THE UNIVERSITY OF NEW SOUTH WALES SCHOOL OF ACCOUNTING ACCT2522 Management Accounting 1 Session 1, 2013 Tutorial Week 12 – Capital Expenditure Decisions Overall Theme This week we discuss the nature and purpose of investment in committed resources, and explore the decision relevant costs and benefits of such decisions. Desired Learning Outcomes and Essential Reading CAPITAL EXPENDITURE DECISIONS After completing this topic, you should be able to: 1. Understand the nature and purpose of capital expenditure decisions 2. Describe a typical capital expenditure process 3. Apply and understand the benefits/limitations of various capital budgeting techniques 4. Understand the value of post‐implementation and post‐completion audits of capital expenditure projects 5. Understand the conflict between using DCF for project evaluations and accrual accounting data for evaluating manager performance Text book Materials: Langfield‐Smith et al. Chapter 21 pp.995‐1034 Self Study Questions (complete in your own time) It is important that you cover the material necessary to meet the learning objectives – unfortunately there is not enough time to include everything of importance in the tutorial. Some of the self‐study questions are quite long – while you may not have time to go through all of them in detail before the tutorial, please make sure you are comfortable with their level of detail and difficulty before the final exam. In addition, please note that the discount tables provided in your text only go to 3 decimal places (d.p) – in the exam the tables will have numbers to 4 d.p, and you should use the complete number given. Question 1: 21.11 Question 2: 21.16 Question 3: E21.31 Question 4: E21.33 (1 and 2B only) Question 5: P21.46 (don’t use Excel unless you want to). 1 000 Cost of lighting and signage 80. and apply its usual hurdle rate of 12% for capital expenditure projects. Likely benefits from having a better road include higher land values.Tutorial Questions (must be prepared prior to the tutorial) If you get stuck with the tutorial questions. to be fully depreciated for tax purposes over 5 years 10. One major drawback would be the increased likelihood of damage to the environment and native wildlife due to a larger tourist population and more movement throughout the area. The tax rate is 30% (in this fictitious example we’re going to assume the council pays tax!).000 Cost of new machine. Should the road be approved given current investment criteria? 2.000 Cost of tarring the new road 30.e. using the answers for guidance.45 (except for 1(e)) Question 2: Adapted final exam question – Solitucity Solitucity is a coastal town with a small population. What is the net present value of the proposed road project? (Please keep discount factors to 4 decimal places). Recently the local council has been considering making the town more accessible by improving the condition of the road. $ Cost of clearing land 90. i. Please note: assume that the one-off costs of developing the road (other than the cost of the new machine) are not depreciated. Other than by sea.000 Cost of sealing the road 20.000 Annual maintenance cost of road 12.. it will help if you attempt the self‐study questions first. greater potential for revenue from tourism related activities. and convenience for residents who may have to leave town for things such as supplies or medical treatment. The following financial information has been provided to the council in order to help with the decision.000 Annual operating costs of new machine 2.000 Required: Note: Present value tables have been provided (following after this question).000 Cost of levelling the ground 55. 1. While the road itself would last many years. Question 1: P21. the council has decided to analyse the costs over a 5 year time horizon.000 Annual revenue from road tolls 35. what other factors might you want to consider before making any recommendations? 2 . Discuss two (2) potential difficulties associated with the council using discounted cash flow analysis to make a decision about the road. the only way of accessing the town is via a rough dirt road off a main expressway. 0078 0.0221 0.0254 0.6302 0.3996 0.0109 0.8535 0.0004 0.0017 0.1372 0.5002 0.0006 0.8573 0.5132 0.1159 0.0926 0.1635 0.0638 0.6806 0.7885 0.8880 0.5835 0.2317 0.0024 0.2076 0.9615 0.6217 0.0012 20 21 0.1037 0.5744 0.2292 0.0023 18 19 0.0118 0.0393 0.0008 0.8900 0.0055 0.2919 0.0150 0.0839 0.3751 0.0135 0.0245 0.2267 0.0040 0.0330 0.0019 0.0938 0.0003 24 25 0.2618 0.3152 0.0004 23 24 0.2072 0.5859 0.0331 0.0024 0.0596 0.0102 0.0247 11 12 0.0222 0.1846 0.1703 0.2502 0.9238 0.0000 30 35 0.0676 0.5523 0.1597 0.0189 0.4039 0.5631 0.0779 0.8065 0.0560 0.4552 0.5000 0.0517 0.2875 0.0126 0.1073 0.6651 0.0030 0.0181 0.2603 4 5 0.0089 0.0068 0.5066 0.1799 0.0514 0.7182 0.0056 0.6342 0.0011 0.7050 0.00 Periods 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 24% 26% 28% 30% 32% 40% Periods 1 0.0443 0.0001 28 29 0.3901 0.0000 0.1401 0.4823 0.0930 0.0092 0.0039 0.1911 0.0115 0.7118 0.0429 0.3677 0.0935 0.0451 0.1085 0.1631 0.0057 0.0006 0.0217 0.9057 0.0610 0.0829 0.3075 0.2703 0.9804 0.7513 0.4104 0.7599 0.0738 0.0010 0.5521 0.0313 0.9423 0.0051 0.0089 0.4348 0.1619 0.5921 0.0949 7 8 0.6407 0.0003 0.1228 0.2394 0.0763 0.2218 0.4936 0.3971 0.1078 0.4523 0.1859 5 6 0.4230 0.2660 0.0151 0.5787 0.0010 0.3139 0.8043 0.0182 0.4746 0.0404 0.0116 0.6756 0.0017 19 20 0.4371 0.7576 0.0072 0.4556 0.0258 0.7903 0.2897 0.0006 0.0508 0.0025 0.0357 0.0725 0.4388 0.0525 0.2326 0.0002 25 26 0.2255 0.0003 0.6246 0.4173 0.3220 0.0262 0.2145 0.0992 0.0291 0.8772 0.8219 0.9259 0.7284 0.0600 0.2176 0.0346 10 11 0.0049 0.0008 0.0013 0.0022 0.3855 0.6864 0.0029 0.5134 0.3505 0.0001 0.3083 0.0472 0.0693 0.6104 0.0431 0.3468 0.0320 0.0021 0.0492 0.8621 0.0691 0.0157 0.8890 0.6355 0.0558 0.0001 0.0116 0.0835 0.0247 0.1079 0.1776 0.1122 0.7142 0.0659 0.5919 0.3501 0.6944 0.5976 0.0491 0.4529 0.0316 0.1890 0.0044 0.0135 0.7430 0.5194 0.1117 0.4999 0.5102 2 3 0.0016 0.0002 26 27 0.5158 0.6730 0.1978 0.0176 12 13 0.0002 0.3968 0.0135 0.0053 0.3538 0.8368 0.0001 0.3305 0.3607 0.1460 0.6006 0.0309 0.0098 0.0419 0.0033 17 18 0.3644 3 4 0.0802 0.4220 0.5553 0.1229 0.1486 0.1163 0.0155 0.0002 0.2499 0.0064 15 16 0.0013 0.1443 0.0469 0.0031 0.1987 0.7026 0.8203 0.4423 0.1351 0.3506 0.0006 22 23 0.2630 0.0573 0.0985 0.0822 0.0037 0.0378 0.3606 0.7432 0.2697 0.7473 0.2791 0.1388 0.0046 16 17 0.5775 0.7938 0.1685 0.2495 0.0662 0.5403 0.1352 0.9612 0.3411 0.7692 0.5584 0.0007 0.0016 0.0397 0.8333 0.0623 0.1300 0.3725 0.0087 0.0068 0.0826 0.7695 0.0356 0.Present Value Tables: PRESENT VALUE OF $1.8929 0.7143 1 2 0.6209 0.5674 0.7972 0.1983 0.0013 0.1615 0.1821 0.3349 0.0150 0.4970 0.1328 6 7 0.0994 0.1956 0.2567 0.0034 0.1252 0.0088 0.7937 0.0061 0.6750 0.0211 0.2470 0.2633 0.8706 0.7813 0.0018 0.0009 21 22 0.0051 0.7002 0.0376 0.0015 0.0020 0.1015 0.3294 0.0031 0.0193 0.0334 0.1594 0.0625 0.4761 0.4019 0.1574 0.2330 0.1346 0.4632 0.0195 0.0205 0.0002 0.0787 0.0460 0.3050 0.3936 0.6496 0.0312 0.2942 0.0728 0.2534 0.2046 0.0261 0.2074 0.0007 0.0196 0.2910 0.0496 0.0046 0.4768 0.0972 0.0039 0.2693 0.0001 27 28 0.0001 29 30 0.0071 0.5739 0.00 Present value of $1.1161 0.0248 0.3335 0.9246 0.0124 0.6299 0.1827 0.8264 0.0649 0.0588 0.1432 0.4665 0.8475 0.0105 0.0847 0.0042 0.2775 0.7730 0.5917 0.0160 0.0062 0.0097 0.6504 0.1954 0.3704 0.1084 0.0431 0.0107 0.4564 0.4688 0.1456 0.7307 0.1839 0.3118 0.0923 0.3503 0.0118 0.0630 0.1164 0.1252 0.5268 0.0026 0.4241 0.6468 0.1741 0.0757 0.0014 0.5245 0.0070 0.0005 0.9434 0.7350 0.0017 0.3149 0.0284 0.0541 0.3207 0.3714 0.0005 0.1301 0.8548 0.8396 0.9091 0.0678 8 9 0.1577 0.0255 0.0000 35 40 0.5645 0.1452 0.0382 0.0271 0.3186 0.7921 0.4057 0.1938 0.0708 0.0126 13 14 0.6095 0.1226 0.4289 0.2366 0.0082 0.6086 0.2083 0.6274 0.0329 0.0030 0.0156 0.0012 0.0000 0.3405 0.2751 0.0000 40 Do NOT detach this page from the examination booklet 3 .0197 0.0208 0.2198 0.0027 0.5339 0.2274 0.0484 9 10 0.7579 0.0090 14 15 0.1789 0.0053 0.0946 0.0168 0.0073 0.0004 0.0374 0.6598 0.1249 0.0943 0.0224 0.6830 0.0188 0.0001 0.0365 0.0010 0. 4941 4.0021 5.8861 1.5693 3.4235 5.0333 3.6901 1.2423 3.0027 6.9844 6.3965 17.1129 2.8444 16.1196 6.8957 6.1371 3.3484 9.1903 3.1772 5.7715 7.1755 7.7751 2.3282 4.4999 30 35 24.3667 6.8850 2.9091 0.3312 3.7932 4.4356 2.0205 2.6523 10.3296 13.0764 2.7982 2.0776 3.4996 26 27 20.8372 3.3719 8.9615 0.0013 3.8351 6.0386 3.3255 6.6052 1.3105 3.2233 3.8514 3.8684 1.4839 15 16 13.5000 35 40 27.3272 3.5889 3 4 3.0511 9.7454 2.6819 3.7746 4.0463 11.5824 5.3916 1.6603 5.6901 2.8083 3.7833 1.4527 5.8913 4.4951 5.1114 3.1428 3.1220 2.2470 12.3649 7.1925 3.4694 6.4559 12 13 11.9731 5.8431 6.1065 1.1248 2.2487 3.5320 2.8100 9.2922 14.4321 4.5026 3.3609 1.4383 11 12 10.5504 5.7069 16.8887 3.2410 2.3332 3.4043 2.8178 5.7641 10.1585 3.0609 2.2469 5.7757 3.7594 2.6847 3.8161 3.7261 3.1566 3.1339 11.7921 6.0416 10.1659 3.1182 5.9776 2.4992 24 25 19.8402 3.2438 7.5294 3.8065 0.6221 12.1109 7.3436 4.0916 4.0833 2.0218 6.6748 9.7327 6.8276 9.9124 3.3790 9 10 8.9906 2.6299 3.2832 3.5631 9.6685 5.1212 3.0404 2.4018 2.9856 8.8223 3.4331 3.6046 3.9247 2.4674 5.1240 2.9234 1.9259 0.7861 3.1062 10.3452 2.0286 4.9563 4.8424 5.6446 6.7648 11.2459 2.8115 3.7908 3.8621 0.8137 6.6351 2.5753 9.5640 3.7135 4.1210 15.1680 6 7 6.8929 0.9966 4.5458 3.0882 2.8772 0.4998 28 29 21.1390 6.1216 8.5235 15.9927 3.6229 4.2883 4.5288 8.3315 1.6487 7.5514 3.8681 2.4099 4.8832 7.4941 18 19 15.7122 8.2335 5.2682 3.1657 10.8450 3.4997 27 28 21.6014 5.5679 3.5278 1.6949 3.5435 3.7429 6.3553 4.1422 5.3230 3.7590 5.5708 3.8568 12.9789 4.5907 11.5656 3.1103 3.9813 1.6546 9.6467 1.8696 4.5887 2.4675 5.8122 4.7692 0.5656 1.2098 5.3066 7.1520 5.8435 4.5777 11.0081 4.8237 6.3202 2.9697 4.9288 5.3851 8.5482 4.6059 3.5098 4.0310 3.2813 16.4985 22 23 18.9246 9.9828 13.9986 18.3297 3.2064 4.4999 29 30 22.1272 2.9094 4.7143 1 2 1.8017 6.6231 5.7705 3.3306 8 9 8.7843 6.8514 7.1300 3.2153 5.00 Present value of annuity of $1.8312 3.1050 6.4918 17 18 14.4775 14 15 12.7928 15.2372 7.9804 0.7296 4.8021 2.0552 7.9920 12.1158 2.4869 2.4212 3.6389 4.1184 9.9377 5.3321 3.3527 4.8839 2.7834 10.9416 1.0971 5.6785 13.3030 4.3037 3.7663 1.2950 8.0957 1.8342 3.8333 0.4804 4.1250 2.4648 3.5687 3.4720 6.5361 6.0032 10.7605 7.5771 2.8181 8.9636 4.2407 3.4062 11.4136 10 11 9.5619 3.8334 1.2014 7.4834 3.1581 9.7860 2.5595 7.5638 4.7509 3.3555 19.2948 3.4392 3.3351 3.1609 7.2497 6.6442 8.9837 13.6646 14.3162 4.8424 3.0971 2.3696 8.8493 11.9095 4.7576 0.1542 3.8332 4.1197 2.3317 3.9847 7.1584 9.2421 4.2919 12.2628 7 8 7.9245 4.6755 4.3305 3.5620 6.3423 4.6730 2.4518 4.6282 6.3711 8.4885 16 17 14.9616 3.5327 3.3514 13.9352 9.8458 3.1622 7.3286 3.5592 3.4699 9.5386 3.4976 3.9038 7.6036 8.9915 4.1842 3.2442 7.4989 23 24 18.7937 0.3121 3.0113 5.9370 2.0726 5.1034 6.7791 8.7487 5.8273 3.9137 2.4979 21 22 17.6061 6.3216 2.5386 4.9464 4.1473 2.1662 2.4982 11.00 Periods 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 24% 26% 28% 30% 1 0.6775 2.1227 2.2161 4.8414 3.1364 5.7985 3.8367 3.1971 4.7184 6.2743 3.1090 2.9830 6.1237 2.9139 15.4651 3.1233 2.3034 10.6870 5.4272 3.1180 2.2223 4.1242 2.4269 8.9747 4.5504 10.0700 6.9426 6.5655 3.3255 3.7101 6.8109 6.0190 2.1944 5.5342 2.Present Value Tables: PRESENT VALUE OF ANNUITY $1.9173 4.2651 5.8729 6.6106 3.5712 3.8475 0.1474 3.9740 6.6502 5.9676 4.4970 20 21 17.5016 4.5000 40 Do NOT detach this page from the examination booklet 4 32% 40% Periods .8161 1.6427 2.1210 2.3198 3.1743 2.7813 0.6065 4.2689 3.0770 7.0591 3.2007 8.2124 3.1624 4.8077 3.8387 3.3729 5.1699 3.4919 4.3837 4.3349 4.4994 25 26 20.5669 3.8527 7.0292 11.1059 8.4587 3.1656 5.9434 0.0021 5.3838 7.0168 8.6631 13.5168 4.0373 2.1601 3.2245 2 3 2.4568 1.1039 2.5177 3.2920 13.8869 7.0352 5 6 5.9371 4.2732 4.9304 2.4235 1.7868 8.1511 3.3254 3.5558 3.9476 4.5903 11.0967 3.3601 6.4958 19 20 16.6580 14.9061 6.1446 5.4509 4.0442 5.3330 3.2578 9.7355 1.4353 6.0133 2.5755 5.3658 6.4511 12.3868 3.6593 10.4773 9.9826 8.0799 3.0915 2.3271 3.8775 5.8684 4.7466 5.4669 4.0112 14.0758 2.3158 3.2105 10.6560 4.6555 3.9607 6.3657 3.5136 7.6048 3.0216 7.9352 6.1644 3.4685 13 14 12.8492 4 5 4. However.14 2 Net present value analysis: Present value of after‐tax savings: $50081.99 5 . Finally. an investigation may be made to consider the reasons.16 In a post‐completion audit of an investment project.33) Proceeds of sale Total after-tax cash flow $1 881 27 765 $29 646 EXERCISE 21. For projects that do not generate accounting profits in the early years of a project. Then the project’s actual NPV or IRR is computed.31 1 Carrying amount = = acquisition cost – accumulated depreciation $150 000 – $116 535 = $33 465 2 Loss on sale = = carry amount – proceeds of sale $33 465 – $27 765 = $5 700 3 Reduced cash outflows from the tax deduction from the loss of sale ($5700 0.14*) = 3.868 Initial investment Net present value Discount rate 10% $243794.tax cash flow = = 186300/ (40500+9581.29 x 0.33 (part 1 and 2B only) 1 Payback period initial investment annual after .11 This statement highlights one of the difficulties of measuring managerial performance based on a business unit’s ROI.72 years *9581. the management accountant gathers information about the actual cash flows generated by the project and compares these with the cash flows projected in the capital budget proposal. 21.29/year. Depreciation is 186300/7years = 26614. but evaluating new projects based on NPV or IRR over the life of the project. Was the estimated life too short? Were cash flows too optimistic? Were some important cash flows omitted? Not all businesses actually undertake post‐completion audits of their capital expenditure decisions.Solutions to Self Study Questions 21. One reason is that it is difficult to isolate the actual cash flows that relate to specific projects. in situations where there are massive cost overruns or other negative outcomes then the audit can provide valuable learning for management. If the project has not met expectations. EXERCISE 21. Dealing with the conflict may require a de‐emphasis on the use of accounting‐based incentive systems. the projections made for the project are compared with the actual results. there is a disincentive for managers to campaign in support of what otherwise may be a highly desirable project. Tax effect = 26614.14 x 4.14 is the amount saved in tax due to depreciation. Another reason is that there may be little incentive for management to review the quality of the initial analysis and subsequent implementation of the project.99 (186 300) $57494.36 = 9581. 58 years 4 It is difficult to quantify many aspects of a strategic investment.2700 2 700 $(36 992) * While it is not specified in the question. In particular.000 Present value of cash flows $(120 000) (80 000) 8 000 1. the company will need to consider if there are any competitive or marketing issues that may also need to be taken into account. some students might also want to recognise the increase in working capital at the end of the life of the CIM.216 39 642 10 000 0. 6 . which suggests that Italiano should not go ahead with the new investment.58 years* * 16 800/29 200 = 0. The analysis indicates that the new investment yields a negative NPV.58 years.a.000 8 000 21 600 5. 3 Calculating the after-tax payback period: 192000/29200 = 6. it is difficult to assess the impact of not going ahead with the investment. Proceeds of sale (c) Income tax impact Year 0 0 Amount $(120 000) (80 000) 0 8 000 1–10 36 000 (1 – 0.PROBLEM 21.46 1&2 (a) Equipment purchase Implementation costs Depreciation over 10 years: Cost $120 000 Implementation 80 000 Salvage value (10 000) Total $190 000 Depreciation is $19 000 p.216 112 666 7 600 5. However.40) 1–10 19 000 0.40 10 10 000 Working capital reduction* Annual cash flows: Rework savings 28 000 Rent reduction 8 000 Increased revenue 16 000 CIM maintenance (16 000) Savings per annum $36 000 (b) Net present value (d) (e) (f) After-tax cash flow $(120 000) (80 000) Discount factor (14%) 1.000 1. These factors may be difficult to capture in financial terms and may be used to qualify the financial analysis. or the impact of competitors’ future actions. Or you can do it the long way: Year 0 1 2 3 4 5 6 7 8 After-tax cash flow $(192 000) 29 200 29 200 29 200 29 200 29 200 29 200 29 200 $30 800 Cumulative total $(192 000) (162 800) (133 600) (104 400) (75 200) (46 000) (16 800) 12 400 $41 600 The payback period is 6.