Use the following 5step process in net present value analysis:
Step 1. Select the discount rate.
Step 2. Identify the costs/benefits to be considered in analysis.
Step 3. Establish the timing of the costs/benefits.
Step 4. Calculate net present value of each alternative.
Step 5. Select the offer with the best net present value.
This section will demonstrate the use of that 5step process in two leasepurchase decision examples using nominal discount rates. You should follow the same steps for any net present value analysis whether you are using nominal discount rates or real discount rates.
LeasePurchase Decision Example 1. Assume that you want to determine which of the following proposals will result in the lowest total cost of acquisition?
Offeror A: Proposes to lease the asset for 3 years. The annual lease payments are Rs10,000 per year. The first payment will be due at the beginning of the lease, the remaining two payments are due at the beginning of Years 2 and 3.
Offeror B: Proposes to sell the asset for Rs29,000. It has a 3year useful life. Salvage value at the end of the 3year period, will be Rs2,000.
Step 1. Select the discount rate. The term of the lease analysis is three years, so we will use the nominal discount rate for three years, 5.4 percent.
Steps 2 and 3. Identify and establish the timing of the costs/benefits to be considered in analysis. The expenditures and receipts associated with the two offers and their timing are delineated in the table below: (Parentheses indicate a cash outflow.)
JOIN KHALID AZIZ
CA MODULE B,C,D FINANCIAL ACCOUNTING 1 & 2, ECONOMICS & COST ACCOUNTING
OfferRelated Expenditures/Receipts
t Offer A Offer B
0 (Rs10,000) (Rs29,000)
1 (Rs10,000) 0
2 (Rs10,000) 0
3 0 Rs2,000
Step 4. Calculate net present value. The tables below summarize the net present value calculations applied to each alternative.
Net present value of Offer A
t Cash Flow DF PV
0 (Rs10,000) 1.0000 (Rs10,000)
1 (Rs10,000) 0.9470 (Rs9,470)
2 (Rs10,000) 0.8968 (Rs8,968)
Net Present Value (Rs28,438)
Note the following points in the net present value calculations above:
o There are no cash inflows associated with Offer A, only outflows.
o Payments due now are not discounted.
o Offeror A payments due at the beginning of Years 2 and 3 are treated as if they are due at the end of Years 1 and 2.
o You could have calculated the net present value of Offer A using the Sum of Discount Factors (Appendix A1) for the payments due at the beginning of Years 2 and 3. Remember that payments due now are not discounted and payments due at the beginning of Years 2 and 3 are treated as if they are due at the end of Years 1 and 2. The calculations would be:
Net present value of Offer B
t Cash Flow DF PV
0 (Rs29,000) 1.0000 (Rs29,000)
3 Rs2,000 0.8492 Rs 1,698
Net Present Value (Rs27,302)
Note the following points in the net present value calculations above:
o Offer B salvage value is treated as a cash inflow at the end of Year 3.
o Payments due now are not discounted.
Step 5. Select the offer with the best net present value. In this example, we would select Offer B, the offer with the smallest negative net present value.
LeasePurchase Decision Example 2. Assume that we want to determine which of the following proposals will result in the lowest acquisition cost?
Offeror A—Proposes to lease the asset for 3 years. The monthly lease payments are Rs1,500; that is, the total amount for each year is Rs18,000. These payments are spaced evenly over the year, so the use of a MYDF would be appropriate.
Offeror B—Proposes to sell the asset for Rs56,000. It has a 3year useful life. At the end of the 3year period it will have a Rs3,000 salvage value.
Step 1. Select the discount rate. The term of the analysis is three years, so we will use the nominal discount rate for three years, 5.6 percent.
Steps 2 and 3. Identify and establish the timing of the costs/benefits to be considered in analysis. The expenditures and receipts associated with the two offers and their timing are delineated in the table below:
Offer Expenditures/Receipts
t Offer A Offer B
0 0 (Rs56,000)
1 (Rs18,000) 0
2 (Rs18,000) 0
3 (Rs18,000) Rs3,000
Step 4. Calculate net present value. The tables below summarize the net present value calculations applied to each alternative.
Net present value of Offer A
t Cash Flow DF PV
1 (Rs18,000) 0.9731 (Rs17,516)
2 (Rs18,000) 0.9215 (Rs16,587)
3 (Rs18,000) 0.8727 (Rs15,709)
Net Present Value (Rs49,812)
NOTE the following points in the net present value calculations above:
o There are no cash inflows associated with Offer A, only outflows.
o Offeror A payments are due monthly, so we used the nominal rate, midyear factors from Table.
o You could also calculate the net present value of Offer A using the Sum of Discount Factors in Table. That calculation would produce a slightly different answer due to rounding differences.
Net present value of Offer B
t Cash Flow DF PV
0 (Rs56,000) 1.0000 (Rs56,000)
3 Rs3,000 0.8492 Rs2,548
Net Present Value (Rs53,452)
Note the following points in the net present value calculations above:
o Offer B salvage value is treated as a cash inflow at the end of Year 3.
o Payments due now are not discounted.
Step 5. Select the offer with the best net present value. In this example, we would select Offer A, the offer with the smallest negative net present value.
9.6  Identifying Issues And Concerns
Questions to Consider in Analysis. As you perform price/cost analysis, consider the issues and concerns identified in this section, whenever you use net present value analysis.
• Is net present value analysis used when appropriate?
Net present value analysis should be used in any analysis supporting Government decisions to initiate, renew, or expand programs or projects which would result in a series of measurable benefits or costs extending for three or more years into the future.
• Are the dollar estimates for expenditures and receipts reasonable?
The base for all present value calculations is estimated future cash flows. The rationale for those estimates must be documented and supported just like any cost estimate. This includes estimates of costs that will be included in the contract or lease agreement and estimates of other cash flows that are not included. All may be used in present value calculations.
• Are the times projected for expenditures and receipts reasonable?
Discount factors depend on the discount rate and the timing of the cash flow. The timing of any cash flow not documented in the contract or lease agreement must be clearly supported. The offeror is responsible for estimating and defending cash flow estimates included in the proposal. Government technical personnel have that responsibility for estimated costs related to item ownership.
• Are the proper discount rates used in the net present value calculations?
Unless precluded by agency policy, discount rates should be taken. If they are not, the rationale must be documented.
• The rate selected should be based on the number of time periods included in the analysis. If the period of the analysis does not match any of the discount rate periods, linear interpolation should be used to estimate a rate for that period of time.
o Nominal discount rates should be used for any analysis not based on constant year dollars. Real discount rates should be used for any analysis that is based on constant year dollars.
• Are the proper discount factors used in analysis?
The discount factor should be calculated considering the timing of the cash flow.
o Endofyear discount factors should be used for cash flows at the beginning or end of the year.
o Midyear discount factors should be used for cash flows in the middle of the year or regularly throughout the year (e.g., monthly or quarterly).
• Are discount factors properly calculated from the discount rate?
Endofyear or midyear discount rates should be calculated following the procedures.
• Have all cash flows been considered?
Net present value analysis must consider all relevant cash flows throughout the decision life cycle.
JOIN KHALID AZIZ
CA MODULE B,C,D FINANCIAL ACCOUNTING 1 & 2, ECONOMICS & COST ACCOUNTING
Friday, November 6, 2009
Subscribe to:
Posts (Atom)
Categories
 #KARACHI #MONSOON (1)
 7 key skills of a project manager (1)
 ACCOUNTING (39)
 ACCOUNTING AND AUDIT SERVICES AVAILABLE (1)
 ACCOUNTING AND MARKETING SERVICES (1)
 Accounting for Bills of Exchange (1)
 Accounting scandals (1)
 ad (3)
 Advertisement (7)
 AMALGAMATION PRACTICE EXERCISES (1)
 B.COM (12)
 B.COM REGULAR 2011 EXAMS (1)
 BILA UNWAN 29/09/2013 بلا عنوان (1)
 BILA UNWAN 30/09/2013 بلا عنوان (1)
 Branch Accounting (1)
 Budget (1)
 Budget 201213 (1)
 Budget 201314 pakistan (1)
 BUDGET 201415 (1)
 BUDGET 201415 SALIENT FEATURES (1)
 Business SWOT Analysis  Threats is an Opportunity (1)
 Capital Budgeting (1)
 CERTIFICATE HOLDERS (1)
 COACHING CLASSES FOR B.COM (1)
 COACHING CLASSES FOR COMMERCE STUDENTS (3)
 COACHING CLASSES FOR COMMERCE STUDENTS: (2)
 COACHING CLASSES FOR FIAACCA STUDENTS IN KARACHI (1)
 Commerce (1)
 COST ACCOUNTING (11)
 Cricket (1)
 Decentralization (1)
 Dividend (1)
 Economics (26)
 EDUCATION (3)
 EID MUBARAK (1)
 ENRON Scandal Summary (1)
 Entertainment (2)
 Evolution of Tax Culture in Pakistan (1)
 EXEMPTIONS AWARDED BY ICAP TO VARIOUS DEGREE (1)
 fia acca (1)
 Finance (1)
 FOOD STREETS OF KARACHI: HUSSAINABAD AND AYESHA MANZIL (1)
 FREELANCE AUDIT (1)
 GOLDEN OPPORTUNITY TO MARKET YOUR BUSINESS (1)
 HISTORY (1)
 HOLDING COMPANIES (1)
 I.COM AND O/A LEVEL (1)
 icmap (1)
 Investment (1)
 Investment Decision (1)
 IQRA EDUCATION NETWORK AND CONSULTANTS: (1)
 JAVED CHOUDRY (1)
 javed chowdry on burma muslim killings (1)
 Joint Products and Joint Product Cost (1)
 KARACHI UNIVERSITY (1)
 KARACHI UNIVERSITY DATE SHEET (1)
 Khula is not regarded as a talaaq even if the word talaaq is used (1)
 MA ECONOMICS (7)
 management (3)
 Management Accounting (14)
 Marital Issueskhula (2)
 Maslow's Theory of Motivation  Hierarchy of Needs (1)
 Methods of Costing ByProducts: (1)
 Movies (1)
 NEW YEAR (1)
 O/A LEVELS (1)
 PARTNERSHIP ACCOUNTS PIECEMEAL DISTRIBUTION (1)
 Politics (3)
 Post Keynesian Economics (1)
 Result (2)
 REVOLUTIONIZING RAMADAN (1)
 RISK ANALYSIS TECHNIQUES (1)
 Segment Reporting and Transfer Pricing: PART 1 (1)
 Sports (1)
 Steps to the Accounting Cycle (1)
 Stock Exchange (1)
 SYLLABUS (2)
 TIME TABLE (1)
 TIMINGS AND VENUES OF EID PRAYERS IN KARACHI (1)
 Top Story (1)
 TOPI DRAMA (1)
 TQM (1)
 Transfer pricing (1)
 Types and Classification of Bill of Exchange (1)
 UNOFFICIAL DATE SHEET B.COM KARACHI UNIVERSITY EXAMS 2011 (1)
 vat (1)
 What is a Term Finance Certificate (TFC) (1)
MY PRESENTATIONS
Khalid aziz
View more presentations from Khalid Aziz.
Analysis of financial statements
View more PowerPoint from Khalid Aziz
Cost of sales
View more presentations from Khalid Aziz
Elasticity+and+its+application
View more presentations from Khalid Aziz
Product costing
View more presentations from Khalid Aziz
Lease and ijarah
View more presentations from Khalid Aziz
Ias 36
View more presentations from Khalid Aziz.
Ias11
View more presentations from Khalid Aziz.
Accounts receivable, inventory, and total quality management
View more presentations from Khalid Aziz.
Abc costig
View more presentations from Khalid Aziz.
Budgeting
View more presentations from Khalid Aziz.
Correlation and regression
View more presentations from Khalid Aziz.
Process cost systems
View more presentations from Khalid Aziz.
Ias 20 from Khalid Aziz
Popular Posts

B.COM PART 1 AND 2 COACHING CLASSES FOR SUPPLEMENTARY EXAMS. HOME AND COACHING. ACCOUNTING, STATISTICS AND ECONOMICS OF PART 1. ADVANCED...

University Of Karachi M.A. (Previous) and M.A. (Final) Examination IN ECONOMICS SCHEME OF STUDIES M.A. (Previous) 1. The examination for deg...

MAECONOMICS PRIVATE KARACHI UNIVERSITY,REGISTRATION DATE EXTENDED.

B.COM 1 & 2 ACCOUNTING, STATISTICS, ECONOMICS, ADVANCED ACCOUNTING, INCOME TAX LAW JOIN SIR KHALID 03223385752 R1173,AL NOOR SOCIETY,...

C.A. is sometimes used to identify the Chief Accountant & Chartered Accountant CAD see CASH AGAINST DOCUMENTS. CAFR see Comprehensive ...

MAECONOMICS FOR EXTERNAL CANDIDATES CRASH CLASSES PREVIOUS & FINAL MICRO ECONOMICS MACRO ECONOMICS ADVANCED STATISTICS FOR ECONOMICS...

In 1943, Dr. Abraham Maslow 's article "A Theory of Human Motivation" appeared in Psychological Review, which were further e...

INCOME TAX FOR B.COM STUDENTS

For Other Professional Qualifications All candidates seeking exemptions are required to apply on the prescribed Exemption form alongwith the...