Matakuliah
Tahun
: V0282 - Manajemen Akuntansi Hotel
: 2009 - 2010
Capital Investment, Leasing, and
Taxation Chapter 12
Chapter Outline
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Capital Budgeting
Capital Investment
Financing Alternatives
Taxation
Learning Outcomes
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Identify the purpose of capital budgeting.
Compute business owners’ investment rates of return.
Identify advantages and disadvantages of capital
financing alternatives such as debt versus equity
financing and lease versus buy decisions.
Determine the effects of taxation on a hospitality
business.
Capital Budgeting
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In business, capital simply refers to money.
Those who invest their capital are, not surprisingly,
called capitalists, and the economic system that allows
for the private ownership of property is called
capitalism.
As is the case in most industries, investing money in
hospitality businesses can be risky.
Capital budgets are used to plan and evaluate
purchases of fixed assets such land, property, and
equipment.
Capital Budgeting
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Purchases of this type are called capital expenditures
and, as you learned previously, are recorded on a
business’s balance sheet.
Capital budgeting is the essential process by which
those in business evaluate which hospitality operations
will be started, which will be expanded, and which will
be closed.
In nearly all cases, business owners seek returns on
their investments which are large enough to justify the
continued investment of their capital.
Capital Budgeting
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In general, capital budgeting techniques can be
classified as those that are directed toward one or more
of the following business activities:
– Establish a business (new venture, sometimes funded by
venture capitalists)
– Expand a business (increase revenues)
– Increase efficiency (reduce expenses)
– Comply with the law (mandated change)
Capital Investment
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Investors seek to balance the concepts of risk, with that
of reward (increase vs. decrease in value).
In most cases, as the amount of risk involved in an
investment increases, the return on that investment also
increases.
As an investor you would ultimately seek to compare
the cost of making an investment today against the
stream of income that the investment will generate in
the future.
To best make this “in the future” value comparison, or
time value of money, which is the concept that money
has different values at difference points in time.
Time Value of Money
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To illustrate the time value of money concept, assume
that you have won $10,000 in the state lottery. Your
options for collecting payment are:
– Receive $10,000 now, or
– Receive $10,000 in four years.
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If you are like most people, you would choose to receive
the $10,000 now.
It makes little sense to defer (delay) a cash flow into the
future when you could have the exact same amount of
money now.
Time Value of Money
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From an investment perspective, those in business
know you can do much more with money if you have it
now because you can earn even more money through
wise investments.
The value of the money that is invested now at a given
rate of interest and grows over time is called the future
value of money. The process of money earning interest
and growing to a future value is called compounding.
See Go Figure! for an illustration of this.
go figure!
To see why this is so, consider Rhonda and Ron. Both are owed $1,000. Rhonda
collects the money owed to her on January 1st while Ron collects the $1,000 owed to
him on December 31st of the same year.
After thoroughly evaluating her investment opportunities, Rhonda takes her money on
January 1st and invests it in a company that will pay her a 10% annual rate of return. As
a result, on December 31st Rhonda would have $1,100 as shown using the total
investment value formula as follows:
Investment + Return on Investment = Total Investment Value
or
$1,000 + ($1,000 X 0.10) = $1,100
As a result of her investment, at the end of the year, Rhonda’s $1000 is now worth
$1,100, while Ron’s $1000 is, of course, still worth only $1,000.
Now, assume that Rhonda elects to re-invest her original $1,000 and all of her
investment earnings. If she does so, Rhonda is poised to increase the future value of her
money even further by earning investment returns over an even longer period of time.
The value of the money that is invested now at a given rate of interest and grows over
time is called the future value of money. The process of money earning interest and
growing to a future value is called compounding.
If Rhonda maintained her investment for four years, it would grow as follows:
Year 1
$1,000 + ($1,000 X 0.10) = $1,100
Year 2
$1,100 + ($1,100 X 0.10) = $1,210
Year 3
$1,210 + ($1,210 X 0.10) = $1,331
Year 4
$1,331 + ($1,331 X 0.10) = $1,464
go figure!
The formula managerial accountants use to quickly compute the future value of an
investment when the rate of return and length of the investment is known is as follows:
Future Value = Investment Amount X (1 + Investment Earnings %)n
or
FVn = PV x (1+i)n
Where FV equals the amount of the investment at the end of the investment period
(future value), PV equals the present value of the investment, n equals the number
of years the investment will be maintained, and i equals the interest rate %.
In the example of Rhonda’s four-year investment, the future value formula would be
computed as:
$1,000 X (1 + 0.10)4 = Future Value
or
$1,000 X (1.464) = $1,464
Time Value of Money
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The effect of a compound investment earning 10%
annual returns is summarized below.
Figure 12.2 Effect of Compound Investment Returns
Value
Year 1
Year 2
Year 3
Year 4
Beginning Value
$1,000
$1,100
$1,210
$1,331
100
110
121
133
$1,100
$1,210
$1,331
$1,464
Investment Earnings
Year End Total Investment Value
Time Value of Money
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When a future value is known, then the present value,
or the amount the future value of money is worth today,
can be determined.
The process of computing a present value is called
discounting, or calculating the value of future money
discounted to today’s actual value.
See Go Figure! for an illustration of this.
(go figure! continued)
When a future value is known, then the present value, or the amount the future value of
money is worth today, can be determined. The process of computing a present value is
called discounting, or calculating the value of future money discounted to today’s actual
value. The formula managerial accountants use to quickly compute the present value of
an investment when the rate of return and length of the investment is known is as
follows:
Present Value =
Future Value
(1 + Investment Earnings %)n
or
PV =
FVn
(1 + i)n
Where FV equals the amount of the investment at the end of the investment period
(future value), PV equals the present value of the investment, n equals the number
of years the investment will be maintained, and i equals the interest rate %.
In the example of Rhonda’s four-year investment, the present value formula would be
computed as:
$1,464
(1 + 0.10)4
= Present Value
or
$1,464
1.464
= $1,000
Put another way, Rhonda’s $1,464 investment (received four years from now) would be
worth $1,000 today.
Time Value of Money
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Future values and present values can be calculated
using the formulas stated in this chapter, time value of
money tables, and/or financial calculators.
As you (and all savvy investors) now recognize,
maximum returns on money invested (ROI) are
achieved by utilizing one or both of the following
investment strategies:
1. Increasing the length of time money is invested
2. Increasing the annual rate of return on the investment
Rates of Return
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Before closely examining rates of return, it is very
important for those in the hospitality industry (as well as
all other industries!) to understand that operating profits
are not the same as return on investment.
Sometimes, a restaurant that achieves a very good
profit (net income) is still not a good investment for the
restaurant’s owner.
In other cases, a restaurant that achieves a less
spectacular net income is a better investment.
See Go Figure! for an illustration of this.
go figure!
For example, assume two restaurant owners have generated $200,000 in net income
after a year of operating their respective restaurants. The first owner invested
$2,000,000 in the operation, and the second owner invested $4,000,000.
Using the ROI formula you learned about in Chapter 3, the owners’ ROIs can be
calculated as follows:
Money Earned on Funds Invested
Funds Invested
or
First Owner:
$200,000
$2,000,000
= 10%
Second Owner:
$200,000
$4,000,000
= 5%
= ROI
Rates of Return
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Actual returns on investment can vary greatly, but few, if
any, investors will for a long period of time invest in a
restaurant if the net income is less than what could be
achieved in other investment opportunities with the
same or lesser risks.
Sophisticated managerial accountants can utilize
several variations of the basic ROI formula to help them
make good decisions about investing their capital.
For working managers interested in maximizing returns
on investment, two of the most important of these
formula variations are:
– Savings Rate of Return
– Payback Period
Savings Rate of Return
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The savings rate of return is the relationship between
the annual savings achieved by an investment and the
initial capital invested.
An example of this information based on Amy Sussums,
a country club manager who is contemplating the
purchase of a new dish machine, is presented in Figure
12.4 and the following Go Figure! exercise.
In many cases, managerial accountants and/or the
owners of a business will set an investment return
threshold (minimum rate of return) that must be
achieved prior to the approval of a capital expenditure.
Figure 12.4 Country Club Dish Machine Cost Analysis
Current Dish Machine
Proposed New Dish Machine
Book Value = $8,000
Cost is $22,000 installed
Expected machine life is three years
Expected machine life is fifteen years
Current value (if sold) is $3,000
Value (if sold) in 15 years is $ 0.
Annual operating costs are $ 41,200
Annual operating costs are $31,000
due to the machines fewer labor hours
required and increased energy
efficiency
go figure!
Based on the information Amy has gathered:
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The new machine costs $22,000 (installed) and the value of the old machine is
$3,000.
Thus, the new capital required to be invested in the machine would be $19,000
($22,000 - $3,000 = $19,000).
Amy will achieve cost savings of $10,200 per year ($41,200 to operate the old
machine - $31,000 to operate the new machine = $10,200 annual savings).
She can compute her savings rate of return as follows:
Annual Savings
Capital Investment = Savings Rate of Return
or
$10,200
$19,000 = 53.7%
Payback Period
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Payback period refers to the length of time it will take to
recover 100% of an amount invested.
Typically, the shorter the time period required to recover
all of the investment amount, the more desirable it is.
Managerial accountants often utilize the payback period
formula to evaluate different investment alternatives.
See Go Figure! for an illustration of this.
go figure!
In the dish machine example cited in Figure 12.4, Amy would compute her payback
period as:
Capital Investment
Annual Income (or Savings) = Payback Period
or
$19,000
$10,200
= 1.86 years (approximately 1 year and 10 months)
Capitalization Rates
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In most cases, business investors are not guaranteed a
return on their investments.
Investment returns typically increase as an investment’s
risk level increases.
To fully appreciate how business investors estimate
their ROIs and then consider risk levels, you must first
understand capitalization rates.
In the hospitality industry, capitalization (cap) rates are
utilized to compare the price of entering a business (the
investment) with the anticipated, but not guaranteed,
returns from that investment (net operating income).
Capitalization Rates
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This ties investment returns to:
– The size of the profits (net operating income) generated by the
business
– The size of the investment in the business
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Net operating income (NOI), in general, is the income
before interest and taxes you would find on a restaurant
or hotel income statement.
Investors generally do not want to pay more than the
true value of any specific hospitality business or
property they are considering purchasing.
See Go Figure! for an illustration of this.
go figure!
To illustrate, consider the High Hills Hotel, which was offered for sale for $16,000,000.
The hotel’s net operating income for the past annual accounting period was $2,000,000.
The cap rate % formula can be restated using the property value as the investment
amount. The computation of the cap rate in this example would be:
Net Operating Income
Property Value
= Cap Rate %
or
$2,000,000
$16,000,000
= 12.5%
Conversely, the property value estimate is calculated as follows:
Net Operating Income
Cap Rate %
= Property Value Estimate
or
$2,000,000
12.5%
= $16,000,000
Capitalization Rates
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Cap rates that are higher tend to indicate a business is
creating very favorable net operating incomes relative to
the business’s value (selling price).
Cap rates that are lower indicate that the business is
generating a smaller level of net operating income
relative to the business’s estimated value (selling price).
In general, cap rates are used to indicate the rate of
return investors expect to achieve on a known level of
investment.
Financing Alternatives
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For investors, financing simply refers to the method of
securing (funding) the money needed to invest.
Theoretically, financing alternatives for a purchase
could range from paying cash for the full purchase price
(100% equity financing) to borrowing the full purchase
price (100% debt financing).
Because investments are typically financed with debt
and/or equity funds, the precise manner in which
financing is secured will have a major impact on the
return on investment (ROI) investors ultimately achieve.
Debt versus Equity Financing
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With debt financing, the investor borrows money and
must pay it back with interest within a certain timeframe.
With equity financing, investors raise money by selling a
portion of ownership in the company.
Common suppliers of debt financing include banks,
finance companies, credit unions, credit card
companies, and private corporations.
Equity financing typically means taking on investors and
being accountable to them.
ROI on equity funds is achieved only after those who
have supplied debt funding have earned their own
ROIs.
Debt versus Equity Financing
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Equity investors typically are entitled to a share of the
business’s profits as long as they hold, or maintain, their
investments.
The amount of ROI generated by an investment is
greatly affected by the ratio of debt to equity financing in
that investment.
The debt to equity ratio in an investment will also affect
the willingness of lenders to supply investment capital.
Figure 12.6 illustrates the affect on equity ROI of
funding the investment with varying levels of debt and
equity.
Figure 12.6 Effect of Debt on Equity Returns
Financing
Debt
Equity
Debt
Equity
Debt
Equity
Debt
Equity
Project Cost
50%
50%
27,000,000
- 13,500,000
13,500,000
60%
40%
27,000,000
- 16,200,000
10,800,000
70%
30%
27,000,000
- 18,900,000
8,100,000
80%
20%
27,000,000
- 21,600,000
5,400,000
Payment or
Return
Interest Payment
ROI
Interest Payment
ROI
Interest Payment
ROI
Interest Payment
ROI
%
Net Operating
Income
Debt
Coverage
Ratio
8.0%
30.1%
5,145,123
- 1,080,000
4,065,123
4.8
8.0%
35.6%
5,145,123
- 1,296,000
3,849,123
4.0
8.0%
44.9%
5,145,123
- 1,512,000
3,633,123
3.4
8.0%
63.3%
5,145,123
- 1,728,000
3,417,123
3.0
Debt versus Equity Financing
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For any investment, the greater the financial leverage or
funding supplied by debt, the greater the ROI achieved
by the investor.
“Why not fund nearly 100% of every investment using
debt?” The answer to this question lies in the column
titled Debt Coverage Ratio.
This is the same ratio as the Times Interest Earned ratio
that you learned about in Chapter 6.
The debt coverage ratio is a measure of how likely the
business is to actually have the funds necessary for
loan repayment.
See Go Figure! which illustrates how to calculate this.
go figure!
The debt coverage ratio can be calculated for 50% debt and 50% equity
financing from Figure 12.6 as follows:
Net Operating Income
Interest Payment
= Debt Coverage Ratio
or
$5,145,123
$1,080,000 = 4.8
Debt versus Equity Financing
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Lenders will analyze debt coverage ratios to determine
the risk they are willing to assume when lending to an
investor’s project.
Projects with lower than desirable debt coverage ratios
will most often come at a higher cost (interest rate).
Because of risk, some lenders will provide debt
financing for no more than 50 to 70% of a project’s total
cost. This creates a loan to value (LTV) ratio, a ratio of
the outstanding debt on a property to the market value
of that property, of 50- 70%.
The project’s owners, then, will have to secure the
balance of the project’s cost in equity funding.
Lease versus Buy Decisions
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Leasing, (an agreement to lease) allows a business to
control and use land, buildings, or equipment without
buying them.
In a lease arrangement, lessors gain immediate income
while still maintaining ownership of their property.
Lessees enjoy limited property rights and distinct
financial and tax advantages, as well as the right, in
many cases, to buy the property at an agreed upon
price at the end of the lease’s term.
Figure 12.7 details some significant differences
between the rights of property owners (lessors) and
lessees of that same property.
Figure 12.7 Select Legal Considerations of Buying vs. Leasing Property
1. Right to Use the Property
Owner
Property use is unlimited in any
legal manner owner sees fit.
Lessee
Property use is strictly limited to the
terms of the lease.
2. Treatment of Cost
Owner
Property is depreciable in
accordance with federal and state
income tax law.
Lessee
Lease payments are deductible as a
business expense, according to federal
and state tax laws.
3. Ability to Finance
Owner
The property can be used as
collateral to secure a loan.
Lessee
The property may not generally be
used to secure a loan.
4. Termination
Owner
Ownership passes to estate
holders.
5. Non-Payment of Lease
Owner
Owner retains the down payment
and/or foreclose on the property.
Lessee
The right to possess the property
concludes with the termination of the
lease contract.
Lessee
Owner retains deposit and/or owner
may evict lessee. For personal
property, the owner may reclaim the
leased item.
Lease versus Buy Decisions
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The most significant financial difference between buying
and leasing is that payments for owned property by
lessors are not listed as a business expense on the
monthly income statement.
Rather, the value of the asset is depreciated over a
period of time appropriate for that specific asset on the
balance sheet.
Payments for most (but not all) leased property by
lessees, however, are considered an operating expense
and thus are listed on the income statement.
See Figure 12.8. for advantages of leasing.
Figure 12.8 Advantages of Leasing
1.
Low Cost Tax Advantages. One of the most popular reasons for leasing is its low cost. A
lease can offer low cost financing because the lessor takes advantage of tax benefits that are
passed to the lessee. If the lessee cannot currently use tax depreciation to offset taxable
income due to current operating losses, depreciation benefits may be lost forever if the
lessee purchases rather than leases.
2.
On or Off Balance Sheet Options. In some cases, a lease can be structured to qualify as an
operating lease, the expense for which is properly reported on the income statement, thus
increasing the business’s flexibility in financial reporting and directly affecting important
financial ratios such as the operating profit percentage.
3.
Improved Return on Investment. Many companies place a heavy emphasis on ROI for
evaluating profitability and performance. Operating leases often have a positive effect on ROI
because leasing typically requires less initial capital to secure an asset than does purchasing.
4.
100% Financing. In many cases, leasing may allow the entire cost of securing an asset to be
financed, while a typical purchase loan requires an initial down payment. Most costs incurred
in acquiring equipment can be financed by the lease. These costs include delivery charges,
interest charges on advance payments, sales or use taxes, and installation costs. Such costs
are not usually financed under alternative methods of equipment financing.
5.
Budget Expansion. The acquisition of equipment not included in a capital expenditure
budget can sometimes be accomplished through use of a lease, with lease payments being
classified as monthly operating expenses.
6.
Joint Ventures. Leasing can be ideal for joint venture partnerships in which tax benefits are
not available to one or more of the joint venture partners. This may be because of the way in
which the partnership was structured, or because of the tax situation of one or more of the
joint venture partners. In such cases, the lessor may utilize the tax benefits, which would
otherwise be lost, and pass those benefits to the joint venture in the form of lower lease
payments.
7.
Improved Cash Flow. Lease payments may provide the lessee with improved cash flow
compared to loan payments. As well, the overall cash flow on a present value basis is often
more attractive in a lease.
Lease versus Buy Decisions
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Despite their varied advantages, leases can have
distinct disadvantages in some cases including:
– Non-ownership of the leased item or property at the end of the
lease.
– In situations where few lease options exist, the cost of leasing
may ultimately be higher than the cost of buying.
– Changing technology may make leased equipment obsolete, but
the lease term is unexpired.
– Significant penalties may be incurred if the lessee seeks to
terminate the lease before its original expiration date.
Taxation
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Managerial accountants who fully understand the very
complex tax laws under which their businesses operate
can help ensure that the taxes these businesses pay
are exactly the amount owed by the business, and no
more.
This is important because when the correct amount of
tax is paid, ROIs will be maximized and not wrongfully
reduced.
Income Taxes
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Taxing entities such as the federal, state, and local
governments generally assess taxes to businesses
based upon their own definitions of taxable income.
It is the job of the tax accountant to ensure that the
businesses they advise do not overpay on their taxes.
Tax avoidance is simply planning business transactions
in such a way as to minimize or eliminate taxes owed.
Tax evasion, on the other hand, is the act of reporting
inaccurate financial information or concealing financial
information in order to evade taxes by illegal means.
Tax avoidance is legal and ethical, while tax evasion is
not.
Income Taxes
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Taxable income is generally defined as gross income
adjusted for various deductions allowable by law.
There are about 2.1 million regular, or “C” corporations
in the United States.
The income tax rates (at the time of this book’s
publication) for C corporations are shown in Figure
12.9.
It is important to understand that all business’s net
income is taxed at the federal level, but it most often
also is taxed at the state and even local levels.
Figure 12.9 Federal Corporate Income Tax Rates
Taxable Income
Over
$0
But Not Over
Tax rate
50,000
15%
50,000
75,000
25%
75,000
100,000
34%
100,000
335,000
39%
335,000
10,000,000
34%
10,000,000
15,000,000
35%
15,000,000
18,333,333
38%
18,333,333+
35%
Corporate Income Tax in Indonesia
Based on UU No. 17 Tahun 2000:
Taxable Income
Rate
Up to Rp 50.000.000,-
10%
Over Rp50.000.000,- but not over Rp 100.000.000,-
15%
Over Rp100.000.000,-
30%
Based on new Tax Law No. 36/2008:
• Single Rate
• 28% for 2009 fiscal year
• 25% for 2010 fiscal year
Bina Nusantara University
Capital Gains Taxes
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A capital gain is the surplus that results from the sale of
an asset over its original purchase price adjusted for
depreciation (asset basis).
A capital loss occurs when the price of the asset sold is
less than the original purchase price adjusted for
depreciation.
Capital gains and losses occur with the sale of real
assets, such as property, as well as financial assets,
such as stocks and bonds.
The federal government (and some states) imposes a
tax on gains from the sale of assets.
Property Taxes
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In addition to income and capital gains taxes, most
hospitality businesses will be responsible for paying
property taxes on the property owned by their
businesses.
These assessments are determined through a real
estate appraisal, which is an opinion of the value of a
property, usually its market value, performed by a
licensed appraiser.
Market value is the price at which an asset would trade
in a competitive setting.
Other Hospitality Industry Taxes
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Hospitality businesses are responsible for reporting and
paying a variety of hospitality industry taxes.
Sales Tax. In most cases, sales taxes are collected
from guests by hospitality businesses for taxes
assessed on the sale of food, beverages, rooms, and
other hospitality services. Typically, the funds collected
are then transferred (forwarded) to the appropriate
taxing authority on a monthly or quarterly basis.
Other Hospitality Industry Taxes
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Occupancy (Bed) Tax. Occupancy (bed) taxes are a
special assessment collected from guests and paid to a
local taxing authority based upon the amount of
revenue a hotel achieves when selling its guest rooms.
Tipped Employee Tax. Tipped employee taxes are
assessed on tips and gratuities given to employees by
guests or the business as taxable income for those
employees. As such, this income must be reported to
the IRS, and taxes, if due, must be paid on that income.
Role of Hospitality Managers
•
While it is not reasonable for most hospitality managers
to become tax experts, it is possible for them to:
1. Be aware of the major entities responsible for tax collection
and enforcement.
2. Be aware of the specific tax deadlines for which they are
responsible.
3. Stay abreast, to the greatest degree possible, of changes in
tax laws that may directly affect their business.
Role of Hospitality Managers
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Directorate General of Tax Office (Ditjen Pajak) is the
taxing authority with which hospitality managers are
likely most familiar.
Among other things, Ditjen Pajak requires businesses to
do the following:
– File quarterly income tax returns and make payments on the
profits earned from business operations.
– Withhold income taxes from the wages of all employees and
deposit these with the Ditjen Pajak at regular intervals.
Role of Hospitality Managers
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Report all employee income earned as tips and
withhold taxes on the tipped income.
Record the value of meals charged to employees when
the meals are considered a portion of an employee’s
income.
Furnish a record of withheld taxes to all employees on
or before January 31 of each year (Form W-2).
It is the role of hospitality managers to stay abreast of
significant changes in tax laws and follow them to the
letter.
Review of Learning Outcomes
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Identify the purpose of capital budgeting.
Compute business owners’ investment rates of return.
Identify advantages and disadvantages of capital
financing alternatives such as debt versus equity
financing and lease versus buy decisions.
Determine the effects of taxation on a hospitality
business.