Capital Budgeting: Alternatives Evaluation and Tax Considerations, Quizzes of Engineering

Download Capital Budgeting: Alternatives Evaluation and Tax Considerations and more Quizzes Engineering in PDF only on Docsity!

Types of Alternatives

Mutually Exclusive Alternatives Independent Alternatives TERM 2

Mutually Exclusive Alternatives

DEFINITION 2 Only one alternative must be selected Must consider null alternative TERM 3

Independent Alternatives

DEFINITION 3 Possible to select any number of available alternatives that may be attractive May not be economically possible to do all attractive alternatives TERM 4

Methods for Selecting Best Alternative

DEFINITION 4 Present Worth Capitalized Cost Annual Cost Benefit-Cost Ratio Rate of Return TERM 5

Present Worth Method

DEFINITION 5 Basis Superior alternative has largest present worth Benefits Suitable for ranking alternatives Indicates degree of superiority Limitations Restricted to mutually exclusive alternatives Alternatives should have same life span

Capitalized Cost Method

Basis Present worth of project with infinite life Capitalized cost is positive when expenses exceed income Benefits Useful when annual costs are equal every year Suitable for ranking alternatives Indicates degree of superiority Limitations Applied to one or more alternatives with infinite life span More work when O&M costs are irregular TERM 7

Annual Cost Method

DEFINITION 7 Basis Superior alternative has lowest annual cost Assumes each alternative replaced by twin at life end EUAC positive when expenses exceed income Benefits Good for comparing alternatives with different life spans Suitable for ranking alternatives Indicates degree of superiority Limitations Restricted to mutually exclusive alternatives TERM 8

Benefit-Cost Method

DEFINITION 8 Basis Project acceptable if present worth of all benefits divided by present worth of all costs greater than one Can be used to rank alternatives if incremental analysis Benefits Useful in municipal projects where benefits and cost accrue to various segments Limitations Difficult to determine if cash flow is cost or disbenefit Cannot directly rank competing projects TERM 9

Rate of Return Method

DEFINITION 9 Basis ROR exceeds MARR are attractive Benefits No knowledge of interest rate necessary Limitations Method often poorly misunderstood and misapplied Cannot just select highest ROR TERM 10

When is incremental analysis required?

DEFINITION 10 Cost-Benefit Method Rate of Return Method

Property Taxes

assessed as a function of owned property value independent of income or profit of firm levied at municipal, county, and/or state level TERM 17

SalesTaxes

DEFINITION 17 assessed on purchases of goods and services independent of gross income or profits relevant to engineering studies as added cost TERM 18

Excise Taxes

DEFINITION 18 assessed on sale of certain nonessential goods and services independent of business income and profit cost ultimately to consumer, despite original target TERM 19

Federal Taxes

DEFINITION 19 Taxes are imposed on taxable income in incremental levels TERM 20

State Taxes

DEFINITION 20 Various rate structures apply in different states

Impact of Taxes

Initial purchases and salvage revenues unaffected by income taxesRevenues and deductible expenses multiplied by 1- t%Depreciation multiplied by t% and added to year's cash flow increases that year's present worth increases after-tax profitability Adds t x depreciation to after-tax cash flow TERM 22

Tax Credits

DEFINITION 22 reduce tax liability by some percentage of qualified investment Qualifying property tangible property depreciable useful life >3 years in service during year credit is claimed TERM 23

Book Deductions

DEFINITION 23 Expense category allowed by IRS where some capitalized investment costs may be recovered TERM 24

Types of Book Deductions

DEFINITION 24 Depreciation Depletion Amortization TERM 25

Depreciation

DEFINITION 25 Applied to capitalized business costs Commonly includes items such as buildings, equipment, etc

Depletion Methods

Cost Depletion Percentage Depletion TERM 32

Cost Depletion

DEFINITION 32 Based on depletion unit TERM 33

Percentage Depletion

DEFINITION 33 Based on percentage of year's gross income TERM 34

DCF-ROR

DEFINITION 34 Basis Today's dollar worth more than tomorrow,s Future dollars are discounted Higher the discount rate, the less the future dollar is worth today TERM 35

DCF-ROR Advantages

DEFINITION 35 Applicable to all capital projects regardless of dollar value Provides effective and consistent evaluation of investment opportunities Determines most financially attractive projects

DCF-ROR Disadvantages

Results heavily dependent upon validity and reliability of assumptions/predictions TERM 37

DCF-ROR Steps

DEFINITION 37 Calculate Annual Cash Flow Construct Cash Flow Diagram Formulate Present Worth Equation Solve for Rate of Return Accept/Reject Project Investment TERM 38

DCF-ROR Inputs

DEFINITION 38 Capex (Capital Cost Estimate) Opex (Operating Cost Estimate) Production Forecast Price Forecast TERM 39

Working Capital

DEFINITION 39 Money required for day-to-day operation of business TERM 40

DCF-ROR Analysis

DEFINITION 40 Calculation of ROR based on discounted values