Cost Accounting (14th Edition)

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Capital Budgeting and Cost Analysis
Learning Objectives
1. Understand the five stages of capital
budgeting for a project
2. Use and evaluate the two main
discounted cash flow (DCF) methods:
the net present value (NPV)
method and the internal rate-ofreturn
(IRR) method
3. Use and evaluate the payback and
discounted payback methods
4. Use and evaluate the accrual
accounting rate-of-return
(AARR) method
5. Identify relevant cash inflows and
outflows for capital budgeting
decisions
6. Understand issues involved in
implementing capital budgeting
decisions and evaluating managerial
performance
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7. Identify strategic considerations in
capital budgeting decisions
A firm’s accountants play an important role when it
comes to deciding the major expenditures, or
investments, a company should make.
Accountants, along with top executives, have to figure out how and
when to best allocate the firm’s financial resources among
alternative opportunities to create future value for the company.
Because it’s hard to know what the future holds and what projects
will ultimately cost, this can be a challenging task, one that
companies like Target constantly confront. To meet this challenge,
Target has developed a special group to make project-related
capital budgeting decisions. This chapter explains the different
methods managers use to get the “biggest bang” for the firm’s
“buck” in terms of the projects they undertake.
Target’s Capital Budgeting Hits the Bull’s-Eye 1
In 2010, Target Corporation, one of the largest retailers in the United
States, will spend more than $2 billion on opening new stores,
remodeling and expanding existing stores, and investing in information
technology and distribution infrastructure.
With intense competition from Wal-Mart, which focuses on lowprices,
Target’s strategy is to consider the shopping experience as a
whole. With the slogan, “Expect more. Pay less.” the company is
focused on creating a shopping experience that appeals to the profile
of its core customer: a college-educated woman with children at
home who is more affluent than the typical Wal-Mart customer. This
shopping experience is created by emphasizing store décor that gives
just the right shopping ambiance.
As a result, investments in the shopping experience are critical to
Target. To manage these complex capital investments, Target has a
Capital Expenditure Committee (CEC), composed of a team of top
executives, that reviews and approves all capital project requests in
excess of $100,000. Project proposals that are reviewed by the CEC
vary widely and include remodeling, relocating, rebuilding, and closing
an existing store to build a new store.
Target’s CEC considers several factors in determining whether to
accept or reject a project. An overarching objective is to meet the
corporate goals of adding a certain number of stores each year (for
1 Sources: David Ding and Saul Yeaton. 2008. Target Corporation. University of Virginia Darden School of
Business No. UV1057, Charlottesville, VA: Darden Business Publishing; Target Corporation. 2010. 2009
annual report. Minneapolis, MN: Target Corporation.