How To Analyze A Capital Investment Problem

Transcription

1 CAPITOLO 15 LE DECISIONI DI LUNGO TERMINE: LA SCELTA DEGLI INVESTIMENTI Approach Capital investment decisions are a special kind of alternative choice problem. They are analyzed in the same way as that used for the problems described in Chapter 26, with the exception that differences in the timing of cash inflows and outflows must be taken into account. This one difference is an important one, however. In order to incorporate its effect in the analysis, one must have a thorough understanding of the concept of present value. Because of the difficulty that students seem to have with the topic, the discussion of present value in the first part of this chapter proceeds quite slowly unless the Appendix to Chapter 8 was previously assigned and discussed. Once students understand the nature and use of this concept, they should have relatively little difficulty with most other topics discussed in the chapter. Quite early in the chapter, the steps in analyzing a capital investment problem are set forth As various aspects of the analysis are discussed, it is a good idea to relate each of them to these steps, and to keep the students continually aware of the purpose of the analysis, namely, to reach a decision on the acceptability of a proposed capital investment. The reason for the omission of depreciation is often difficult to understand. Students must appreciate that the procedure takes into account the recovery of the investment, and that to include depreciation as a separate item of cost would be double counting. In addition to the text discussion of this point, it may be desirable to introduce additional illustrations. It may also be desirable to relate this topic to the corresponding discussion in Chapter 26. Students have difficulty in understanding the depreciation tax shield. They learned in Chapter 26 that noncash costs are to be disregarded, but now they are told that noncash depreciation is to be counted, and this seems contradictory. This point needs to be discussed in depth. Students should understand that the amount of depreciation does not directly enter the cash flow calculation. It is the amount of income tax that is the cash flow; depreciation is used only to calculate the amount of income tax. The description and the examples have been stated and arranged in such a way that, hopefully, this point is emphasized. In the latter part of the chapter, several methods of investment analysis are described and compared. Although the net present-value method is described as being superior to the discounted cash-flow method, not too much importance should be attached to this point. In most real-life problems, either method gives satisfactory results. Any method that uses present values is superior to all methods that disregard present values (e.g., payback, unadjusted return), and it is a good idea to stress this point. (In practice, companies tend to use several methods simultaneously.)

2 Problemi Problem 15-12: Plastic Ecosistema a. Comparisons of Cash Flows and Taxable Income: Year Total Straight-line (a)... $6,000 $6,000 $6,000 $6,000 $6,000 $30,000 MACRS... 6,000 9,600 5,400 4,500 4,500 30,000 Difference in taxable income , ,500 +1,500 0 Difference in 0-1, Difference in after-tax income , Difference in cumulative cash flow (tax postponed) ,440 1, b. The MACRS method produces faster cash flows because of a tax advantage in early years which decreases the funds spent for taxes. (1) $30,000/5 years, or $6,000 per year (2) $30,000 x MACRS allowance for given year. Problem 15-2: Corrine Company a. SELL OR RENT If sell Cost... $270,000 Accumulated depreciation ,000 ($270,000/15 years) x 10 years Book value... 90,000 Selling price ,000 Long-term gain ,000 40,500 Net gain after tax... 94,500 Net cash inflow = $225,000 - $40, $184,500 If rent Rent proceeds per year... $72,000 Maintenance, etc.... $27,000 Depreciation... 18,000 45,000 Net rent income before tax... 27,000 10,800 Net rent after tax... $16,200 b. The cash flow of $45,000 - $10,800, or $34,200, after tax for five years is $171,000, which is less than the after-tax profit from a sale now. (The present value of $34,200 for 5 years at, say, 10%, is even less than the $156,150 and more accurate, making the sale even more attractive.) But, the value of the warehouse 5 years hence is not

3 mentioned. It might be sold at a large enough gain to offset the difference between rent proceeds and a sale now. Rent might increase, or expenses increase. Evidence is weighted in favor of a sale now for after-tax benefits. Problem 15-3 Domande sul capital budgeting a. The investment/inflow ratio = $10,000 annual cash inflow = 6.2, so if the investment is $10,000, the annual cash inflow is $10, , or $1,613. c. An investment/inflow ratio of 6.2, for 12 years, from Table B is approximately a 12% internal rate of return. b. The investment/inflow ratio = investment $1,500 = 6.14, so the investment = $9,210 ($1,500 x 6.14). c. The investment/inflow ratio from Table B for 7 years, at 16% is The investment is therefore $5,000 annual cash inflow x = $20,195, the maximum price to pay. d. The investment/inflow ratio for 7 years, at 14%, from Table B, is $4,639, which is the maximum investment per dollar of annual savings. Problem 15-4: Wellington SpA Calculation of Project Returns Project Useful Life Investment/ Inflow (a) Return (b) Rank 1 6 years % 1st % 3rd % 2nd % 4th negative 5th (a) $100,000 $25,000 = ,000 30,000 = ,000 5,000 = ,000 10,000 = ,500 = 4.0 (a) Returns for Projects 1-3 are from Table B. Project 4 s return is zero, since the nondiscounted inflows ($10,000 x 2) exactly equal the initial investment. Project 5 over its entire life returns only $37,500 of the initial $50,000 investment, so its return must be negative.

4 Problem 15-5: Ricerca e Sviluppo di Baxton SpA a. Differential after-tax cash flows (000 omitted): Sales... $1,000 $1,600 $800 Material, labor, direct overhead Added rent (12,500 x $4) Depreciation Differential cost , Differential income Differential income taxes.(40%) Differential net income Add back depreciation Differential cash flow from product Salvage value Net differential cash flow... $ 510 $ 600 $480 Cash outlay for project: Purchase price... $ 900 Modifications Installation Testing Total... $1,080 b. The payback period is slightly less than two years, since the initial investment is $1,080,000 and the sum of the first two years inflows is $1,110,000. Thus, if a two-year payback period is the decision criterion, the project is acceptable. c Net income... $ 13, Net income , Net income ,500 $352,500 Average income ,500 (1) Average investment* ,000 (2) Accounting rate of return... 22% (1 2) d. The project should be adopted if a 20% after-tax rate of return is required: Present value of cash flows at 20%: 1984: $510,000 x = $ 424, : 600,000 x = 416, : 480,000 x = 277,920 $1,119,150 The present value of $1,119,150 is greater than the initial outlay of $1,080,000; therefore, the project more than satisfies the 20% requirement. e. If the student does not have access to a calculator or computer programmed to make IRR calculations,

5 the IRR must be estimated using a trial-and-error approach. The IRR is slightly in excess of 22%, as shown by these calculations: Year Cash Flow 22% Factor 22% P.V. 24% Factor 24% P.V $510, $ 418, $ 411, , , , , , ,520 $1,085,880 $1,052,580 *The initial investment ($1,080,000) is sometimes used in this calculation; this would make the accounting rate of return = 11%.