The document discusses capital budgeting techniques used to evaluate long-term investment projects. It describes discounted and non-discounted methods, including payback period, accounting rate of return, net present value, internal rate of return, and profitability index. Examples are provided to demonstrate how to calculate and apply each method. The payback period, accounting rate of return, and internal rate of return techniques do not incorporate the time value of money, while net present value and profitability index are discounted cash flow methods.

1. CAPITAL BUDGETING
DECISIONS
CAPITAL BUDGETING
TECHNIQUES
ACC 041 Managerial Accounting

2. PRESENTERS
ANGELICA
MADEL CAMBA
JERRY RIVERA

3. CAPITAL BUDGETING
Used to describe how managers plan significant investments in projects
that have long term implications.
TYPICAL CAPITAL BUDGETING DECISIONS
1. Cost Reduction Decisions
2. Expansion Decisions
3. Equipment Selection Decisions
4. Lease or Buy Decisions
5. Equipment Replacement Decisions

4. . DISCOUNTED NON-DISCOUNTED
CAPITAL BUDGETING TECHNIQUES

5. NON-DISCOUNTED/
TRADITIONAL
METHOD
Payback period method
Accounting rate of return method
(ARR)

6. Payback Method
● This method focuses on the payback period.
● The payback period is the length of time that it
takes for a project to recoup its initial cost out of
the cash receipts that it generates.
● This period is sometimes referred to as” the time
that it takes for an investment to pay for itself.”
The basic premise of the payback method is that
the more quickly the cost of an investment can
be recovered, the more desirable is the
investment. The payback period is expressed in
years.
● When the net annual cash inflow is the same
every year, the following formula can be used to
calculate the payback period.

7. Payback Method
York company needs a new milling machine. The company is considering two machines. Machine A and machine B.
Machine A costs $15,000 and will reduce operating cost by $5,000 per year. Machine B costs only $12,000 but will
also reduce operating costs by $5,000 per year.
Required:
● Calculate payback period.
● Which machine should be purchased according to payback method?
CALCULATION:
Machine A payback period = $15,000 / $5,000 = 3.0 years
Machine B payback period = $12,000 / $5,000 = 2.4 years
DECISION:
According to payback calculations, York company should purchase machine B, since it has a shorter payback period
than machine A.

8. Payback Method Example 2
● Goodtime Fun Centers, Inc., operates many outlets in the eastern states. Some of the vending machines in
one of its outlets provide very little revenue, so the company is considering removing the machines and
installing equipment to dispense soft ice cream. The equipment would cost $80,000 and have an eight-year
useful life. Incremental annual revenues and costs associated with the sale of ice cream would be as
follows:
Sales
- $150,000
Variable Expenses - 90,000
Contribution Margin - $ 60,000
Fixed Expenses
Salaries -
27,000
Maintenance -
3,000
Depreciation -
10,000
Total Fixed Expenses - 40,000
Other Info:
The vending machines can be sold for P5,000 scrap value. The
company will not purchase equipment unless it has a payback period
of three years or less. Does the ice cream dispenser pass this hurdle?
Question:
1. Compute the investment required..
2. Compute the payback period.
3. Accept or Reject?

9. Payback Method Example 2
Step 1: Compute the net annual cash
inflow
Since the net annual cash inflow is not
given, it must be computed before the
payback period can be determined:
Net operating
income
$20,000
Add: Noncash
deduction for
depreciation
10,000
Net annual cash
inflow
$30,000
Step 2: Compute the payback period
Using the net annual cash inflow figure from above, the
payback period can be determined as follows:
Cost of the new
equipment
$80,000
Less salvage value of old
equipment
5,000
Investment required $75,000
Payback period = Investment required / Net annual cash inflow
= $75,000 / $30,000
= 2.5 years
STEP 3.
Since the proposed equipment has a payback
period of less than three years, the company’s
payback requirement has been met.

10. Accounting Rate of
Return
● Another capital budgeting technique that does not involve discounted cash flows.
● The method is also known as the SIMPLE rate of return, the unadjusted rate of return, and the
financial statement method.
● the simple rate of return method does not focus on cash flows. Rather, it focuses on accounting net
operating income. The approach is to estimate the revenue that will be generated by a proposed
investment and then to deduct from these revenues all of the projected expenses associated with the
project.
[Simple rate of return = (Incremental revenues − Incremental expenses, including depreciation)
= Annual Incremental net operating income) / Initial investment*]
*The investment should be reduced by any salvage from the sale of old equipment.

11. Accounting Rate of Return Method
Brigham Tea, Inc., is a processor of low acid tea. The company is contemplating purchasing equipment for an
additional processing line. The additional processing line would increase revenues by $90,000 per year. Incremental
cash operating expense would be $40,000 per year. The equipment would cost $180,000 and have a nine year life.
No salvage value is projected.
Annual incremental revenue
$ 90,000
Annual incremental cash operating expenses $40,000
Annual Depreciation ($180,000/9years) 20,000
Annual Incremental Expenses
60,000
Annual Incremental net operating income $
30,000
Solution
ARR= Annual Incremental net operating income) / Initial
investment
= $ 30,000/$180,000
=16.7%

12. DISCOUNTED
METHOD

13. Net Present Value
Method
● The Difference between a project’s cash inflow and cash outflows which determines
whether or not the project is an acceptable investment.
● Time value of money and all cash inflows and outflows are converted into present
value.

14. Net Present Value Method

15. EXAMPLE . . . . . . . . . . . . . . .
Harper company is contemplating the purchase of a machine capable of
performing certain operations that are now performed manually. The
machine will cost $5,000, and it will last for five years. At the end of
five-years period the machine will have a zero scrap value. Use of the
machine will reduce labor costs by $1,800 per year. Harper company
requires a minimum pretax return of 20% on all investment projects.
Should the machine be purchased?

16. SOLUTION . . . . . . . . . . . . . . .
Initial Cost $5,000
project(year) 5
Annual Cost
Savings
$1,800
Salvage
value
0
Required
rate of return
20%
Item Years amount of
cash flows
20% Present value
of cash flows
Annual Cost
savings
1-5 $1,800 ***2.991 $5,384
Initial Investment Now -5,000 1,000 -5,000
Net Present Value $384
Harper company should purchase the
new machine. The present value of the
cost savings is $5,384, as compared to
a present value of only $5,000 for the
required investment (cost of the
machine). Deducting the present value
of the required investment from the
present value of the cost savings a net
value of $384. Whenever the net
present value is zero or greater, as in
our example, an investment project is
acceptable. Whenever the net present
value is negative an investment project
is not acceptable.
Decision:

17. Internal Rate of Return
● is the rate of return promised by an investment project over its useful life.
● It is sometime referred to simply as yield on project.
● The internal rate of return is computed by finding the discount rate that equates the present value of a project’s cash
out flow with the present value of its cash inflow
● the internal rate of return is that discount rate that will cause the net present value of a project to be equal to zero.
[Factor of internal rate of return
= Investment required / Net annual cash inflow]

18. Internal Rate of Return Method
A school is considering the purchase
of a large tractor-pulled lawn mower.
At present, the lawn is moved using a
small hand pushed gas mower. The
large tractor-pulled mower will cost $
16,950 and will have a useful life of
10 years. It will have only a negligible
scrap value, which can be ignored.
The tractor-pulled mower will do the
job much more quickly than the old
mower and would result in a labor
savings of $ 3,000 per year.
To compute the internal rate of return
promised by the new mower, we must
find the discount rate that will cause
the new present value of the project
to be zero. How do we do this?
Initial cost
Life of the project (years)
Annual cost savings
Salvage value
$16,500
10
$3,000
0
Item Years
Amount of cash
flow
12%
factor
Present value
of cash flows
Annual cost savings
Initial investmentNet
present value
1―10
Now
$3,000
(16,950)
5.650*
1,000
$16,950
(16950)
———
0
Investment required / Net annual
cash inflow
= $16,950 / $3,000
= 5.650

19. Profitability Index
● alternatively referred to as value investment ratio (VIR) or profit
investment ratio (PIR), describes an index that represents the
relationship between the costs and benefits of a proposed project.
● It is calculated as the ratio between the present value of future expected
cash flows and the initial amount invested in the project.
● A higher PI means that a project will be considered more attractive.
● The profitability index (PI) is a measure of a project's or investment's
attractiveness.
● The PI is calculated by dividing the present value of future expected cash
flows by the initial investment amount in the project.
● A PI greater than 1.0 is deemed as a good investment, with higher values
corresponding to more attractive projects.
● Under capital constraints and mutually exclusive projects, only those with
the highest PIs should be undertake