Fluent Essays

Please see the below the questions below that I would like to have individually answered. This assignment must consist of 1200+ words with 3 Scholarly Sources, the below reference must be used as one source. Please put the question number by the answer so that I know what answer goes with each question.**NO PLAGIARISM WHATSOEVER**1. Solve problems 5-29, 5-30 and 5-36 in the text pp. 194-195. Discuss result by answering the follow questions. 1. How are these project influenced by their funding source?2. Which characteristic should be valued most in prioritization?3. How would debt funding impact analysis and comparisons?2. Based on your findings from the previous analysis of 5-29, 5-30, and 5-36, provide justification for funding one of these projects (you may only choose one of the three). 3. Which factors influence the results of TVM analysis?4. What are the main limitations to the utilization of CBA?5. How does the utilization of debt financing impact capital planning?Reference and Textbook are below;Finkler, S. A., Calabrese, T., Purtell, R., & Smith, D. L. (2013). Financial management for public, health, and not-for-profit organizations (4th ed.). Boston: Pearson. textbook.pdf Unformatted Attachment Preview 5 CAPITAL BUDGETING The learning objectives of this chapter are to:  introduce capital budgeting and explain why a separate capital budget is needed;  define capital assets, in both theory and practice; S  explain the time value of money (TVM) concept and discuss the basic tools of TVM, including compounding and discounting, present M I present the tools of investment analysis, including net present cost, annualized cost, net present value, and internal rate of return; define and discuss cost-benefit analysis; and T define and discuss payback and accounting rate of return. H , and future value, and annuities;    A D As discussed in Chapter 2, when an operating budget is prepared, it includes costs that the Acoming year. Sometimes, however, the organization organization expects to incur for the spends money on the acquisition of M resources that will provide it with benefits beyond the INTRODUCTION coming year. A capital asset is anything the organization acquires that will help it to provide goods or services in more than one fiscal year.1 When organizations contemplate the acquisition of capital assets, special2attention is often paid to the appropriateness of the decision. The process of planning for the purchase of capital assets is often referred to as capital budgeting. A capital budget0is prepared as a separate document, which becomes part of the organization’s master budget. 0 In some organizations, all capital budgeting is done as part of the annual planning 8 and their purchase is planned for the coming year. process. Specific items are identified, In other organizations, an overall dollar T amount is approved for capital spending for the coming year. Then individual items are evaluated and approved for acquisition throughout S the year as the need for those items becomes apparent. One concern in the capital budget process is that adequate attention be paid to the timing of cash payments and receipts. Often large amounts of money are paid to acquire 1 162 Financial Management for Public, Health, and Not-for-Profit Organizations, Fourth Edition, by Steven A. Finkler, Thad D. Calabrese, Robert M. Purtell, and Daniel L. Smith. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc. ISBN 1-323-02300-3 A fiscal year may be a calendar year, or it may be any 12-month period. December 31 is the most common fiscal year-end. However, many not-for-profit organizations and local governments begin their fiscal year on July 1, or September 1, rather than January 1. The federal government begins its year on October 1. Generally, the fiscal year is chosen so that the end of the year coincides with the slowest activity level of the year. This allows accountants to take the time needed to summarize the year’s activity. Governments may choose a fiscal year that allows sufficient time for the body that approves the budget to review, revise, and adopt the budget by the beginning of the fiscal year. This requires coordination between the choice of the fiscal year-end and the time of the year that the legislative body is in session. Chapter 5 • Capital Budgeting 163 capital items well in advance of the collection of cash receipts earned from the use of those items. When an organization purchases a capital asset, it must recognize that by using cash today to acquire a capital asset, it is forgoing a variety of other potential uses for that money. At a minimum, cash could be put in an interest-earning account, and in the future the organization would have the original amount plus interest. As a result, paying $1,000 today cannot be equated with receiving $1,000 several years from now. One would only give up $1,000 today if the benefit to be realized from doing so is worth at least the $1,000 plus the interest that could be earned. This gives rise to a concept referred to as the time value of money (TVM). Based on the TVM concept discussed in this chapter, the financial appropriateness of an investment can be calculated. The discussion in this chapter examines TVM techniques for investment analysis, including net present cost, annualized cost, net present value, and internal rate of return. The chapter then examines an approach called cost-benefit analysis which governS ments often use in evaluating capital budgeting decisions. M The chapter concludes with a discussion of the payback and accounting rate of I but since they are sometimes return approaches. Both approaches have their limitations, used the reader should be aware of the methods and their T drawbacks. H , ISBN 1-323-02300-3 WHY DO WE NEED A SEPARATE CAPITAL BUDGET? Assume that the Hospital for Ordinary Surgery (HOS) is considering adding a new wing. The hospital currently has annual revenues of $150 million and annual operating expenses of $148 million. The cost to construct the Anew wing is $360 million. Once opened, the new wing is expected to increase the annual revenues and operating costs of HOS by $70 million and $20 million, respectively, D excluding the cost of constructing the building itself. A The operating budget for HOS would include $220 million in revenue (i.e., the M original $150 million plus the new $70 million). If the entire cost of the new wing is charged to operating expenses, the total operating expenses would be $528 million (i.e., $148 million of expenses, the same as last year, plus $20 million in new operating 2 expenses, plus the $360 million for the new building). This would result in a loss of 0 the project might be rejected as $308 million for the year. This amount is so huge that being totally unfeasible. 0 However, the benefit of the $360 million investment in the new wing will be real8 that provide benefits beyond ized over many years, not just one. When large investments the current year are included in an operating budget,Tthey often look much too costly. However, if one considers their benefits over an extended period of time, they may not be too costly. The role of the capital budget is to pull theS acquisition cost out of the operating budget and place it in a separate budget where its costs and benefits can be evaluated over its complete lifetime. Suppose that the top management of HOS, after careful review and analysis, decides that the benefits of the new hospital wing over its full lifetime are worth its $360 million cost. Based on the recommendation of chief operating officer (COO) Steve Netzer, as well as the hospital’s chief executive officer (CEO) and chief financial officer (CFO), the Board of Trustees of HOS approves the capital budget, including the cost of construction of the new wing. The cost of that capital asset will be spread out over its useful life, with a portion included in the operating budget each year. The process of spreading out the cost of a capital asset over the years the asset is used is called amortization, a general term that refers to any allocation over a period of Financial Management for Public, Health, and Not-for-Profit Organizations, Fourth Edition, by Steven A. Finkler, Thad D. Calabrese, Robert M. Purtell, and Daniel L. Smith. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc. 164 Part II • Planning time. Amortization of the cost of a physical asset is referred to as depreciation. Each year a portion of the cost of the asset is treated as an expense called depreciation expense.2 The aggregate amount of the cost of an asset that has been charged as an expense over the years the asset has been owned is referred to as accumulated depreciation. For example, if HOS builds the new hospital wing for $360 million and expects it to have a useful lifetime of 40 years, the depreciation expense each year would be $9 million ($360 million  40 years).3 Rather than showing the full building cost of $360 million as an expense in the first year, only $9 million is shown as an expense for the first year. After owning the building for three years, the accumulated depreciation will be $27 million ($9 million  3 years).4 DEFINITION OF CAPITAL ASSETS: THEORY AND PRACTICE In theory, a capital asset is any resource that will benefit the organization in more than one fiscal year. This means that, inS theory, if we were to buy something that will last for just six months, it could be a capital Mitem if part of the six months falls in one year and part falls in the next. In practice, however, organizations only treat items with a lifetime of more than one year as being capitalI assets. This is done to keep the bookkeeping simpler. Similarly, most organizations only T treat relatively costly acquisitions as capital assets. In theory, there should be no price limitation. A ballpoint pen purchased for 50 cents can be a capital asset if its life extends H from one accounting year into the next. However, no organization would treat the pen as, a capital asset. The pen would simply be included in the operating expenses in the year it is acquired. This is because its cost is so low. The cost of allocating 25 cents of depreciation in each of two years would exceed the value of the information generated by that allocation. A What about something more expensive like a $200 report-binding machine? In D not treat a $200 machine that is expected to last practice, most organizations would for 10 years as a capital asset. TheAreason is that even though it will last for more than 12 months, it is relatively inexpensive. If we were to depreciate it, we could divide the M $200 cost by 10 years and come out with a charge of $20 per year. For some very small organizations, the difference between charging $200 in 1 year and zero in the subsequent 9 years versus charging $20 per year for 10 years might be significant. However, that 2 would generally not be the case. 0 perfectly accurate. Compromises are made in Accounting information is rarely the level of accuracy based on the0cost of being more accurate and the value of more accurate information. Some estimates are unavoidable. Did we use half of the ink of the 50-cent pen in each of two years? 8 Perhaps we used 40 percent of the ink one year and 60 percent of the ink the next. A truly T correct allocation would therefore require charging S 2 Financial Management for Public, Health, and Not-for-Profit Organizations, Fourth Edition, by Steven A. Finkler, Thad D. Calabrese, Robert M. Purtell, and Daniel L. Smith. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc. ISBN 1-323-02300-3 At times, an organization may own a capital asset that does not have physical form, such as a patent. The allocation of the cost of such an asset is simply referred to by the generic term amortization. Some assets literally empty out (e.g., oil wells, coal mines) and amortization of the cost of such assets is referred to as depletion. 3 This example has been somewhat simplified. In most cases, we would expect the building to still have some value at the end of the useful lifetime. That residual, or salvage, value would be deducted from the cost before calculating the annual depreciation expense. For example, if we expect the building to be worth $40 million after 40 years, then only $320 million ($360 million cost less $40 million salvage) would be depreciated. The annual depreciation would be $8 million ($320  40 years) instead of $9 million. 4 From an economic perspective, true depreciation represents the amount of the capital asset that has been consumed in a given year. We could measure that by assessing the value of the asset at the beginning and end of the year. The depreciation expense would be the amount that the asset had declined in value. In practice, it is difficult to assess the value of each capital asset each year. Therefore, accounting uses simplifications such as an assumption that an equal portion of the value of the asset is used up each year. Alternatives, referred to as accelerated depreciation methods, are designed to better approximate true economic depreciation. They are discussed in Appendix 11-A at the end of Chapter 11. Chapter 5 • Capital Budgeting 165 40 percent of the cost of the 50-cent pen in one year and 60 percent of the cost the next year. Similarly, we do not know exactly how much of the binding machine is used each year. Will it really last 10 years, or will it last 11 years? Accounting records should be reasonable representations of what has occurred from a financial viewpoint and should allow the user of the information to make reasonable decisions. It is true that charging the full $200 cost in the year of purchase will overstate the amount of resources that have been used up in that year. However, it is easier to do it that way. The organization must weigh whether the simplified treatment is likely to create a severe enough distortion that it will affect decisions that must be made. For the 50-cent pen, that is never likely to happen. For a $360 million building addition, by contrast, treating the full cost as a current year expense would likely affect decisions. The hard part is determining where to draw the line. Organizations must make a policy decision regarding what dollar level is so substantial that it is worth the extra effort of depreciating the asset (allocating a share of its cost to each year it is used) rather than charging it all as S an expense in the year of acquisition. To most organizations, the difference between charging $200 in one year or $20 a M year for 10 years will not be large enough to affect any decisions. In some organizations, I the difference between charging $50,000 in one year versus $5,000 per year for 10 years would not be large enough to affect any decisions. A cutoff of $1,000, or $5,000, or even T $10,000 would be considered to be reasonable by many public, health, and not-for-profit H organizations. Many organizations use even higher levels. , WHY DO CAPITAL ASSETS WARRANT SPECIAL ATTENTION? It seems reasonable to include just one year’s worth A of depreciation expense in an operating budget. However, that does not fully explain why a totally separate budget D to be special approaches for is prepared for capital assets, or why there should need evaluating the appropriateness of individual capital asset A acquisitions. Some additional reasons that capital assets warrant special attention are: M ISBN 1-323-02300-3 • the initial cost is large, • the items are generally kept a long time, • we can only understand the financial impact if we2evaluate the entire lifetime of the assets, and 0 • since we often pay for the asset early and receive payments as we use it later, the 0 time value of money must be considered. 8 pen, the binding machine) are Since small capital expenditures (e.g., the ballpoint often not treated as capital assets, the items that are T included in the capital budgeting process are generally expensive. When the cost of an item is high, a mistake can be costly. Long-term acquisitions often lock us in, and aSmistake may have repercussions for many years. For example, suppose that HOS unwittingly buys 10 inferior patient monitors for $50,000 each. As we use them, we learn of their shortcomings and hear of another type of monitor that we could have purchased that performs better. Although we may regret the purchase, we may not have the resources to be able to discard the monitors and replace them. We may have to use the inferior machines for a number of years. To avoid such situations, the capital budgeting process used by many organizations requires a thorough review of the proposed investment and a search for alternative options that might be superior. The impact of capital acquisitions can only be understood if we consider their full lifetime. Suppose that a donor offers to pay the full cost for a new, larger, wonderful building for the organization. Do we need to look any further? The building will be free! Financial Management for Public, Health, and Not-for-Profit Organizations, Fourth Edition, by Steven A. Finkler, Thad D. Calabrese, Robert M. Purtell, and Daniel L. Smith. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc. 166 Part II • Planning However, that is not quite correct. Perhaps the new building will cost money to operate (for heat, power, maintenance, security, etc.) but will not generate any additional revenue or support for the organization beyond the donation to acquire it. The operating costs of the building must be considered. Capital budgets should consider all revenue and expense implications of capital assets over their useful lifetime. Governments face similar issues when they determine whether they should build a new school. Analysis of the feasibility of the new school building must consider whether we will be able to afford to run it once it is built. Governments must try to assess the likely impact of the added annual operating costs on the tax structure of the town, city, county, or state. Thus, capital budgeting takes a broad view, considering all the likely impacts of making a capital acquisition. A last, and critical, issue relates to the timing of payments and receipts. Often capital assets are acquired by making a cash payment at the time of acquisition. However, the cash the organization will receive as it uses the asset comes later. In the meantime, there is a cost for the money invested S in the project. Since cash is not available for free, we must consider the rent we pay for it. M When we use someone’s office or apartment, we pay rent for it. When we use I for that use. Rent paid for the use of someone’s someone’s money, we also pay rent money is called interest. For capitalTassets, the rental cost for money used over a period of years can be substantial, and its effect must be considered when we decide whether it makes sense to acquire the item. H In fact, there is an opportunity , cost for all resources used by an organization. Each resource could be used for some other purpose. We often refer to the opportunity cost of using resources in an organization as the cost of capital. Part of the cost of capital is reflected in the interest that the organization A pays on its debt. However, there is also a cost of using the resources that the organization owns. If they are not used to buy a particular capital D else. Thus, whenever a capital asset is purchased, asset, they could be used for something we must consider the cost of the money A used for that purchase. Calculations related to the cost of capital or cost of money are referred to as time value of money computations. M THE TIME VALUE OF MONEY 2 Financial Management for Public, Health, and Not-for-Profit Organizations, Fourth Edition, by Steven A. Finkler, Thad D. Calabrese, Robert M. Purtell, and Daniel L. Smith. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc. ISBN 1-323-02300-3 A dollar today is not worth the same amount as a dollar at some future time. Imagine 0 someone $10,000 today with the expectation that whether we would be willing to lend they would give us back $10,000 in0five years. Would we consider that to be a reasonable investment? Probably not. If we had instead invested the money in a safe bank account or U.S. Treasury security that pays8interest, at the end of five years we would have our $10,000 plus interest. Getting $10,000 T in five years is not as good as having $10,000 today. This gives rise to a concept referred to as the time value of money (TVM). Suppose that the Museum of Technology S is considering buying computers for an exhibit for $50,000. The money would come from cash that the museum currently has. It will be able to charge $12,000 per year in special admissions fees for the exhibit for five years. At that point, the exhibit will be closed and the computers will be obsolete and will be thrown away. If the museum uses a capital budget, the initial cash outlay will be $50,000, and the full five years of ... Purchase answer to see full attachment