THEUNIVERSITYOFNEWSOUTHWALES

SCHOOLOFACCOUNTING
ACCT2522ManagementAccounting1
Session1,2013

TutorialWeek12CapitalExpenditureDecisions

OverallTheme

Thisweekwediscussthenatureandpurposeofinvestmentincommittedresources,andexplore
thedecisionrelevantcostsandbenefitsofsuchdecisions.

DesiredLearningOutcomesandEssentialReading

CAPITALEXPENDITUREDECISIONS
Aftercompletingthistopic,youshouldbeableto:
1.

Understandthenatureandpurposeofcapitalexpendituredecisions

2.

Describeatypicalcapitalexpenditureprocess

3.

Apply and understand the benefits/limitations of various capital budgeting

techniques

4.

Understandthevalueofpostimplementationandpostcompletionauditsof
capitalexpenditureprojects

5.

Understand the conflict between using DCF for project evaluations and
accrualaccountingdataforevaluatingmanagerperformance

TextbookMaterials:

LangfieldSmithetal.

Chapter21
pp.9951034

SelfStudyQuestions(completeinyourowntime)

It is important that you cover the material necessary to meet the learning objectives unfortunately
there is not enough time to include everything of importance in the tutorial. Some of the selfstudy
questionsarequitelongwhileyoumaynothavetimetogothroughallofthemindetailbeforethe
tutorial,pleasemakesureyouarecomfortablewiththeirlevelofdetailanddifficultybeforethefinal
exam.Inaddition,pleasenotethatthediscounttablesprovidedinyourtextonlygoto3decimalplaces
(d.p) in the exam the tables will have numbers to 4 d.p, and you should use the complete number
given.

Question1:21.11
Question2:21.16
Question3:E21.31
Question4:E21.33(1and2Bonly)
Question5:P21.46(dontuseExcelunlessyouwantto).

TutorialQuestions(mustbepreparedpriortothetutorial)

Ifyougetstuckwiththetutorialquestions,itwillhelpifyouattempttheselfstudyquestionsfirst,
usingtheanswersforguidance.

Question1:P21.45(exceptfor1(e))

Question2:AdaptedfinalexamquestionSolitucity

Solitucity is a coastal town with a small population. Other than by sea, the only way of accessing the
town is via a rough dirt road off a main expressway. Recently the local council has been considering
making the town more accessible by improving the condition of the road. Likely benefits from having
a better road include higher land values, greater potential for revenue from tourism related activities,
and convenience for residents who may have to leave town for things such as supplies or medical
treatment. One major drawback would be the increased likelihood of damage to the environment and
native wildlife due to a larger tourist population and more movement throughout the area.
The following financial information has been provided to the council in order to help with the
decision. While the road itself would last many years, the council has decided to analyse the costs over
a 5 year time horizon, and apply its usual hurdle rate of 12% for capital expenditure projects. The tax
rate is 30% (in this fictitious example were going to assume the council pays tax!).
Please note: assume that the one-off costs of developing the road (other than the cost of the new
machine) are not depreciated.
$
Cost of clearing land
90,000
Cost of levelling the ground
55,000
Cost of tarring the new road
30,000
Cost of sealing the road
20,000
Cost of lighting and signage
80,000
Cost of new machine, to be fully depreciated for tax purposes over 5 years
10,000
Annual operating costs of new machine
2,000
Annual maintenance cost of road
12,000
Annual revenue from road tolls
35,000
Required:
Note: Present value tables have been provided (following after this question).
1. What is the net present value of the proposed road project? (Please keep discount factors to 4
decimal places). Should the road be approved given current investment criteria?
2. Discuss two (2) potential difficulties associated with the council using discounted cash flow
analysis to make a decision about the road, i.e., what other factors might you want to consider
before making any recommendations?

Present Value Tables: PRESENT VALUE OF $1.00

Present value of $1.00
Periods

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

24%

26%

28%

30%

32%

40% Periods

0.9804 0.9615 0.9434 0.9259 0.9091 0.8929 0.8772 0.8621 0.8475 0.8333 0.8065 0.7937 0.7813 0.7692 0.7576 0.7143

0.9612 0.9246 0.8900 0.8573 0.8264 0.7972 0.7695 0.7432 0.7182 0.6944 0.6504 0.6299 0.6104 0.5917 0.5739 0.5102

0.9423 0.8890 0.8396 0.7938 0.7513 0.7118 0.6750 0.6407 0.6086 0.5787 0.5245 0.4999 0.4768 0.4552 0.4348 0.3644

0.9238 0.8548 0.7921 0.7350 0.6830 0.6355 0.5921 0.5523 0.5158 0.4823 0.4230 0.3968 0.3725 0.3501 0.3294 0.2603

0.9057 0.8219 0.7473 0.6806 0.6209 0.5674 0.5194 0.4761 0.4371 0.4019 0.3411 0.3149 0.2910 0.2693 0.2495 0.1859

0.8880 0.7903 0.7050 0.6302 0.5645 0.5066 0.4556 0.4104 0.3704 0.3349 0.2751 0.2499 0.2274 0.2072 0.1890 0.1328

0.8706 0.7599 0.6651 0.5835 0.5132 0.4523 0.3996 0.3538 0.3139 0.2791 0.2218 0.1983 0.1776 0.1594 0.1432 0.0949

0.8535 0.7307 0.6274 0.5403 0.4665 0.4039 0.3506 0.3050 0.2660 0.2326 0.1789 0.1574 0.1388 0.1226 0.1085 0.0678

0.8368 0.7026 0.5919 0.5002 0.4241 0.3606 0.3075 0.2630 0.2255 0.1938 0.1443 0.1249 0.1084 0.0943 0.0822 0.0484

10

0.8203 0.6756 0.5584 0.4632 0.3855 0.3220 0.2697 0.2267 0.1911 0.1615 0.1164 0.0992 0.0847 0.0725 0.0623 0.0346

10

11

0.8043 0.6496 0.5268 0.4289 0.3505 0.2875 0.2366 0.1954 0.1619 0.1346 0.0938 0.0787 0.0662 0.0558 0.0472 0.0247

11

12

0.7885 0.6246 0.4970 0.3971 0.3186 0.2567 0.2076 0.1685 0.1372 0.1122 0.0757 0.0625 0.0517 0.0429 0.0357 0.0176

12

13

0.7730 0.6006 0.4688 0.3677 0.2897 0.2292 0.1821 0.1452 0.1163 0.0935 0.0610 0.0496 0.0404 0.0330 0.0271 0.0126

13

14

0.7579 0.5775 0.4423 0.3405 0.2633 0.2046 0.1597 0.1252 0.0985 0.0779 0.0492 0.0393 0.0316 0.0254 0.0205 0.0090

14

15

0.7430 0.5553 0.4173 0.3152 0.2394 0.1827 0.1401 0.1079 0.0835 0.0649 0.0397 0.0312 0.0247 0.0195 0.0155 0.0064

15

16

0.7284 0.5339 0.3936 0.2919 0.2176 0.1631 0.1229 0.0930 0.0708 0.0541 0.0320 0.0248 0.0193 0.0150 0.0118 0.0046

16

17

0.7142 0.5134 0.3714 0.2703 0.1978 0.1456 0.1078 0.0802 0.0600 0.0451 0.0258 0.0197 0.0150 0.0116 0.0089 0.0033

17

18

0.7002 0.4936 0.3503 0.2502 0.1799 0.1300 0.0946 0.0691 0.0508 0.0376 0.0208 0.0156 0.0118 0.0089 0.0068 0.0023

18

19

0.6864 0.4746 0.3305 0.2317 0.1635 0.1161 0.0829 0.0596 0.0431 0.0313 0.0168 0.0124 0.0092 0.0068 0.0051 0.0017

19

20

0.6730 0.4564 0.3118 0.2145 0.1486 0.1037 0.0728 0.0514 0.0365 0.0261 0.0135 0.0098 0.0072 0.0053 0.0039 0.0012

20

21

0.6598 0.4388 0.2942 0.1987 0.1351 0.0926 0.0638 0.0443 0.0309 0.0217 0.0109 0.0078 0.0056 0.0040 0.0029 0.0009

21

22

0.6468 0.4220 0.2775 0.1839 0.1228 0.0826 0.0560 0.0382 0.0262 0.0181 0.0088 0.0062 0.0044 0.0031 0.0022 0.0006

22

23

0.6342 0.4057 0.2618 0.1703 0.1117 0.0738 0.0491 0.0329 0.0222 0.0151 0.0071 0.0049 0.0034 0.0024 0.0017 0.0004

23

24

0.6217 0.3901 0.2470 0.1577 0.1015 0.0659 0.0431 0.0284 0.0188 0.0126 0.0057 0.0039 0.0027 0.0018 0.0013 0.0003

24

25

0.6095 0.3751 0.2330 0.1460 0.0923 0.0588 0.0378 0.0245 0.0160 0.0105 0.0046 0.0031 0.0021 0.0014 0.0010 0.0002

25

26

0.5976 0.3607 0.2198 0.1352 0.0839 0.0525 0.0331 0.0211 0.0135 0.0087 0.0037 0.0025 0.0016 0.0011 0.0007 0.0002

26

27

0.5859 0.3468 0.2074 0.1252 0.0763 0.0469 0.0291 0.0182 0.0115 0.0073 0.0030 0.0019 0.0013 0.0008 0.0006 0.0001

27

28

0.5744 0.3335 0.1956 0.1159 0.0693 0.0419 0.0255 0.0157 0.0097 0.0061 0.0024 0.0015 0.0010 0.0006 0.0004 0.0001

28

29

0.5631 0.3207 0.1846 0.1073 0.0630 0.0374 0.0224 0.0135 0.0082 0.0051 0.0020 0.0012 0.0008 0.0005 0.0003 0.0001

29

30

0.5521 0.3083 0.1741 0.0994 0.0573 0.0334 0.0196 0.0116 0.0070 0.0042 0.0016 0.0010 0.0006 0.0004 0.0002 0.0000

30

35

0.5000 0.2534 0.1301 0.0676 0.0356 0.0189 0.0102 0.0055 0.0030 0.0017 0.0005 0.0003 0.0002 0.0001 0.0001 0.0000

35

40

0.4529 0.2083 0.0972 0.0460 0.0221 0.0107 0.0053 0.0026 0.0013 0.0007 0.0002 0.0001 0.0001 0.0000 0.0000 0.0000

40

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Present Value Tables: PRESENT VALUE OF ANNUITY $1.00

Present value of annuity of $1.00
Periods

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

24%

26%

28%

30%

0.9804

0.9615

0.9434

0.9259 0.9091 0.8929 0.8772 0.8621 0.8475 0.8333 0.8065 0.7937 0.7813 0.7692 0.7576 0.7143

1.9416

1.8861

1.8334

1.7833 1.7355 1.6901 1.6467 1.6052 1.5656 1.5278 1.4568 1.4235 1.3916 1.3609 1.3315 1.2245

2.8839

2.7751

2.6730

2.5771 2.4869 2.4018 2.3216 2.2459 2.1743 2.1065 1.9813 1.9234 1.8684 1.8161 1.7663 1.5889

3.8077

3.6299

3.4651

3.3121 3.1699 3.0373 2.9137 2.7982 2.6901 2.5887 2.4043 2.3202 2.2410 2.1662 2.0957 1.8492

4.7135

4.4518

4.2124

3.9927 3.7908 3.6048 3.4331 3.2743 3.1272 2.9906 2.7454 2.6351 2.5320 2.4356 2.3452 2.0352

5.6014

5.2421

4.9173

4.6229 4.3553 4.1114 3.8887 3.6847 3.4976 3.3255 3.0205 2.8850 2.7594 2.6427 2.5342 2.1680

6.4720

6.0021

5.5824

5.2064 4.8684 4.5638 4.2883 4.0386 3.8115 3.6046 3.2423 3.0833 2.9370 2.8021 2.6775 2.2628

7.3255

6.7327

6.2098

5.7466 5.3349 4.9676 4.6389 4.3436 4.0776 3.8372 3.4212 3.2407 3.0758 2.9247 2.7860 2.3306

8.1622

7.4353

6.8017

6.2469 5.7590 5.3282 4.9464 4.6065 4.3030 4.0310 3.5655 3.3657 3.1842 3.0190 2.8681 2.3790

10

8.9826

8.1109

7.3601

6.7101 6.1446 5.6502 5.2161 4.8332 4.4941 4.1925 3.6819 3.4648 3.2689 3.0915 2.9304 2.4136

10

11

9.7868

8.7605

7.8869

7.1390 6.4951 5.9377 5.4527 5.0286 4.6560 4.3271 3.7757 3.5435 3.3351 3.1473 2.9776 2.4383

11

12

10.5753

9.3851

8.3838

7.5361 6.8137 6.1944 5.6603 5.1971 4.7932 4.4392 3.8514 3.6059 3.3868 3.1903 3.0133 2.4559

12

13

11.3484

9.9856

8.8527

7.9038 7.1034 6.4235 5.8424 5.3423 4.9095 4.5327 3.9124 3.6555 3.4272 3.2233 3.0404 2.4685

13

14

12.1062 10.5631

9.2950

8.2442 7.3667 6.6282 6.0021 5.4675 5.0081 4.6106 3.9616 3.6949 3.4587 3.2487 3.0609 2.4775

14

15

12.8493 11.1184

9.7122

8.5595 7.6061 6.8109 6.1422 5.5755 5.0916 4.6755 4.0013 3.7261 3.4834 3.2682 3.0764 2.4839

15

16

13.5777 11.6523 10.1059

8.8514 7.8237 6.9740 6.2651 5.6685 5.1624 4.7296 4.0333 3.7509 3.5026 3.2832 3.0882 2.4885

16

17

14.2919 12.1657 10.4773

9.1216 8.0216 7.1196 6.3729 5.7487 5.2223 4.7746 4.0591 3.7705 3.5177 3.2948 3.0971 2.4918

17

18

14.9920 12.6593 10.8276

9.3719 8.2014 7.2497 6.4674 5.8178 5.2732 4.8122 4.0799 3.7861 3.5294 3.3037 3.1039 2.4941

18

19

15.6785 13.1339 11.1581

9.6036 8.3649 7.3658 6.5504 5.8775 5.3162 4.8435 4.0967 3.7985 3.5386 3.3105 3.1090 2.4958

19

20

16.3514 13.5903 11.4699

9.8181 8.5136 7.4694 6.6231 5.9288 5.3527 4.8696 4.1103 3.8083 3.5458 3.3158 3.1129 2.4970

20

21

17.0112 14.0292 11.7641 10.0168 8.6487 7.5620 6.6870 5.9731 5.3837 4.8913 4.1212 3.8161 3.5514 3.3198 3.1158 2.4979

21

22

17.6580 14.4511 12.0416 10.2007 8.7715 7.6446 6.7429 6.0113 5.4099 4.9094 4.1300 3.8223 3.5558 3.3230 3.1180 2.4985

22

23

18.2922 14.8568 12.3034 10.3711 8.8832 7.7184 6.7921 6.0442 5.4321 4.9245 4.1371 3.8273 3.5592 3.3254 3.1197 2.4989

23

24

18.9139 15.2470 12.5504 10.5288 8.9847 7.7843 6.8351 6.0726 5.4509 4.9371 4.1428 3.8312 3.5619 3.3272 3.1210 2.4992

24

25

19.5235 15.6221 12.7834 10.6748 9.0770 7.8431 6.8729 6.0971 5.4669 4.9476 4.1474 3.8342 3.5640 3.3286 3.1220 2.4994

25

26

20.1210 15.9828 13.0032 10.8100 9.1609 7.8957 6.9061 6.1182 5.4804 4.9563 4.1511 3.8367 3.5656 3.3297 3.1227 2.4996

26

27

20.7069 16.3296 13.2105 10.9352 9.2372 7.9426 6.9352 6.1364 5.4919 4.9636 4.1542 3.8387 3.5669 3.3305 3.1233 2.4997

27

28

21.2813 16.6631 13.4062 11.0511 9.3066 7.9844 6.9607 6.1520 5.5016 4.9697 4.1566 3.8402 3.5679 3.3312 3.1237 2.4998

28

29

21.8444 16.9837 13.5907 11.1584 9.3696 8.0218 6.9830 6.1656 5.5098 4.9747 4.1585 3.8414 3.5687 3.3317 3.1240 2.4999

29

30

22.3965 17.2920 13.7648 11.2578 9.4269 8.0552 7.0027 6.1772 5.5168 4.9789 4.1601 3.8424 3.5693 3.3321 3.1242 2.4999

30

35

24.9986 18.6646 14.4982 11.6546 9.6442 8.1755 7.0700 6.2153 5.5386 4.9915 4.1644 3.8450 3.5708 3.3330 3.1248 2.5000

35

40

27.3555 19.7928 15.0463 11.9246 9.7791 8.2438 7.1050 6.2335 5.5482 4.9966 4.1659 3.8458 3.5712 3.3332 3.1250 2.5000

40

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32%

40% Periods

SolutionstoSelfStudyQuestions

21.11This statement highlights one of the difficulties of measuring managerial performance

basedonabusinessunitsROI,butevaluatingnewprojectsbasedonNPVorIRRoverthe
lifeoftheproject.Forprojectsthatdonotgenerateaccountingprofitsintheearlyyearsof
aproject,thereisadisincentiveformanagerstocampaigninsupportofwhatotherwise
maybeahighlydesirableproject.Dealingwiththeconflictmayrequireadeemphasison
theuseofaccountingbasedincentivesystems.

21.16 Inapostcompletionauditofaninvestmentproject,themanagementaccountantgathersinformationabout
the actual cash flows generated by the project and compares these with the cash flows projected in the
capitalbudgetproposal.ThentheprojectsactualNPVorIRRiscomputed.Finally,theprojectionsmadefor
the project are compared with the actualresults. If theprojecthas not met expectations, an investigation
may be made to consider the reasons. Was the estimated life too short? Were cash flows too optimistic?
Weresomeimportantcashflowsomitted?

Not all businesses actually undertake postcompletion audits of their capital expenditure decisions. One
reasonisthatitisdifficulttoisolatetheactualcashflowsthatrelatetospecificprojects.Anotherreasonis
thattheremaybelittleincentiveformanagementtoreviewthequalityoftheinitialanalysisandsubsequent
implementation of the project. However, in situations where there are massive cost overruns or other
negativeoutcomesthentheauditcanprovidevaluablelearningformanagement.

EXERCISE21.31
1

Carrying amount

=
=

acquisition cost accumulated depreciation

$150 000 $116 535 = $33 465

Loss on sale

=
=

carry amount proceeds of sale

$33 465 $27 765 = $5 700

Reduced cash outflows from the tax deduction from the loss of sale ($5700 0.33)
Proceeds of sale
Total after-tax cash flow

$1 881
27 765
$29 646

EXERCISE21.33(part1and2Bonly)
1

Paybackperiod

initial investment

annual after - tax cash flow

=186300/(40500+9581.14*)=3.72years

*9581.14istheamountsavedintaxduetodepreciation.Depreciationis186300/7years=26614.29/year.
Taxeffect=26614.29x0.36=9581.14
2

Netpresentvalueanalysis:

Presentvalueofaftertaxsavings:
$50081.14x4.868

Initialinvestment
Netpresentvalue

Discountrate
10%
$243794.99
(186300)
$57494.99

PROBLEM21.46
1&2
(a)

Equipment purchase
Implementation costs

Depreciation over 10 years:

Cost $120 000
Implementation 80 000
Salvage value (10 000)
Total $190 000
Depreciation is $19 000 p.a.
Proceeds of sale

(c)

Income
tax impact

Year
0
0

Amount
$(120 000)
(80 000)

8 000

110

36 000

(1 0.40)

110

19 000

0.40

10

10 000

Working capital reduction*

Annual cash flows:
Rework savings
28 000
Rent reduction
8 000
Increased revenue 16 000
CIM maintenance (16 000)
Savings per annum $36 000

(b)

Net present value

(d)

(e)

(f)

After-tax
cash flow
$(120 000)
(80 000)

Discount
factor
(14%)
1.000
1.000

Present
value of
cash flows
$(120 000)
(80 000)

8 000

1.000

8 000

21 600

5.216

112 666

7 600

5.216

39 642

10 000

0.2700

2 700
$(36 992)

* While it is not specified in the question, some students might also want to recognise the increase in working capital
at the end of the life of the CIM.
The analysis indicates that the new investment yields a negative NPV, which suggests that Italiano should not
go ahead with the new investment. However, the company will need to consider if there are any competitive or
marketing issues that may also need to be taken into account. These factors may be difficult to capture in
financial terms and may be used to qualify the financial analysis.
3

Calculating the after-tax payback period: 192000/29200 = 6.58 years. Or you can do it the long way:
Year
0
1
2
3
4
5
6
7
8

After-tax
cash flow
$(192 000)
29 200
29 200
29 200
29 200
29 200
29 200
29 200
$30 800

Cumulative
total
$(192 000)
(162 800)
(133 600)
(104 400)
(75 200)
(46 000)
(16 800)
12 400
$41 600

The payback period is 6.58 years*

* 16 800/29 200 = 0.58 years

It is difficult to quantify many aspects of a strategic investment. In particular, it is difficult to assess the impact
of not going ahead with the investment, or the impact of competitors future actions.