 Prof. W. Bentz         A&MIS 212                        14
Labor Variances Example                        Zippy




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.
Prof. W. Bentz       A&MIS 212                   15
Labor Rate Variance               Zippy


Based on labor usage:
  AQ  (ar - sr)
    = 1,550 hrs.($6.20 - $6.00)
     = $310 Unfavorable




Prof. W. Bentz   A&MIS 212          16
 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 Unfavorable
 Zippy



 Prof. W. Bentz     A&MIS 212              17
 Labor Variances Summary                                          Zippy




 Actual Hours              Actual Hours               Standard Hours
     ×                         ×                             ×
 Actual Rate              Standard Rate                 Standard Rate
 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


              Rate variance                 Efficiency variance
             $310 unfavorable               $300 unfavorable
 Prof. W. Bentz                 A&MIS 212                          18
     Labor Efficiency Variance –
           A Closer Look
 Poorly                          Poor
 trained                        quality
 workers                       materials

                 Unfavorable
                  Efficiency
                  Variance
   Poor                          Poorly
supervision                    maintained
of workers                     equipment
Prof. W. Bentz    A&MIS 212         19
    Variable Overhead Variances
           (VOH) Example
                                               Zippy
  Hanson Inc. has the following variable
  manufacturing overhead standard to
  manufacture one Zippy
        1.5 standard hours per Zippy at $3.00 per
        direct labor hour
  Last week 1,550 hours were worked to make
  1,000 Zippies, and $5,115 was spent for
  variable manufacturing overhead.


Prof. W. Bentz          A&MIS 212               20
VOH Spending Variance
                                     Zippy


Based on labor usage:
  AQ  (ar - sr)
    = 1,550 hrs.  ($3.30 - $3.00)
     = $465 Unfavorable




Prof. W. Bentz   A&MIS 212             21
 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 Unfavorable
 Zippy




 Prof. W. Bentz     A&MIS 212               22
Variable Manufacturing
Overhead Variances                                              Zippy




Actual Hours            Actual Hours                Standard Hours
    ×                       ×                              ×
Actual Rate            Standard Rate                  Standard Rate
 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


          Spending variance               Efficiency variance
          $465 unfavorable                $150 unfavorable
Prof. W. Bentz                A&MIS 212                           23
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


Prof. W. Bentz       A&MIS 212                24
                 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




Prof. W. Bentz         A&MIS 212        25
      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

Prof. W. Bentz   A&MIS 212                26
      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




Prof. W. Bentz   A&MIS 212            27
          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


Prof. W. Bentz       A&MIS 212                   28
Per Unit Standard Cost                Zippy




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



Prof. W. Bentz   A&MIS 212            29
                   Chapter 12 Topics
 Segment margin
                Report format
                Omission of costs
                Treatment of traceable costs
                Treatment of common costs
                Telescoping of segments




Prof. W. Bentz                A&MIS 212         30
                                E12-2
Parts 1 & 2
                          Raner, Harris & Chan
                           Income Statement
                     For the Year Ending December 31, 2001


                        Total Company        Chicago              Minneapolis
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%




   Prof. W. Bentz                  A&MIS 212                               31
                                   E12-2
E12-2

                               Raner, Harris & Chan
                                Income Statement
                         For the Year Ending December 31, 2001


                            Minneapolis           Medical               Dental
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%




   Prof. W. Bentz                     A&MIS 212                                32
                 Chapter 12 Topics
 Return on investment
          ROI = Net income from operations
                 Average Operating Assets
          ROI = Margin  Turnover
          ROI = NIO/Sales  Sales/Avg. Op. Assets




Prof. W. Bentz          A&MIS 212               33
                 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




Prof. W. Bentz            A&MIS 212                     34
                 Example
Sales                          $25,000,000
Net operating income           $ 3,000,000
Average operating assets       $10,000,000




Prof. W. Bentz     A&MIS 212                 35
                     Example
ROI              = $3,000,000/$10,000,000
                 = 30%
Or

Margin = $3M/$25M = 12%
Turnover = $25M/$10M = 2.5
ROI      = 12%  2.5 = 30%

Prof. W. Bentz          A&MIS 212           36
                 Example
 Residual income
    = $3M – 20%  $10M
    = $3M - $2M
    = $1M




Prof. W. Bentz     A&MIS 212   37
      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.


Prof. W. Bentz   A&MIS 212                38
                 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.

Prof. W. Bentz        A&MIS 212         39
                 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.
Prof. W. Bentz          A&MIS 212           40
       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                41
       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


Prof. W. Bentz        A&MIS 212             42
                 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).



Prof. W. Bentz         A&MIS 212       43
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



Prof. W. Bentz        A&MIS 212           44
          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.

Prof. W. Bentz     A&MIS 212             45
      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.
Prof. W. Bentz   A&MIS 212             46
      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.


Prof. W. Bentz    A&MIS 212              47
Example of a Single Constraint
                                 Product
  Unit Information          X       Y         Z
Selling 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


Prof. W. Bentz            A&MIS 212                48
       Unconstrained Production
  Sales With No Constraint on Production
  Product Unit cm      Units       CM
     X     $ 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


Prof. W. Bentz     A&MIS 212            49
          Constrained Labor Case
                                      Product
   Unit Information         X            Y        Z
Selling 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




Prof. W. Bentz            A&MIS 212                    50
          Constrained Labor Case
  Sales With Constrained* Labor Hours
 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
Prof. W. Bentz     A&MIS 212          51
          Constrained Labor Case
    Sales With Constraint on Direct Labor
  Product cm/hour       Units         CM
     X     $ 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


Prof. W. Bentz      A&MIS 212              52
    Constrained Machine Hours
                                    Product
  Unit Information        X            Y        Z
Selling 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




Prof. W. Bentz        A&MIS 212                     53
    Constrained Machine Hours
Sales With 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
Prof. W. Bentz    A&MIS 212             54
  CM - Constrained Mach. Hrs.
  Sales With Constrained* Machine Hours
  Product Unit cm      Units      CM
     X     $ 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


Prof. W. Bentz     A&MIS 212            55
                 Recapitulation


Recap:                               CM
Unconstained case                 $ 407,000
Constrained labor case            $ 315,000
Constrained machine hours         $ 323,000




Prof. W. Bentz        A&MIS 212           56
          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                57
        Sell or Process Further
                                           A           B           C
Sales 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



Prof. W. Bentz                 A&MIS 212                               58
             Sell or Process Further
Analysis of Sell or Process Further
                                            A            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



Prof. W. Bentz                  A&MIS 212                                 59
   Introduction to Accounting


                 Capital Budgeting




Prof. W. Bentz          A&MIS 212    60
                 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.




Prof. W. Bentz     A&MIS 212               61
                 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.
Prof. W. Bentz         A&MIS 212           62
                 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.
Prof. W. Bentz            A&MIS 212           63
                 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         64
                 Internal rate of return

Symbolically,

PV = iN=0CFi (1+r)-i

To find the internal rate of return, find
 that value of r such that
0.0 = i=0CFi (1+r)-i

Prof. W. Bentz            A&MIS 212        65
  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.


Prof. W. Bentz     A&MIS 212                 66
                 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




Prof. W. Bentz            A&MIS 212           67
Interpolation Example (p. 676)
Investment required           $6,000
Annual cost savings           $1,500
Life of project              15 years




Prof. W. Bentz   A&MIS 212              68
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




Prof. W. Bentz   A&MIS 212            69
                 Factor Interpolation
20% factor (table)                   4.192 4.192
Project factor (computed)            4.000
22% factor (table)                         3.923
   Difference                        0.192 0.269




Prof. W. Bentz           A&MIS 212                 70
                 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)


Prof. W. Bentz        A&MIS 212            71
                 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%



Prof. W. Bentz         A&MIS 212     72
                 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

Prof. W. Bentz     A&MIS 212              73
                 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.




Prof. W. Bentz     A&MIS 212           74
                 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)


Prof. W. Bentz     A&MIS 212              75
                 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




Prof. W. Bentz     A&MIS 212             76
                 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!




Prof. W. Bentz     A&MIS 212            77
                 Factor Interpolation
18% factor (table)                   3.498 3.498
Project factor (computed)            3.333
20% factor (table)                         3.326
   Difference                        0.165 0.172




Prof. W. Bentz           A&MIS 212             78
                 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%

Prof. W. Bentz         A&MIS 212             79
                 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.


Prof. W. Bentz       A&MIS 212          80
                 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.




Prof. W. Bentz       A&MIS 212            81
                      Project ROI
Project ROI (Simple rate of return) =
   Incremental income from operations
         Incremental investment

       Incremental revenue –incremental expenses
            Incremental investment
       OR

ΔROI =               Incremental IO
                 Incremental investment

Prof. W. Bentz              A&MIS 212         82
                 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


Prof. W. Bentz        A&MIS 212                83
Payback for Example 3 Above
Payback = $10,000/$3,000
        = 3.33 years or
          3 years, 4 months




Prof. W. Bentz   A&MIS 212    84
             Payback for Example 4
                                        Unrecovered
Period Investment Cash inflow            Investment
   1              $10,000    $2,000       $8,000
   2                         $4,000       $4,000
   3                         $6,000




 Prof. W. Bentz             A&MIS 212              85
Payback: Uneven Cash Flows
Payback = 2 + (4,000 / 6,000)
        = 2 2/3 years or 2 years, 8 mo.




Prof. W. Bentz   A&MIS 212                86
    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.




Prof. W. Bentz    A&MIS 212              87
                 Discount rate for NPV
 Cost of capital
 Target rate of return set by financial
  managers for this purpose
 The opportunity cost of capital




Prof. W. Bentz           A&MIS 212         88
                 Chapter 15
 Chapter 15 brings the issue of taxes
  into our study of capital budgeting.




Prof. W. Bentz      A&MIS 212            89
                 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 operations
2. Operating expenses (other than
   depreciation)
3. Income tax savings due to the
   reduction in income for depreciation

Prof. W. Bentz        A&MIS 212            90
                 Taxable Events
4. Disposal of an asset for gain or loss
5. Disposal of a fully-depreciated asset
   (tax methods) for its salvage value
6. Special expenses usually described as
   repairs, overhaul, or renovation, which
   represent tax-deductible items
7. Dividend income, interest income, and
   interest expense


Prof. W. Bentz        A&MIS 212          91
                 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
Prof. W. Bentz          A&MIS 212       92
                 Non-taxable Events
3. Purchase of an operating asset or an
   investment
4. Borrowing money (taking out a loan)
5. Repaying the principal (not the
   interest) on a loan
6. Payment of dividends by a corporation



Prof. W. Bentz          A&MIS 212      93

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:2
posted:2/17/2013
language:Unknown
pages:93