How is Capital Budgeting Used to Make Decisions?
Read this section, which discusses capital budgeting and decision-making, net present values, annuity tables, and internal rate of return. Large corporations use capital budgeting techniques when investing in real estate projects or large equipment projects.
Julie Jackson is the president and owner of Jackson's Quality Copies, a store that makes photocopies for its customers and that has several copy machines. Julie has the following discussion with Mike Haley, the company's accountant:
|ulie:||Mike, I think it's time to buy a new copy machine. Our volume of copies has increased dramatically over the last year, and we need a copier that does a better job of handling the big jobs.|
|Mike:||Do you have any idea how much the new machine will cost?|
|Julie:||We can purchase a new copier for $50,000, maintenance costs will total $1,000 a year, and the copier is expected to last 7 years. Since the new machine is quicker and will require less attention by our employees, we should save about $11,000 a year in labor costs.|
|Mike:||Will it have any salvage value at the end of seven years?|
|Julie:||Yes. The salvage value should be about $5,000.|
|Mike:||How soon do you want to do this?|
|Julie:||As soon as possible. From what I can tell, this is a winning proposition. The cash inflows of $82,000 that we will get from the labor cost savings and the salvage value exceed the cash outflows of $57,000 that we expect to spend on the machine and annual maintenance costs. What do you think?|
|Mike:||Let me take a look at the numbers before we jump into this. We have to consider more than just total cash inflows and outflows. I'll get back to you by the end of the week.|
|Julie:||Okay, thanks for your help!|
Jackson's Quality Copies is facing a decision common to many organizations: whether to invest in equipment that will last for many years or to continue with existing equipment. This type of decision differs from the decisions covered in the previous chapter because long-term investment decisions affect organizations for several years. We will return to Julie's plan to purchase a new copier after we provide background information on long-term investment decisions.
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