Principles of Managerial Accounting

1. Principles of Managerial Accounting Chapter 14

2. Time Value of Money • A dollar today is worth more than a dollar received in the future.

3. Future amount of $1 • Table 14C-1 page 702 • If you invest $1,000 for 10 years at 10%, how much will you be able to withdraw from your investment? • 1,000 x 2.594 = 2,594

4. Future amount of annuity • Table 14C-2 page 703 • How much would an investment of $1,000 made at the end of each year for 10 years at 10% accumulate to? • 1,000 x 15.938 = 15,938

5. Present value of $1 • Table 14C-3 page 703 • What is the present value of being able to receive $1,000, 10 years from today, if the relevant interest rate is 10%? • 1,000 x .386 = 386

6. Present value of an annuity • Table 14C-4 page 704 • How much would you need to invest today to receive $1,000 at the end of each year for the next 10 years with a relevant interest rate of 10%? • 1,000 x 6.145 = 6,145

7. Capital budgeting • Planning and financing capital outlays for purchase of new machines, introduction of new products, and modernization of facilities. • A commitment of funds now in order to receive cash flows in the future.

8. Typical capital budgeting decisions • Screening decisions – proposed project must meet some preset standard of acceptance • Eg. Investment must generate at least 20% return. • Preference decisions – selecting from several competing courses of action.

9. Discounted Cash Flows-Net present value method • The present value of a project is the difference between the present value of all cash inflows and the present value of all cash outflows. • If the net present value is positive, the investment project is acceptable. • The discount rate is typically the minimum required rate of return of investment projects.

10. Cost of capital • The overall cost to an organization of obtaining investment funds including the cost of both debt and equity sources.

11. Discounted cash flows – Internal rate of return method • Internal rate of return is the rate of return on an investment over its useful life • Rate on any investment is compared to whatever rate of return the organization requires on its investment projects. • If internal rate of return is equal to or greater than the required rate of return, the project is acceptable.

12. Investments in automated equipment • Cost of automated equipment is generally greater than conventional equipment • Front end costs are greater—engineering, software, training • Benefits – reduced labor costs, more reliable, more consistent, faster, fewer defects, higher quality, less scrap

13. Payback Period Method • Length of time that it takes for an investment project to recoup its initial cost out of the cash inflows that it generates • Payback period = Investment required / Net annual cash inflow • Disadvantage of this method – ignores time value of money

14. Simple rate of return • Also known as the accounting rate of return • Simple rate of return = Incremental revenues – Incremental expenses/ Initial investment • Disadvantage – does not use cash flow, includes depreciation, ignores time value of money

15. Assignment • Exercises 1, 6 Problem 13