Fiji National University ACC602: Strategic Management Accounting

College of Business, Hospitality & Tourism Semester 1, 2020

School of Accounting Tutorial 10 (for discussion in week 11)

Discussion:

1. How do capital expenditure decisions differ from tactical decisions? Give examples to
explain.
2. Discuss the relative importance of quantitative and qualitative information in capital
expenditure decisions.

Practice Problems:

Question 3.

After-tax cash flows; various methods of investment analysis: manufacturer

1
Before-tax After-tax After-tax
Cash flows Timing amount Tax effect cash flow net profit
Investment Year 0 $(108000) – $(108 000) –

Cash savings Years 1 – 5 $ 42 000 $(16800) $ 25 200 $25 200

 Depreciation effect Years 1 – 5 (21 600) 8 640 8 640 (12 960)
Totals $ 33 840 $ 12 240

investment
(a) Payback period = after - tax cash flow = 108 000/33840 = 3.19 years
annual after-tax net profit
(b) Accounting rate of return = investment ( initial or average)
Initial investment Average investment

12240/108000 = 11.3% 12240/54000 = 22.7%

(c) Net present value = (after-tax cash flows × annuity discount factor)
– initial investment
= ($33840  3.6048) Table 4 = PV = 121986.43

= NPV = 121986 – 108 000 = 13 986(rounded)NPV

present value of after - tax cash flows

(d) Profitability index (PI) = initial investment
= PV / initial Inv. = 121986.43/108 000 = 1.13

(e) The internal rate of return is approximately 17% above but less than 18% per cent.

2 The payback method is inferior because it ignores the time value of money and cash proceeds beyond the
payback period. However, it is useful in that it tells management how long it will take to recoup its original
investment.
The accounting rate of return method is inferior because it uses accounting profit and investment instead of
cash flows. In addition, it also ignores the time value of money.
The net present (NPV), profitability index (PI), and internal rate of return (IRR) methods are similar. These
three discounted cash flow methods consider the time value of money and the timing of cash flows.
Consequently, they are all superior to the first two methods.
Question 5.

Ranking investment proposals; after-tax profits; NPV versus profitability index: service
firm

(a) Neighbouring town restaurant:

Net after-tax cash inflows $75 000

 Annuity discount factor (r = .10, n = 20)  8.514
Present value of annual cash flows 638 550
Cash outflow at time 0 (600 000)
Net present value of after-tax cash flows $38 550

(b) Mobile restaurant:

Net after-tax cash inflows $53 700
 Annuity discount factor (r = .10, n = 10)  6.145
Present value of annual cash flows 329 986
Cash outflow at time 0 (300 000)
Net present value of after-tax cash flows $29 986
present value of cash flows, exclusive of initial investment
2 Profitability index = initial investment
(a) Neighbouring town restaurant:
$638 550
Profitability index = $600 000 = 1.06 (rounded)
(b) Mobile restaurant:
$329 986
Profitability index = $300 000 = 1.10 (rounded)
3 Building a restaurant in the neighbouring town ranks first on NPV, but the mobile
restaurant ranks first on the profitability index.
4 The two projects have different lives, which makes it particularly difficult to rank them. It
is not clear what will happen in years 11 through 20 if the mobile restaurant project is
chosen.

THE END