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CHAPTER EIGHT
Long-Term (Capital Investment) Decisions
Long-term decisions require a consideration of the time value of money in
addition to cost behavior and the relevance of costs. In this chapter, tools
are developed that aid managers in making long-term decisions. The net
Key Concepts
• If the present value of cash inflows is greater than or equal to the
present value of cash outflows (the NPV is greater than or equal to
zero), the investment provides a return at least equal to the discount
rate (the minimum required rate of return), and the investment is
acceptable.
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Learning Objectives
LO1— Evaluate capital investment decisions using the NPV method
LO2— Evaluate capital investment decisions using the IRR method
Lecture Outline
A. Introduction
o Capital investment decisions are long-term decisions
involving the purchase (or lease) of new machinery and
equipment and the acquisition or expansion of facilities used
in a business.
o Cash outflows include the original investment in the project,
any additional working capital needed during the life of the
investment, repairs and maintenance needed for machinery
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B. Net Present Value (LO1)
o NPV uses discount rate for its analysis.
C. Internal Rate of Return (LO2)
Key Concept
If the present value of cash inflows is greater than or equal to the present
Key Concept
The internal rate of return (IRR) is the actual yield, or return, earned by an
investment.
Key Formula
PVA = R (DFAn,r)
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o The rate of return assumed to be earned on the reinvested
amounts depends on whether the NPV or the IRR method is
used.
3. The Importance of Qualitative Factors
D. Screening and Preference Decisions (LO3)
o Both NPV and IRR can be used as a screening tool. They
1. Profitability Index
o PI is calculated by dividing the present value of the cash
E. The Impact of Taxes on Capital Investment Decisions (LO4)
Key Concept
The profitability index is a useful tool for making preference decisions because
it can be used to compare projects that require investment of different amounts.
Key Concept
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1. The Depreciation Tax Shield
o Depreciation expense reduces a company’s taxable income
F. The Payback Method (LO5)
o The payback period is the length of time needed to pay back
the initial investment.
Key Concept
Taxes are a major source of cash outflows for many companies and must
be taken into consideration in calculations of the time value of money.
Key Concept
The payback method can be useful as a quick approximation of discounted
Key Formula
Payback period = Original investment ÷ Net annual cash inflows
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End-of-Chapter Material
This chapter has a number of very good short exercises dealing with the