Chapter Sixteen

Capital Expenditure Decisions

McGraw-Hill/Irwin

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Learning Objective 1

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Discounted-CashDiscounted-Cash-Flow Analysis
Plant expansion Equipment selection Equipment replacement

Cost reduction

Lease or buy

Net-PresentNet-Present-Value Method
o o o o

Prepare a table showing cash flows for each year, Calculate the present value of each cash flow using a discount rate, Compute net present value, If the net present value (NPV) is positive, accept the investment proposal. Otherwise, reject it.

Net-PresentNet-Present-Value Method
Mattson Co. has been offered a five year contract to provide component parts for a large manufacturer.
Cost and revenue information Cost of special equipment $160,000 Working capital required 100,000 Relining equipment in 3 years 30,000 Salvage value of equipment in 5 years 5,000 Annual cash revenue and costs: Sales revenue from parts 750,000 Cost of parts sold 400,000 Salaries, shipping, etc. 270,000

Net-PresentNet-Present-Value Method
At the end of five years the working capital will be released and may be used elsewhere by Mattson. Mattson uses a discount rate of 10%.

Should the contract be accepted?

Net-PresentNet-Present-Value Method
Annual net cash inflows from operations
Sales revenue Cost of parts sold Gross margin Less out-of-pocket costs Annual net cash inflows $ 750,000 400,000 350,000 270,000 $ 80,000

Net-PresentNet-Present-Value Method
Investment in equipment Working capital needed Years Now Now Cash Flows $(160,000) (100,000) 10% Factor 1.000 1.000 Present Value $ (160,000) (100,000)

Net-PresentNet-Present-Value Method
Investment in equipment Working capital needed Annual net cash inflows Years Now Now 1-5 Cash Flows $(160,000) (100,000) 80,000 10% Factor 1.000 1.000 3.791 Present Value $ (160,000) (100,000) 303,280

Present value of an annuity of $1 factor for 5 years at 10%.

Net-PresentNet-Present-Value Method
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Years Now Now 1-5 3 Cash Flows $(160,000) (100,000) 80,000 (30,000) 10% Factor 1.000 1.000 3.791 0.751 Present Value $ (160,000) (100,000) 303,280 (22,530)

Present value of $1 factor for 3 years at 10%.

Net-PresentNet-Present-Value Method
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equip. Years Now Now 1-5 3 5 Cash Flows $(160,000) (100,000) 80,000 (30,000) 5,000 10% Factor 1.000 1.000 3.791 0.751 0.621 Present Value $ (160,000) (100,000) 303,280 (22,530) 3,105

Present value of $1 factor for 5 years at 10%.

Net-PresentNet-Present-Value Method
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equip. Working capital released Net present value Years Now Now 1-5 3 5 5 Cash Flows $(160,000) (100,000) 80,000 (30,000) 5,000 100,000 10% Factor 1.000 1.000 3.791 0.751 0.621 0.621 Present Value $ (160,000) (100,000) 303,280 (22,530) 3,105 62,100 $ 85,955

Mattson should accept the contract because the present value of the cash inflows exceeds the present value of the cash outflows by $85,955. The project has a positive net present value.

Internal-Rate-ofInternal-Rate-of-Return Method
The internal rate of return is the true economic return earned by the asset over its life. The internal rate of return is computed by finding the discount rate that will cause the net present value of a project to be zero.

Internal-Rate-ofInternal-Rate-of-Return Method
Black Co. can purchase a new machine at a cost of $104,320 that will save $20,000 per year in cash operating costs. The machine has a 10-year life.

Internal-Rate-ofInternal-Rate-of-Return Method
Future cash flows are the same every year in this example, so we can calculate the internal rate of return as follows:
Investment required Net annual cash flows $104, 320 $20,000 = Present value factor

= 5.216

Internal-Rate-ofInternal-Rate-of-Return Method
The present value factor (5.216) is located on the Table IV in the Appendix. Scan the 10period row and locate the value 5.216. Look at the top of the column and you find a rate of 14% which is the internal rate of return.
$104, 320 $20,000

5.216

Internal-Rate-ofInternal-Rate-of-Return Method
Heres the proof . . .
Investment required Annual cost savings Net present value Year Now 1-10 Amount $ (104,320) 20,000 14% Factor 1.000 5.216 Present Value (104,320) 104,320 $ -

Learning Objective 2

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Comparing the NPV and IRR Methods

Net Present Value The cost of capital is used as the actual discount rate. Any project with a negative net present value is rejected.

Comparing the NPV and IRR Methods

Net Present Value The cost of capital is used as the actual discount rate. Any project with a negative net present value is rejected. Internal Rate of Return The cost of capital is compared to the internal rate of return on a project. To be acceptable, a projects rate of return must be greater than the cost of capital.

Comparing the NPV and IRR Methods

The net present value method has the following advantages over the internal rate of return method . . .
Easier to use. Easier to adjust for risk. Provides more usable information.

Assumptions Underlying Discounted-CashDiscounted-Cash-Flow Analysis

All cash flows are treated as though they occur at year end. Assumes a perfect capital market. Cash inflows are immediately reinvested at the required rate of return.

Cash flows are treated as if they are known with certainty.

Choosing the Hurdle Rate

The discount rate generally is associated with the companys cost of capital. The cost of capital involves a blending of the costs of all sources of investment funds, both debt and equity.

Depreciable Assets
Both the NPV and IRR methods focus on cash flows, and periodic depreciation charges are not cash flows . . .
Tax Return Form 1120

Depreciation is tax deductible and . . .

Reduces cash outflows for taxes.

Learning Objective 3

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Comparing Two Investment Projects

To compare competing investment projects we can use the following net present value approaches:
Total-Cost Approach. Incremental-Cost Approach.

TotalTotal-Cost Approach
Each system would last five years. 12 percent hurdle rate for the analysis.
MAINFRAME PC _ Salvage value old system $ 25,000 $ 25,000 Cost of new system (400,000) (300,000) Cost of new software ( 40,000) ( 75,000) Update new system ( 40,000) ( 60,000) Salvage value new system 50,000 30,000 ================================================ Operating costs over 5-year life: Personnel (300,000) (220,000) Maintenance ( 25,000) ( 10,000) Other costs ( 10,000) ( 5,000) ( 20,000) ( 20,000) Datalink services Revenue from time-share 25,000 -

TotalTotal-Cost Approach
MAINFRAME ($) Acquisition cost computer Acquisition cost software System update Salvage value Operating costs Time sharing revenue Total cash flow X Discount factor Present value PERSONAL COMPUTER ($) Acquisition cost computer Acquisition cost software System update Salvage value Operating costs Time sharing revenue Total cash flow X Discount factor Present value Today (400,000) ( 40,000) Year 1 Year 2 Year 3 Year 4 Year 5 ( 40,000) 50,000 (335,000) (335,000) (335,000) (335,000) (335,000) (335,000) 20,000 20,000 20,000 20,000 20,000 20,000 440,000 (315,000) (315,000) (355,000) (315,000) (265,000) X 1.000 X .893 X .797 X .712 X .636 X .567 (440,000) (281,295) (251,055) (252,760) (200,340) (150,255)

SUM = ($1,575,705)
Today (300,000) ( 75,000) Year 1 Year 2 Year 3 Year 4 Year 5

( 60,000) 50,000 (235,000) (235,000) (235,000) (235,000) (235,000) (235,000) -0-0-0-0-0-0_ 375,000 (235,000) (235,000) (295,000) (235,000) (205,000) X 1.000 X .893 X .797 X .712 X .636 X .567 (375,000) (209,855) (187,295) (210,040) (149,460) (116,235)

SUM = ($1,247,885)

TotalTotal-Cost Approach

Net cost of purchasing Mainframe system Net Present Value of costs

($1,575,705)

Net cost of purchasing Personal Computer system ($1,247,885) ($ 327,820)

Mountainview should purchase the personal computer system for a cost savings of $327,820.

IncrementalIncremental-Cost Approach
Irrelevant
MAINFRAME PC _ Differentials Salvage value old system $ 25,000 $ 25,000 0 Cost of new system (400,000) (300,000) (100,000) Cost of new software ( 40,000) ( 75,000) 35,000 Update new system ( 40,000) ( 60,000) 20,000 Salvage value new system 50,000 30,000 20,000 =========================================================== Operating costs over 5-year life: Personnel (300,000) (220,000) ( 80,000) Maintenance ( 25,000) ( 10,000) ( 15,000) Other costs ( 10,000) ( 5,000) ( 5,000) ( 20,000) ( 20,000) 0 Datalink services Revenue from time-share 20,000 20,000

IncrementalIncremental-Cost Approach
INCREMENTAL ($) Acquisition cost computer Acquisition cost software System update Salvage value Operating costs Time sharing revenue Total cash flow X Discount factor Present value Today (100,000) 35,000 Year 1 Year 2 Year 3 Year 4 Year 5

20,000 20,000 (100,000) (100,000) (100,000) (100,000) (100,000) 20,000 20,000 20,000 20,000 20,000 20,000 ( 65,000) ( 80,000) ( 80,000) ( 80,000) ( 80,000) ( 60,000) X 1.000 X .893 X .797 X .712 X .636 X .567 ( 65,000) ( 71,440) ( 63,760) ( 42,720) ( 50,880) ( 34,020)

SUM = ($ 327,820)

TotalTotal-Incremental Cost Comparison

Total Cost: Net cost of purchasing Mainframe system Net Present Value of costs Incremental Cost: Net Present Value of costs ($ 327,820) ($1,575,705)

Net cost of purchasing Personal Computer system ($1,247,885) ($ 327,820)

Different methods, Same results.

Managerial Accountants Role

Managerial accountants are often asked to predict cash flows related to operating cost savings, additional working capital requirements, and incremental costs and revenues. When cash flow projections are very uncertain, the accountant may . . .
increase the hurdle rate, use sensitivity analysis.

Postaudit of Investment Projects

A postaudit is a follow-up after the project has been approved to see whether or not expected results are actually realized.

Learning Objective 4

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Income Taxes and Capital Budgeting

Cash flows from an investment proposal affect the companys profit and its income tax liability.
Income = Revenue - Expenses + Gains - Losses

AfterAfter-Tax Cash Flows

High Country Department Stores Income Statement For the Year Ended Jun 30, 2007 Revenue Expenses Income before taxes Income taxes Net Income $ 1,000,000 (475,000) 525,000 (210,000) 315,000

The tax rate is 40%, so income taxes are $525,000 40% = $ 210,000

Cash Revenues
High Countrys management is considering the purchase of a new truck that will increase cash revenues by $110,000 and increase cash cost of goods sold by $60,000. The company is subject to a tax rate of 40%.

Lets calculate the companys after-tax cash flows.

AfterAfter-Tax Cash Flows

High Country Department Stores Income Statement For the Year Ended Jun 30, 2007 Revenue Cash CGS Income before taxes Income taxes Net Income $ 110,000 ( 60,000) 50,000 (20,000) 30,000_

The tax rate is 40%, so income taxes are $50,000 40% = $ 20,000

AfterAfter-Tax Cash Flows

High Country Department Stores Income Statement For the Year Ended Jun 30, 2007 Revenue Cash CGS Income before taxes Income taxes $ 110,000 ( 60,000) 50,000 (20,000)

Net Income 30,000_ A short cut works like this: Increase in income ( 1 - tax rate)

$50,000 ( 1 - .4) = $20,000

Noncash Expenses
Not all expenses require cash outflows. The most common example is depreciation.
Recall that High Countrys proposal involved the purchase of a truck. The truck cost $40,000 and will be depreciated over four years using straightline depreciation. The truck is to be purchased on June 30, 2007. One-half year depreciation is taken in 2007.

Noncash Expenses
Here is a complete depreciation schedule for High Country.
Year 1 2 3 4 5 Depreciation Expense $ 5,000 10,000 10,000 10,000 5,000 40,000 Tax Reduced Tax Rate Payment _ 40% $ 2,000 40% 4,000 40% 4,000 40% 4,000 40% 2,000 16,000

Depreciation Tax Shield

Net Present Value Analysis

Calculation of the present value of proposal cash flows.
INCREMENTAL ($) Acquisition cost Cash flows from proposal Depreciation shield Total cash flow X Discount factor Present value Today $( 40,000) Year 1 Year 2 Year 3 Year 4 Year 5

$ 18,000 $ 36,000 $ 36,000 2,000 4,000 4,000 ( 40,000) 20,000 40,000 40,000 X 1.000 X .893 X .797 X .712 ( 40,000) 17,860 31,880 28,480

$ 36,000 $ 18,000 4,000 2,000 40,000 20,000 X .636 X .567 25,440 11,340

SUM = $ 75,000

The sum of the present values from this proposal is a positive $75,000

Learning Objective 5

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Modified Accelerated Cost Recovery System (MACRS)

Tax depreciation is usually computed using MACRS. Here are the depreciation rate for 3, 5, and 7-year class life assets.
Year 1 2 3 4 5 6 7 8 3-year 33.33% 44.45% 14.81% 7.41% 5-year 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 7-year 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%

Modified Accelerated Cost Recovery System (MACRS)

A company is considering the purchase of a machine that will increase after-tax cash flows by $20,000 over the next five years. The machine is depreciated using MACRS and the company uses a 10% discount rate to compute all present values. The machine will cost $100,000 and the company is subject to a 28% tax rate.

Lets calculate the net present value of the proposal.

Modified Accelerated Cost Recovery System (MACRS)

Calculation of the present value of the depreciation tax shield.
Tax Year Depreciation Tax 1 $ 20,000 $ 2 32,000 3 19,200 4 11,520 5 11,520 6 5,760 $ 100,000 PV of Tax Shield Shield 5,600 $ 5,090 8,960 7,401 5,376 4,037 3,226 2,203 3,226 2,003 1,613 910 $ 21,644

$5,600 (1.10)^-1

$20,000 28%

$100,000 20%

Modified Accelerated Cost Recovery System (MACRS)

Calculation of the present value proposal cash flows.
Cash Flows Year 1 $ 20,000 2 20,000 3 20,000 4 20,000 5 20,000 6 $ 100,000 PV of Cash Flows $ 18,180 16,520 15,020 13,660 12,420 $ 75,800

$20,000 (1.10)^-1

Modified Accelerated Cost Recovery System (MACRS)

Net present value of the proposal.
PV of Cash Flows Year 1 $ 18,180 2 16,520 3 15,020 4 13,660 5 12,420 6 $ 75,800 PV of Tax Present Shield Value $ 5,090 $ 23,270 7,401 23,921 4,037 19,057 2,203 15,863 2,003 14,423 910 910 $ 21,644 $ 97,444

The present value of the proposal is less than the cost of the equipment ($100,000). The proposal has a negative net present value.

Investment in Working Capital

Some investment proposals require additional outlays for working capital such as increases in cash, accounts receivable, and inventory.
Current assets $ 100,000 Less: current liabilities (65,000) Working capital $ 35,000

Learning Objective 6

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Extended Illustration
Let take a close look at a present value analysis for an investment decision facing James Company. James Company

Extended Illustration
James Company has been offered a five-year contract to provide component parts for a large manufacturer.
Cost and revenue information Cost of special equipment $160,000 Working capital required 100,000 Relining equipment in 3 years 30,000 Salvage value of equipment in 5 years 5,000 Annual cash revenue and costs: Sales revenue from parts 750,000 Cost of parts sold 400,000 Salaries, advertising and others 200,000

Extended Illustration
At the end of five years the working capital will be released and may be used elsewhere by James. James Company uses a discount rate of 10%. James uses straight-line depreciation. All items in this example are taxed at 30%.

Should the contract be accepted?

Extended Illustration
Annual accounting income from operations
Sales revenue Cost of parts sold Gross margin Salaries and other Depreciation expense Income before taxes Income taxes Net income $ 750,000 450,000 300,000 200,000 31,000 69,000 20,700 48,300

Remember depreciation is a non-cash nonexpense that provides a tax shield.

Extended Illustration
Annual cash inflows from operations
Sales revenue Cost of parts sold Gross margin Salaries and other Depreciation expense Income before taxes Income taxes Net cash flows $ 750,000 450,000 300,000 200,000 100,000 20,700 79,300

Remember depreciation is a non-cash nonexpense that provides a tax shield.

Extended Illustration
Years Now Now 1-5 3 5 5 Cash Flows $(160,000) (100,000) 79,300 (21,000) 5,000 100,000

Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equipment Working capital released Net present value

10% Factor 1.000 1.000

0.751 0.621 0.621

The relining is considered normal maintenance and will reduce income in year 3. Because the cost is tax deductible, income will be lower by $21,000 ($30,000 1- tax rate).

Extended Illustration
Years Now Now 1-5 3 5 5 Cash Flows $(160,000) (100,000) 79,300 (21,000) 5,000 100,000

Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equipment Working capital released Net present value

10% Factor 1.000 1.000

0.751 0.621 0.621

Because the salvage value of the equipment will equal the book value (cost less accumulated depreciation), there will be no taxable gain or loss.

Extended Illustration
Investment in equipment Working capital needed Annual net cash inflows Years Now Now 1-5 Cash Flows $(160,000) (100,000) 79,300 10% Factor 1.000 1.000 Present Value $(160,000) (100,000) 303,402

Net Cash PV of Cash Year Inflow PV Factor Inflow 1 $ 79,300 0.909 $ 72,084 2 79,300 0.862 68,357 3 79,300 0.751 59,554 4 79,300 0.683 54,162 5 79,300 0.621 49,245 $ 396,500 $ 303,402

Extended Illustration
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Years Now Now 1-5 3 Cash Flows $(160,000) (100,000) 79,300 (21,000) 10% Factor 1.000 1.000 0.751 Present Value $(160,000) (100,000) 303,402 (15,771)

Present value of $1 factor for 3 years at 10%.

Extended Illustration
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equipment Years Now Now 1-5 3 5 Cash Flows $(160,000) (100,000) 79,300 (21,000) 5,000 10% Factor 1.000 1.000 0.751 0.621 Present Value $(160,000) (100,000) 303,402 (15,771) 3,105

Present value of $1 factor for 5 years at 10%.

Extended Illustration
Investment in equipment Working capital needed Annual net cash inflows Relining of equipment Salvage value of equipment Working capital released Net present value Years Now Now 1-5 3 5 5 Cash Flows $(160,000) (100,000) 79,300 (21,000) 5,000 100,000 10% Factor 1.000 1.000 0.751 0.621 0.621 Present Value $(160,000) (100,000) 303,402 (15,771) 3,105 62,100 $ 92,836

We should accept the contract because the present value of the cash inflows exceeds the present value of the cash outflows by $92,836. The project has a $92,836. positive net present value.

Extended Illustration
General decision rule . . .
If the Net Present Value is . . . Positive . . . Then the Project is . . . Acceptable, since it promises a return greater than the required rate of return. Acceptable, since it promises a return equal to the required rate of return. Not acceptable, since it promises a return less than the required rate of return.

Zero . . .

Negative . . .

Learning Objective 7

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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Ranking Investment Projects

We can invest in either of these projects. Use a 10% discount rate to determine the net present value of the cash flows.
Project A Immediate cash outlay $ 100,000 Cash inflows: $ 50,000 Year 1 Year 2 40,000 Year 3 30,000 Total inflows $ 120,000 Project B $ 100,000 $ 30,000 40,000 50,000 $ 120,000

Ranking Investment Projects

We can invest in either of these projects. Use a 10% discount rate to determine The total cash flows are the same, the pattern of the flows is of the cash flows. net present value but the
Project A Immediate cash outlay $ 100,000 Cash inflows: $ 50,000 Year 1 Year 2 40,000 Year 3 30,000 Total inflows $ 120,000

different.

Project B $ 100,000 $ 30,000 40,000 50,000 $ 120,000

Ranking Investment Projects

Lets calculate the present value of the cash flows associated with Project A.
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project A $(100,000) $ 50,000 40,000 30,000 PV Factor 1.000 PV $(100,000)

Ranking Investment Projects

Lets calculate the present value of the cash flows associated with Project A.
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project A $(100,000) $ 50,000 40,000 30,000 PV Factor 1.000 0.909 PV $(100,000) 45,450

(1.10)-1 = 0.909 rounded

Ranking Investment Projects

Lets calculate the present value of the cash flows associated with Project A.
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project A $(100,000) $ 50,000 40,000 PV Factor 1.000 0.909 0.826 PV $(100,000) 45,450 33,040

(1.10)-2 = 0.826 rounded

Ranking Investment Projects

Lets calculate the present value of the cash flows associated with Project A.
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project A $(100,000) $ 50,000 40,000 30,000 PV Factor 1.000 0.909 0.826 0.751 PV $(100,000) 45,450 33,040 22,530 $ 1,020

This project has a positive net present value which means the projects return is greater than the discount rate.

Ranking Investment Projects

Here is the net present value of the cash flows associated with Project B.
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project B $(100,000) $ 30,000 40,000 50,000 PV Factor 1.000 0.909 0.826 0.751 PV $(100,000) 27,270 33,040 37,550 $ (2,140)

Project B has a negative net present value which means the projects return is less than the discount rate.

Internal Rate of Return (IRR)

The interest rate that equates the present value of inflows and outflows from an investment project.

Internal Rate of Return (IRR)

When the cash flows from a project are constant, the present value of an annuity factor can be used to approximate the rate of return.
A project cost $90,119, and will yield net cash inflows of $25,000 at the end of each of the next five years.

Lets determine the IRR for this project!

Internal Rate of Return (IRR)

Required Investment PV factor = Annual net cash flow $90,119 PV factor = $25,000 PV factor = 3.605 rounded
The present value of an annuity factor of 3.605, is an internal rate of return of 12%. 12%.

Learning Objective 8

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Alternative Methods for Making Investment Decisions

Payback Method
Payback Initial investment = period Annual after-tax cash inflow afterA company can purchase a machine for $20,000 that will provide annual cash inflows of $4,000 for 7 years.

Payback = period

$20,000 $4,000

= 5 years

Payback: Pro and Con

Fails to consider the time value of money. Does not consider a projects cash flows beyond the payback period.

Payback: Pro and Con

Provides a tool for roughly screening investments. For some firms, it may be essential that an investment recoup its initial cash outflows as quickly as possible.

Accounting-Rate-ofAccounting-Rate-of-Return Method
Discounted-cash-flow method focuses on cash flows and the time value of money.

Accounting-rate-of-return method focuses on the incremental accounting income that results from a project.

Accounting-Rate-ofAccounting-Rate-of-Return Method
The following formula is used to calculate the accounting rate of return:
Average Average incremental - incremental expenses, revenues including depreciation = Initial investment

Accounting rate of return

Accounting-Rate-ofAccounting-Rate-of-Return Method
Meyers Company wants to install an espresso bar in its restaurant.
The espresso bar:
Cost $140,000 and has a 10-year life. Will generate incremental revenues of $100,000 and incremental expenses of $80,000 including depreciation.

What is the accounting rate of return on the investment project?

Accounting-Rate-ofAccounting-Rate-of-Return Method
Accounting = rate of return $100,000 - $80,000 $140,000 = 14.3%

The accounting rate of return method is not recommended for a variety of reasons, the most important of which is that it ignores the time value of money.

Capital Budgeting Practices

90 80 70 60 50 40 30 20 10 0
Payback IRR ARR NPV 75 86

Percent of managers who believe each technique is important.

71 75 69 68 64 60 53 46

Korea Japan U.S.

28

20

Learning Objective 9

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Estimating Cash Flows:

The Role of Activity-Based Costing ActivityABC systems generally improve the ability of an analyst to estimate the cash flows associated with a proposed project.

Justification of Investments in Advanced Manufacturing Systems

Hurdle rates are too high Time horizons are too short Bias towards incremental projects

Benefits difficult to quantify

Greater cash flow uncertainty

Learning Objective 10

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Inflation Effects
Nominal Dollars Real dollars

End of Chapter 16