Use the basic tools and concepts of financial analysis:
investment, return, future value, present value, annuities, and required rate
of return.
Investment and Return
Present Value
What is the present value of $127.63 to be received 5 years from now when the rate of return is 5% per year? $100.00
PV = FV ÷(1 + r)n

Time Value of Money
The future value of money is the value that an amount invested today will be after a stated number of periods at a given rate of return. How much would an initial amount of $100 accumulate over five years when the rate of return is 5% per year?
Time Value of Money
A central concept in capital budgeting is the time value of money. Because money can earn a return, its value depends on the time period in which it is received. Amounts of money received at different periods of time must be converted to their value on a common date to be compared.
Investment is the monetary value of the assets that the organization gives up to acquire a long-term asset. Return is the increased cash inflows in the future that are attributable to the long-term asset. Investment and return are the foundations of capital budgeting analysis.
Capital Budgeting Chapter 8
Learning Objective 1
Describe the nature and importance of long-term
assets.
Long-Term (Capital) Assets
What are long-term capital assets? Long-term capital assets are equipment or facilities that provide productive services to the organization for more than one accounting period.
Year 4: $1.2155 Year 3: $1.1576 Year 2: $1.1025 Year 1: $1.05 Year 0: $1.00
Present Value
What is the present value of money? It is the current monetary worth of an amount to be paid in the future under stated conditions of interest and compounding. Analysts call a future cash flow’s value at time zero its present value. The process of computing present value is called discounting.
Long-Term (Capital) Assets
What is capital budgeting? It is a systematic approach to evaluating an investment in long-term assets.
Learning Objective 2
Time Value of Money
Today
Year 5
5% 5% 5% 5% 5%
$100.00
$127.63
FV = PV ×(1 + r)n
Time Value of Money
Compound Growth of Investment, 5 periods at 5% Year 5: $1.2763
Long-Term (Capital) Assets
Organizations have developed specific tools to control the acquisition and use of longterm assets for three reasons: 1 Organizations commit to long-term assets for extended periods of time. 2 The amount of capital committed is usually very large. 3 The long-term nature of capital assets creates technological risk for organizations.