Fiji National University ACC602: Strategic Management Accounting

College of Business, Hospitality & Tourism Semester 1, 2020

School of Accounting Tutorial 9 (for discussion in week 9)

Discussion:

1. Explain how capital budgeting can impact on a firm’s competitiveness

2. Discuss the broader issues concerning the company’s decision to proceed with a particular
investment/project.

Practice Problems:

Question1

Payback period; uneven cash flows: service firm

1. Net revenue/cash-flow in year 1 is ($350 000 – 50 000) = 300 000, which increases at the
rate of 10 per cent per annum.
As the expenditure is a deduction for tax purposes, the after-tax amount is the amount to
be recouped.
GrossAfter tax (A x (1-Tax rate))

–––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––

Year 1 initial expenditure $731 000 $489770

Year 1 net revenue 300 000 201000

 Cost Remaining to cover 288770

Year 2 net revenue (inc by 10%) 330 000 221100

Cost Remaining to cover 67 670

Year 3 net revenue (inc by 10%) 363 000 243210

Cost recovered..….Payback period is therefore 2 years + (67 670  243210) = 0.28

Thus payback period = 2.28 years

2. Net present value = $423693 @ discount rate of 10%

Incremental Increment l Incremental Aftertax Discount Present

Year revenue expense profit profit factor value

1 350 000 50 000 300 000 201000 .909 182709

2 385 000 55 000 330 000 221100 .826 182629

3 423 500 60 500 363 000 243210 .751 182651

4 465 850 66 550 399 300 267531 .683 182724

5 512 435 73 205 439 230 294284 .621 182750

Present Value of after-tax incremental profit $913463

Less: After-tax cash flow for initial expenditure [731 000  (1 – .33)] 489 770
Net present value $423693

Question 2.
Net present value; payback period; accounting rate of return: pancake parlour
1. (a) Mall restaurant:
Net after-tax cash inflows $ 50 000
 Annuity discount factor (r = .10, n = 20)   8.514
Present value of annual cash flows $425 700
Cash outflow at time 0  400 000
Net present value $ 25 700

(b) Downtown restaurant:

 2 $ 35 800
 Annuity discount factor (r = .10, n = 10)   6.145
Present value of annual cash flows $219 991
Cash outflow at time 0  200 000
Net present value $ 19 991

initial investment
2. (a). Payback period = annual after-tax cash inflow
(i) Mall restaurant:
$ 400000
Payback period = $ 50000 = 8 years
(ii) Downtown restaurant:
$200 000
Payback period = $ 35800 = 5.6 years (rounded)
average average incremental expenses

( incremental
revenue
)(
− ( including depreciation and
income taxes) )
(b) Accounting rate of return = initial investment
(i) Mall restaurant:
$ 50000
Accounting rate of return = $ 400000 = 12.5%
(ii) Downtown restaurant:
$ 35800
Accounting rate of return = $200 000 = 17.9%

(c) The owner’s criteria will lead to selection of the downtown restaurant.

(d) Neither the payback period nor the accounting rate of return method considers the time value of
money. Moreover, the payback method ignores cash flows beyond the payback period.
On the positive side, both methods can provide a simple means of screening a large number of
investment proposals.

THE END