STUDENT
CHAPTER 8
MANAGERIAL
ACCOUNTING
PowerPoint Presentation by
Gail B. Wright
Professor Emeritus of Accounting
Bryant University
© Copyright 2008 Thomson South-Western, a part of The
Thomson Corporation. Thomson, the Star Logo, and SouthWestern are trademarks used herein under license.
10TH EDITION
BY
MAHER, STICKNEY & WEIL
CAPITAL EXPENDITURE DECISIONS
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Managerial Decision Making
LEARNING OBJECTIVES
1. Explain the reasoning behind separation of
investing & financing of long-term decisions.
2. Explain role of capital expenditure decisions in
strategic planning process.
3. Describe steps of net present value method for
making long-term decisions using discounted cash
flows; explain effect of income taxes on cash
flows.
4. Explain how spreadsheets help analyst conduct
sensitivity analyses of capital budgeting.
Continued
2
Managerial Decision Making
LEARNING OBJECTIVES
5. Describe internal rate of return method of
assessing investment alternatives.
6. Explain why analysts need more than cash
flow analysis to justify or reject investment.
7. Explain why capital investment process
requires audits.
8. Identify behavioral issues involved in
capital budgeting.
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Managerial Decision Making
☼
CHAPTER GOAL
☼
This chapter explains how the differential
principle applies to long–term decisions where
the focus is on changes in operating capacity
over several future time periods. Present value
analysis, also called discounted cash flow
(DCF), provides analysts with the appropriate
technique.
4
LO 1
CAPITAL BUDGETING:
Definition
Managerial Decision Making
Involves deciding which longterm investments to take
involving capital (long-term)
assets.
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LO 2
Managerial Decision Making
STRATEGIC PLANNING
In strategic planning, an organization
decides on major programs & the
resources to devote to them.
Strategic planning provides the
context for capital expenditure
decisions.
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LO 2
Managerial Decision Making
BENEFITS: Long-Term Investments
Reducing potential to make mistakes improves
product
Making goods, delivering services that competitors
cannot
Reducing cycle time to make product
Permanently reducing costs to provide such an
advantage that competitors cannot afford to enter
market
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LO 3
Managerial Decision Making
DISCOUNTED CASH FLOW
(DCF): Definition
Aids in evaluating investments
involving cash flows over time
where there is a significant
difference between cash payment
& receipt.
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LO 3
ELEMENTS OF DISCOUNT RATE
Managerial Decision Making
The choice of a discount rate should consider the
following
A pure rate of interest that reflects the productive
capability of capital assets
A risk factor reflecting the riskiness of the project
An increase reflecting inflation expected to occur
over the life of the project.
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LO 3
RISK-FREE RATE: Definition
Managerial Decision Making
Is the pure interest rate +
expected inflation.
10
LO 3
NOMINAL INTEREST RATE:
Definition
Managerial Decision Making
Includes all 3 factors: pure
interest, risk premium, &
expected inflation.
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LO 3
DECISION RULE
Managerial Decision Making
If the present value of future cash
inflows exceeds the present value of
future cash outflows for a proposal,
the firm should accept the project.
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LO 3
CASH FLOW VARIETIES
Initial cash flows:
Occur at beginning of project
Periodic cash flows
Occur during life of project
Managerial Decision Making
Terminal cash flows
Occur at end of project
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LO 4
3 ESTIMATES
The calculation of NPV for a proposed project
requires 3 types of projections
Managerial Decision Making
Amount of future cash flows
Timing of future cash flows
Discount rate
Note: errors in predicting amounts of future cash flows will
likely have the largest impact.
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LO 5
INTERNAL RATE OF RETURN
(IRR): Definition
Is the discount rate that equates
the NPV of the series to 0.
Managerial Decision Making
(Also called the time-adjusted rate
of return.)
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LO 5
DECISION RULE
Managerial Decision Making
If the internal rate of return exceeds the
cutoff (hurdle) rate, the project should be
accepted.
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LO 5
J
E
P
Managerial Decision Making
JEP’s
hurdle rate
is 12%.
Should they
accept this
project?
EXHIBIT 8.4
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LO 6
JUSTIFYING INVESTMENTS
Investments in computer-integrated manufacturing are
often difficult because of difficulties in applying
discounted cash flow methods
Hurdle rate too high
Should be cost of capital
Managerial Decision Making
Bias toward incremental projects
Uncertainty about operating cash flows
Exclusion of benefits that are difficult to quantify
More flexibility
Shorter cycle & lead times
Reduction of non-value-added costs
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LO 6
LONG-TERM INVESTMENTS
3 types of long term capital investments are
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Replacement & minor improvements
Expansion
Strategic moves
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LO 7
AUDITING
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Auditing to compare estimates of capital
budgeting projects to actual results provides
advantages
Audits identify which estimates were wrong to
correct in future
Managers can use audits to reward good planning
Audits create environment that removes the
temptation to inflate estimates & benefits
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LO 8
Managerial Decision Making
BEHAVIORAL ISSUES
Planners have a desire to implement a project,
meet performance measures. This can
influence their objectivity in making
estimates. Additionally, conflicts may arise
between criteria used to evaluate individual
projects and criteria used to evaluate an
organization’s overall or unit performance.
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Managerial Decision Making
CHAPTER 8
THE END
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