1. A SMORGASBORD OF CAPITAL BUDGETING PERFORMANCE MEASURES Susanka Company’s president invited proposals from her management team for capital expenditures, and approved four proposals submitted by four different managers. She told the four managers that a bonus would be paid to the manager with the most successful capital project. The success of each project can be evaluated based on Net Present Value, Pre-Tax Accounting Rate of Return, Payback Method, or Internal Rate of Return. The following data are available.

2. ManagerInitial Cost of the Asset Useful LifeNet Annual Increase to Cash Flows from the Project Mrs. White$280,0002 years$170,050 Professor Plum $300,0001 years$330,000 Mr. Green$560,00014 years$97,825 Ms. Scarlet$2,000,00016 years$280,000

3. A SMORGASBORD OF CAPITAL BUDGETING PERFORMANCE MEASURES All four of the capital expenditures have zero terminal value. Straight-line depreciation is used. The discount rate is 10%. You are a financial analyst working for (look at your handout). Which performance measure (or measures) will you recommend that your manager adopt in order to claim the bonus?

4. ManagerInitial Cost of the Asset Useful LifeNet Annual Increase to Cash Flows from the Project Mrs. White$280,0002 years$170,050 Professor Plum $300,0001 years$330,000 Mr. Green$560,00014 years$97,825 Ms. Scarlet$2,000,00016 years$280,000

5. ManagerInitial Cost of the Asset Net Annual Increase to Cash Flows from the Project Payback period Mrs. White$280,000$170,0501.65 years Professor Plum $300,000$330,0000.91 years Mr. Green$560,000$97,8255.72 years Ms. Scarlet$2,000,000$280,0007.14 years Payback Method = initial cost ÷ average net annual cash flow.

6. ManagerInitial Cost of the Asset Net Annual Increase to Cash Flows from the Project Payback period Mrs. White$280,000$170,0501.65 years Professor Plum $300,000$330,0000.91 years Mr. Green$560,000$97,8255.72 years Ms. Scarlet$2,000,000$280,0007.14 years Payback Method

7. ManagerInitial Cost of the Asset Net Annual Increase to Cash Flows from the Project Asset’s Useful Life Mrs. White$280,000$170,0502 years Professor Plum $300,000$330,0001 year Mr. Green$560,000$97,82514 years Ms. Scarlet$2,000,000$280,00016 years Net Present Value

8. ManagerCalculation of NPV Mrs. White($170,050 x 1.7355) - $280,000 = $15, 122 Professor Plum ($330,000 x 0.9091) - $300,000 = $3 Mr. Green($97,825 x 7.3667) - $560,000 = $160,647 Ms. Scarlet($280,000 x 7.8237) - $2,000,000 = $190,636 Net Present Value

9. ManagerCalculation of NPV Mrs. White($170,050 x 1.7355) - $280,000 = $15, 122 Professor Plum ($330,000 x 0.9091) - $250,000 = $3 Mr. Green($97,825 x 7.3667) - $560,000 = $160,647 Ms. Scarlet ($280,000 x 7.8237) - $2,000,000 = $190,636 Net Present Value

10. ManagerInitial Cost of the Asset Net Annual Increase to Cash Flows from the Project Asset’s Useful Life Mrs. White$280,000$170,0502 years Professor Plum $300,000$330,0001 year Mr. Green$560,000$97,82514 years Ms. Scarlet$2,000,000$280,00016 years Internal Rate of Return

11. ManagerCalculation of IRR Mrs. White$280,000 ÷ $170,050 = 1.647 1.647 in Row 2 → 14% Professor Plum $300,000 ÷ $330,000 = 0.909 0.909 in Row 1 → 10% Mr. Green$560,000 ÷ $97,825 = 5.7245 5.7245 in Row 14 → 15% Ms. Scarlet $2,000,000 ÷ $280,000 = 7.143 7.143 in Row 16 → between 11% & 12% Internal Rate of Return

12. ManagerCalculation of IRR Mrs. White$280,000 ÷ $170,050 = 1.647 1.647 in Row 2 → 14% Professor Plum $300,000 ÷ $330,000 = 0.909 0.909 in Row 1 → 10% Mr. Green$560,000 ÷ $97,825 = 5.7245 5.7245 in Row 14 → 15% Ms. Scarlet $2,000,000 ÷ $280,000 = 7.143 7.143 in Row 16 → between 11% & 12% Internal Rate of Return

13. ManagerInitial Cost of the Asset Net Annual Increase to Cash Flows from the Project Asset’s Useful Life Mrs. White$280,000$170,0502 years Professor Plum $300,000$330,0001 year Mr. Green$560,000$97,82514 years Ms. Scarlet$2,000,000$280,00016 years Accounting Rate of Return

14. ManagerCalculation of Annual Depreciation Expense Mrs. WhiteAnnual Depreciation Expense = $280,000 ÷ 2 = $140,000 Professor Plum Annual Depreciation Expense = $300,000 Mr. GreenAnnual Depreciation Expense = $560,000 ÷ 14 = $40,000 Ms. Scarlet Annual Depreciation Expense = $2,000,000 ÷ 16 = $125,000 Accounting Rate of Return

15. ManagerCalculation of Average Book Value Mrs. WhiteAverage Book Value = $280,000 ÷ 2 = $140,000 Professor Plum Average Book Value = $300,000 ÷ 2 = $150,000 Mr. GreenAverage Book Value = $560,000 ÷ 2 = $280,000 Ms. Scarlet Average Book Value = $2,000,000 ÷ 2 = $1,000,000 Accounting Rate of Return

16. ManagerCalculation of Accounting Rate of Return Mrs. White($170,050 - $140,000) ÷ $140,000 = 21.5% Professor Plum ($330,000 - $300,000) ÷ $150,000 = 20.00% Mr. Green($97,825 - $40,000) ÷ $280,000 = 20.65% Ms. Scarlet ($280,000 - $125,000) ÷ $1,000,000 = 15.5% Accounting Rate of Return

17. ManagerCalculation of Accounting Rate of Return Mrs. White ($170,050 - $140,000) ÷ $140,000 = 21.5% Professor Plum ($330,000 - $300,000) ÷ $150,000 = 20.00% Mr. Green($97,825 - $40,000) ÷ $280,000 = 20.65% Ms. Scarlet ($280,000 - $125,000) ÷ $1,000,000 = 15.5% Accounting Rate of Return

18. ManagerPaybackNPVIRRARR Mrs. White  Professor Plum  Mr. Green  Ms. Scarlet  Summary