Managerial Accounting

CAPITAL BUDGETING &
TRANSFER PRICING
A Review Presentation
CAPITAL
Definition & Importance
Criteria/Methods
BUDGETING Problem-Solving
Techniques & Shortcuts
DefinitionOInvest
& Importance
Long-term Asset Invested Funds Future Benefits

CRITERIA/Methods
OInvest
Non-Discounting Discounting
Payback Period Discounted Payback Period

Accounting Rate of Return Net Present Value
Profitability Index
Internal Rate of Return
Payback
OInvest Period
Ilang taon bago mabalik

puhunan ko?
LOTS Formula
L = Lower year
O–T
L+
O = Outlay
S
T = Total inflows until lower year
S = Subsequent inflow
Payback
OInvest Period
Ilang taon bago mabalik

puhunan ko?
Year
Steps
1. Get total cumulative inflows per year ≤ outlay.
2. Identify LOTS.
a. LOWER year
b. OUTLAY
c. TOTAL inflows until lower year
d. SUBSEQUENT inflow after lower year
3. Use formula.
Payback
OInvest Period
Varying annual inflows

A firm would like to invest Year Cash Flow
₱250,000 on a long-term 0 (250,000)
asset.
1 40,000
The expected cash benefits 2 60,000
are given on the right. 3 70,000
4 56,000
What is the payback period?
5 64,000
Payback
OInvest Period
StepOInvest
1
A firm would like to invest Year Cash Flow Cumulative
₱250,000 on a long-term 0 (250,000) (250,000)
asset.
1 40,000 40,000
The expected cash benefits 2 60,000 100,000
are given on the right. 3 70,000 170,000
4 56,000 226,000
What is the payback period?
5 64,000 290,000
Payback
OInvest Period
StepOInvest
2
Year Cash Flow Cumulative
Outlay 0 (250,000) (250,000)
1 40,000 40,000
Total inflows
until lower year 2 60,000 100,000
3 70,000 170,000
Lower year 4 56,000 226,000
Subsequent inflow 5 64,000 -

Payback
OInvest Period
StepOInvest
3
LOTS Formula
Year Cash Flow Cumulative
O–T 0 (250,000) (250,000)
L+
S
1 40,000 40,000
2 60,000 100,000
3 70,000 170,000
4 56,000 226,000
250k – 226k
4+ 5 64,000 –
64k
PP = 4.375 years
Bailout
OInvestPeriod

A firm would like to invest Year Cash Flow Salvage Value
₱250,000 on a long-term asset.
0 (250,000) (250,000)
The expected cash benefits are 1 40,000 100,000

given on the right. The salvage
2 60,000 80,000
value is ₱100,000 and
decreases by ₱20,000 annually. 3 70,000 60,000
4 56,000 40,000
What is the bailout period?
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
1
Year Cash Flow Salvage Value Cumulative
0 (250,000) (250,000) (250,000)
1 40,000 100,000
2 60,000 80,000
3 70,000 60,000
4 56,000 40,000
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
1
0 (250,000) (250,000) (250,000)
1 40,000 100,000 140,000
2 60,000 80,000
3 70,000 60,000
4 56,000 40,000
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
1
0 (250,000) (250,000) (250,000)
1 40,000 100,000 140,000
2 60,000 80,000 180,000
3 70,000 60,000
4 56,000 40,000
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
1
0 (250,000) (250,000) (250,000)
1 40,000 100,000 140,000
2 60,000 80,000 180,000
3 70,000 60,000 230,000
4 56,000 40,000
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
1
0 (250,000) (250,000) (250,000)
1 40,000 100,000 140,000
2 60,000 80,000 180,000
3 70,000 60,000 230,000
4 56,000 40,000 266,000
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
2
0 (250,000) (250,000) (250,000) Outlay
1 40,000 100,000 140,000
2 60,000 80,000 180,000
Lower year 3 70,000 60,000 230,000 Total inflows

until lower year
Subsequent 4 56,000 40,000 266,000
inflow
5 64,000 20,000
Bailout
OInvestPeriod
StepOInvest
3
0 (250,000) (250,000) (250,000) Outlay
1 40,000 100,000 140,000
2 60,000 80,000 180,000
Lower year 3 70,000 60,000 230,000 Total inflows

until lower year
Subsequent 4 56,000 40,000 266,000
inflow
5 64,000 20,000
250k – 230k
3+ = 3.357
56k
DISCOUNTEDOInvest
Payback Period
Just add
Year one step!
Steps
1. Get the present value for each year.
2. Get total cumulative inflows per year ≤ outlay.
3. Identify LOTS.
a. LOWER year
b. OUTLAY
c. TOTAL inflows until lower year
d. SUBSEQUENT inflow after lower year
4. Use formula.
DISCOUNTEDOInvest
Payback Period

₱250,000 on a long-term 0 (250,000)
asset.
1 40,000
The expected cash benefits 2 60,000
are given on the right. 3 70,000
4 56,000
The firm's cost of capital is
5 64,000
4%. What is the discounted
payback period?
DISCOUNTEDOInvest
Payback Period
StepOInvest
1
Discounted annual inflows
A firm would like to invest Year Cash Flow PV
₱250,000 on a long-term 0 (250,000) (250,000)
asset.
1 40,000 38,462
4 56,000 47,689
5 64,000 52,603
payback period?
DISCOUNTEDOInvest
Payback Period
StepOInvest
2
A firm would like to invest Year PV Cumulative
₱250,000 on a long-term 0 (250,000) (250,000)
asset.
1 38,462 38,462
4 47,689 203,854
5 52,603 –
payback period?
DISCOUNTEDOInvest
Payback Period
StepOInvest
3
Year PV Cumulative
Outlay 0 (250,000) (250,000)
1 38,462 38,462
Total inflows
until lower year 2 55,473 93,935
3 62,230 156,165
Lower year 4 47,689 203,854
Subsequent inflow 5 52,603 –

DISCOUNTEDOInvest
Payback Period
StepOInvest
4
LOTS Formula Discounted annual inflows
Year PV Cumulative
O–T 0 (250,000) (250,000)
L+
S
1 38,462 38,462
2 55,473 93,935
3 62,230 156,165
4 47,869 204,033
250,000 –
204,033
4+ 5 52,603 –
52,603
PP = 4.874 years
Payback
OInvest Period
Constant annual inflows Varying annual inflows 4% Discounted annual inflows
Year Cash Flow Year Cash Flow Year Cash Flow
0 (250,000) 0 (250,000) 0 (250,000)
1 58,000 1 40,000 1 38,462
2 58,000 2 60,000 2 55,473
3 58,000 3 70,000 3 62,230
4 58,000 4 56,000 4 47,869
5 58,000 5 64,000 5 52,603
PP = 4.310 years PP = 4.375 years PP = 4.874 years

Accounting Rate of Return
OInvest
Sa puhunan ko, ilang % ang

magiging profit ko?
Initial Average
investment investment
APAT APAT APAT = Average profit after tax
AFAM AFAM + TV AFAM = Average fixed assets maintained

2 TV = Terminal value
OInvest
How good will this investment

be based on accounting profit?
Year
Steps
1. Calculate:
a. Average profit after tax
b. Average fixed assets maintained
2. Use formula.
OInvest
After-tax profit & fixed assets

The annual profit after tax Year APAT AFAM
and fixed assets maintained 1 20,000 90,000
from a specific investment is
2 22,000 80,000
shown on the right.
3 24,000 70,000
What is the investment's 4 26,000 60,000

average rate of return? 5 28,000 50,000
OInvest
StepOInvest
1
After-tax profit & fixed assets
The annual profit after tax Year APAT AFAM
and fixed assets maintained 1 20,000 90,000
from a specific investment is
2 22,000 80,000
shown on the right.
3 24,000 70,000
What is the investment's 4 26,000 60,000

simple rate of return? 5 28,000 50,000
Average 24,000 70,000

OInvest
StepOInvest
2
APAT–AFAM Formula After-tax profit & fixed assets
Year APAT AFAM
APAT 1 20,000 90,000
AFAM 2 22,000 80,000
3 24,000 70,000
4 26,000 60,000
Based o
n
INITIAL i
24,000 nvestm 5 28,000 50,000
ent
70,000 Average 24,000 70,000
ARR = 34.29%
OInvest
StepOInvest
2
APAT–AFAM Formula After-tax profit & fixed assets
Year APAT AFAM
APAT 1 20,000 90,000
AFAM 2 22,000 80,000
3 24,000 70,000
4 26,000 60,000
Based o
n
24,000 AVERAG
E inves
5 28,000 50,000
70,000 + 0 tment
Average 24,000 70,000
2
ARR = 68.58%
NET PRESENT
OInvest VALUE
Magkano 'yung kita ko
pagkatapos ng investment?
NINO Formula (RATS–OWO)
Net Inflows (PV) – Inflows Outflows

Net Outflows (PV) Return of working capital Outlay
Annual after-tax inflows Working capital
Tax benefit from Overhaul
depreciation
Salvage value
NET PRESENT
OInvest VALUE
PV of 1 PV of OA
(1 + i)ᵗ 1 – (1 + i)ᵗ
i
nly for
Used o STANT
i = interest rate
t = number of years CON WS
L IN FLO
ANNU A
NET PRESENT
OInvest VALUE
Year
Steps
1. For each figure:
a. Which is it—inflow or outflow?
b. When did it occur?
c. What is the PV factor?
2. Calculate and sum up present values.
3. Use formula.
NET PRESENT
OInvest VALUE

A firm would like to invest in hi-tech equipment
Year Cash Flow
requiring extensive training and testing.
0 (550,000)
It will be sold at the start of the 6th year for 1 (500,000)

₱50,000 when its book value is zeroed out.
2 450,000
Internal hurdle rate is 14%, and effective tax 3 350,000

rate is 40%.
4 350,000
Its projected after-tax cash flows per year are 5 350,000
on the right. What is the NPV?

NET PRESENT
OInvest VALUE

A firm would like to invest in hi-tech equipment
Year Cash Flow
requiring extensive training and testing.
0 (550,000)
It will be sold at the start of the 6th year for 1 (500,000)

₱50,000 when its book value is zeroed out.
2 450,000
Internal hurdle rate is 14%, and effective tax 3 350,000

rate is 40%.
4 350,000
Its projected after-tax cash flows per year are 5 350,000
on the right. What is the NPV? 5 30,000

NET PRESENT
OInvest VALUE
StepOInvest
1
Year Cash Flow +/– When PVF
0 (550,000)
1 (500,000)
2 450,000
3 350,000
4 350,000
5 350,000
5 30,000
NET PRESENT
OInvest VALUE
StepOInvest
1
0 (550,000) –
1 (500,000) –
2 450,000 +
3 350,000 +
4 350,000 +
5 350,000 +
5 30,000 +
NET PRESENT
OInvest VALUE
StepOInvest
1
0 (550,000) – 0
1 (500,000) – 1
2 450,000 + 2
3 350,000 + 3
4 350,000 + 4
5 350,000 + 5
5 30,000 + 5
NET PRESENT
OInvest VALUE
StepOInvest
1
0 (550,000) – 0 1
1 (500,000) – 1 0.877
2 450,000 + 2 0.769
3 350,000 + 3 0.675
4 350,000 + 4 0.592
5 350,000 + 5 0.519
5 30,000 + 5 0.519
NET PRESENT
OInvest VALUE
StepOInvest
2
+/– Cash Flow PVF PV Sum
– (550,000) 1
– (500,000) 0.877
+ 450,000 0.769
+ 350,000 0.675
+ 350,000 0.592
+ 350,000 0.519
+ 30,000 0.519
NET PRESENT
OInvest VALUE
StepOInvest
2
– (550,000) 1 (550,000)
– (500,000) 0.877 (438,500)
+ 450,000 0.769 346,050
+ 350,000 0.675 236,250
+ 350,000 0.592 207,200
+ 350,000 0.519 181,650
+ 30,000 0.519 15,570

NET PRESENT
OInvest VALUE
StepOInvest
2
– (550,000) 1 (550,000)
– (500,000) 0.877 (438,500) (988,500)
+ 450,000 0.769 346,050
+ 350,000 0.675 236,250
+ 350,000 0.592 207,200
+ 350,000 0.519 181,650
+ 30,000 0.519 15,570 986,720

NET PRESENT
OInvest VALUE
StepOInvest
3
– (550,000) 1 (550,000)
– (500,000) 0.877 (438,500) (988,500)
+ 450,000 0.769 346,050
+ 350,000 0.675 236,250
+ 350,000 0.592 207,200
+ 350,000 0.519 181,650
+ 30,000 0.519 15,570 986,720
NPV (1,780)
Profitability
OInvest Index
Ilang % 'yung kita ko
NINO (÷) Formula
Net Inflows (PV) Inflows Outflows

Net Outflows (PV) Return of working capital Outlay
Annual after-tax inflows Working capital
Tax benefit from Overhaul
depreciation
Salvage value
Profitability
OInvest Index
Ilang % 'yung kita ko
Year
Steps
1. For each figure:
a. Which is it—inflow or outflow?
b. When did it occur?
c. What is the PV factor?
2. Calculate and sum up present values.
3. Use formula.
Profitability
OInvest Index
Investment Projects
The firm is selecting from 3
Criteria A B C
possible projects shown on
the right. NPV 23,370 29,827 27,333
IRR 18.7% 17.6% 17.2%

Which is the best investment
Initial cost 200,000 235,000 190,000
in terms of profitability?
Profitability
OInvest Index
Investment Projects
Criteria A B C
the right. NPV 23,370 29,827 27,333
IRR 18.7% 17.6% 17.2%

Initial cost 200,000 235,000 190,000
Net inflows 223,370 264,287 217,333
Profitability
OInvest Index
StepOInvest
3
Investment Projects
Criteria A B C
the right. NPV 23,370 29,827 27,333
IRR 18.7% 17.6% 17.2%

Initial cost 200,000 235,000 190,000
PI 1.1169 1.1269 1.1439
Profitability
OInvest Index
StepOInvest
3
Investment Projects
Criteria A B C
the right. NPV 23,370 29,827 27,333
IRR 18.7% 17.6% 17.2%

Initial cost 200,000 235,000 190,000
PI 1.1169 1.1269 1.1439
Internal Rate
OInvest of Return
Anong discount rate gagamitin
para maging 0 NPV?
NONIY Formula
Notes
Net Outflows Present values are not used.
Net Inflows
The formula will yield the PV factor
Years which you will use to find the IRR.
Internal Rate
OInvest of Return
Anong discount rate gagamitin
para maging 0 NPV?
Year
Steps Lazy Steps

1. Use formula. 1. For each IRR in the choices:
2. Trace PV factor to table. a. If constant inflows, get PVF of OA.
3. Use trial and error or b. If uneven inflows, get PV of 1 for
interpolation. each year.
2. Calculate total NPV for each choice.
3. Pick the choice that would make NPV
closest to 0.
Internal Rate
OInvest of Return
Even annual inflows

₱100,000 on a long-term 1 50,000
asset. The expected cash
2 50,000
benefits are given on the
right. 3 50,000
What is the IRR?

A. 23% – 2.0113 C. 21%
B. 22% D. 20%
Internal Rate
OInvest of Return
StepOInvest
1
Even annual inflows
₱100,000 on a long-term 1 50,000
2 50,000
right. 3 50,000
What is the IRR?

A. 23% – 2.0113 C. 21%
B. 22% D. 20%
Internal Rate
OInvest of Return
StepOInvest
1
Even annual inflows
₱100,000 on a long-term 1 50,000
2 50,000
right. 3 50,000
What is the IRR?

A. 23% – 2.0113 C. 21%
B. 22% – 2.0422 D. 20%
Internal Rate
OInvest of Return
StepOInvest
2
Even annual inflows
₱100,000 on a long-term 1 50,000
2 50,000
right. 3 50,000
What is the IRR? Choice PV of inflows NPV

A 100,565 565
A. 23% – 2.0113 C. 21%
B. 22% – 2.0422 D. 20% B 102,110 2,110
Internal Rate
OInvest of Return
StepOInvest
3
Even annual inflows
₱100,000 on a long-term 1 50,000
2 50,000
right. 3 50,000
What is the IRR? Choice PV of inflows NPV

A 100,565 565
A. 23% – 2.0113 C. 21%
B. 22% – 2.0422 D. 20% B 102,110 2,110
Internal Rate
OInvest of Return

₱100,000 on a long-term 1 40,000
2 50,000
right. 3 60,000
What is the IRR?

A. 23% – 2.0113 C. 21%
B. 22% D. 20%
Internal Rate
OInvest of Return
StepOInvest
1
Year Cash Flow 22% PVF 22% PV 21% PVF 21% PV
1 40,000 0.8197 32,788 0.8264 33,056
2 50,000 0.6719 33,595 0.6830 34,150
3 60,000 0.5507 33,042 0.5645 33,870
Sum 99,425 101,076

Internal Rate
OInvest of Return
StepOInvest
2
1 40,000 0.8197 32,788 0.8264 33,056
2 50,000 0.6719 33,595 0.6830 34,150
3 60,000 0.5507 33,042 0.5645 33,870
Sum 99,425 101,076
NPV (575) 1,076

Internal Rate
OInvest of Return
StepOInvest
3
1 40,000 0.8197 32,788 0.8264 33,056
2 50,000 0.6719 33,595 0.6830 34,150
3 60,000 0.5507 33,042 0.5645 33,870
Sum 99,425 101,076
NPV (575) 1,076
B
PP Formula ARR ARR
Initial Average
O–T APAT APAT

L+
S AFAM AFAM + TV
2
NPV Formula PI Formula IRR Formula

(RATS–OWO)
Net Inflows (PV)
Net Outflows
Net Inflows (PV) – Net Outflows (PV) Net Inflows
Net Outflows (PV) Years
TRANSFER
Definition & Importance
General Rule
PRICING Problem-Solving
Techniques & Shortcuts
DefinitionOInvest
& Importance
Proper signals Capacity Internal matter

General
OInvest Rule
Ano ba mawawala sa akin
kapag nagbenta ako sa amin?
Is there idle capacity?

Yes – Differential cost only
No – Differential cost + Opportunity cost
Minimum transfer price
Lost CM
VC +
# Units transferred
Excess Capacity
OInvest
Division A can produce 2,000 units and expects to sell 1,500

units. Division B desires to purchase 100 units from Division A.
Division A sells each unit at ₱100 per unit. Its variable cost is ₱25,
and fixed costs total ₱30,000.
What is the minimum transfer price?

Excess Capacity
OInvest
Division A can produce 2,000 units and expects to sell 1,500 units. Division B desires to
purchase 100 units from Division A.
Division A sells each unit at ₱100 per unit. Its variable cost is ₱25, and fixed costs total
₱30,000.
Lost CM
VC +
# Units transferred
Excess Capacity
OInvest
Division A can produce 2,000 units and expects to sell 1,500 units. Division B desires to
purchase 100 units from Division A.
Division A sells each unit at ₱100 per unit. Its variable cost is ₱25, and fixed costs total
₱30,000.
0
25 + = 25
100
At Capacity
OInvest
Division B is currently purchasing a part from an outside supplier.

Division A has no excess capacity and produces and sells this part
for ₱19 and ₱31, respectively.
If Division B buys from Division A, the latter can reduce its variable
cost on internal transfers by ₱3.
What transfer price would Division A establish?

At Capacity
OInvest
Division B is currently purchasing a part from an outside supplier. Division A has no

excess capacity and produces and sells this part for ₱19 and ₱31, respectively.
If Division B buys from Division A, the latter can reduce its variable cost on internal
transfers by ₱3.
What transfer price would Division A establish?
12
19 + = 31
1

Managerial Accounting

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Managerial Accounting

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CAPITAL BUDGETING &

Long-term Asset Invested Funds Future Benefits

Payback Period Discounted Payback Period

Ilang taon bago mabalik

Ilang taon bago mabalik

Varying annual inflows

The expected cash benefits 2 60,000

are given on the right. 3 70,000

The expected cash benefits 2 60,000 100,000

are given on the right. 3 70,000 170,000

Lower year 4 56,000 226,000

Subsequent inflow 5 64,000 -

O–T 0 (250,000) (250,000)

Varying annual inflows

The expected cash benefits are 1 40,000 100,000

1 40,000 100,000 140,000

1 40,000 100,000 140,000

2 60,000 80,000 180,000

1 40,000 100,000 140,000

2 60,000 80,000 180,000

3 70,000 60,000 230,000

1 40,000 100,000 140,000

2 60,000 80,000 180,000

3 70,000 60,000 230,000

4 56,000 40,000 266,000

1 40,000 100,000 140,000

2 60,000 80,000 180,000

Lower year 3 70,000 60,000 230,000 Total inflows

1 40,000 100,000 140,000

2 60,000 80,000 180,000

Lower year 3 70,000 60,000 230,000 Total inflows

Varying annual inflows

The expected cash benefits 2 60,000

are given on the right. 3 70,000

The expected cash benefits 2 60,000 55,473

are given on the right. 3 70,000 62,230

The expected cash benefits 2 55,473 93,935

are given on the right. 3 62,230 156,165

Lower year 4 47,689 203,854

Subsequent inflow 5 52,603 –

O–T 0 (250,000) (250,000)

Constant annual inflows Varying annual inflows 4% Discounted annual inflows

Year Cash Flow Year Cash Flow Year Cash Flow

0 (250,000) 0 (250,000) 0 (250,000)

1 58,000 1 40,000 1 38,462

2 58,000 2 60,000 2 55,473

3 58,000 3 70,000 3 62,230

4 58,000 4 56,000 4 47,869

5 58,000 5 64,000 5 52,603

PP = 4.310 years PP = 4.375 years PP = 4.874 years

Sa puhunan ko, ilang % ang

APAT APAT APAT = Average profit after tax

AFAM AFAM + TV AFAM = Average fixed assets maintained

How good will this investment

After-tax profit & fixed assets

What is the investment's 4 26,000 60,000

What is the investment's 4 26,000 60,000

Average 24,000 70,000

APAT 1 20,000 90,000

AFAM 2 22,000 80,000

APAT 1 20,000 90,000

AFAM 2 22,000 80,000

NINO Formula (RATS–OWO)