Capital Budgeting Theories: Basic Concepts

 

Capital Budgeting

MODULE 9 CAPITAL BUDGETING THEORIES: Basic Concepts Decision Making Process 2. The frst frst step in in the decisio decision-maki n-making ng proces process s is to A. deter determine mine and and evaluate evaluate possible possible course courses s o action. action. B. identiy the problem problem and assign respon responsibility sibility.. C. ma mak ke a dec decis isio ion. n. D. review review resul results ts o the the decision decision.. Strategic planning 39.Strategic planning is the process o deciding on an organization’ A. minor programs programs and the approximate approximate resourc resources es to be devoted devoted to them them B. major programs programs and the approximate approximate resourc resources es to be devoted devoted to them them C. minor pr programs ograms prior prior to consideration consideration o o resources resources that that might be be needed D. major pro programs grams prior to to consideration consideration o resources resources that that might be needed needed Capital budgeting defned 1. The long long-te -term rm plannin planning g proc process ess or making making and fnanc fnancing ing invest investmen ments ts that aect aect a company’s fnancial results over a number o years is reerred to as A. ca capi pita tall bu budg dget etin ing g C. ma mast ster er budg budget etin ing g B. strategic planning D. long-range planning 3. Capital Capital budgetin budgeting g is the proces process s A. used iin n sell or or process process urth urther er decisio decisions. ns. B. o dete determi rmining ning how how much capit capital al stock stock to issue issue C. o making making capital capital expen expenditur diture e decisions decisions D. o eliminatin eliminating g unprofta unproftable ble product product line line 5. A capital capital investmen investmentt decision decision is essenti essentially ally a decisio decision n to: A. exc exchang hange e current current assets assets or current current liabiliti liabilities. es. current ent cash outows outows or the promise promise o receiving receiving uture uture cash inows. inows. B. exchange curr C. exchang exchange e current current cash ow rom rom operatin operating g activities activities or uture uture cash inows rom rom investing activities. D. exchange current current cash inows inows or uture cash outows. outows. Risk & return 6. The highe higherr the risk risk element element in in a projec project, t, the A. mor more e attract attractive ive the the investm investment ent is. is. B. high higher er the the net present present value value is. is. C. higher higher the the cost cost o capita capitall is. is. higher er the the discou discount nt rate rate is. is. D. high 9. Cos Costt o o capi capital tal is the A. amoun amountt the company company must must pay or or its plant plant assets assets.. B. divid dividends ends a company company must must pay on its equity equity sec securit urities. ies. C. cost the company must must incur to obtain its capital capital resourc resources. es. D. cost cost the company company is char charged ged by invest investmen mentt banke bankers rs who handle handle the issua issuance nce o  equity or long-term debt securities. 14.How should the ollowing projects projects be listed in order o increasing increasing risk? A. New ven ventur ture, e, replac replacement ement,, expansi expansion. on. B. Re Replac placement ement,, new ventur venture, e, expansio expansion. n. Replac placement ement,, expansio expansion, n, new ventur venture. e. C. Re D. Expansion Expansion,, replaceme replacement, nt, new ventur venture. e. 41.Pr 41.Problem oblems srates associat assothat ciated ed justiying ing investment investments s in high-tech high-tech pr projec ojects ts oten oten include include discount arewith too justiy A. low a and nd time time horizo horizons ns that that are are too long long B. high a and nd time time horizons horizons that that are are too long long C. high and and time time horizons horizons that that are are too short short 227

 

Capital Budgeting

D. low and and time horizo horizons ns that that are too too short short 60.In evaluating high-tech projects, projects, A. only ta tangib ngible le benefts benefts should should be be consider considered. ed. B. only int intang angible ible benefts benefts should should be consid considere ered. d. C. both tangible tangible and intangible intangible benefts should be considered. considered. D. neither tang tangible ible nor intangible benefts should should be consider considered. ed.  Types  Types o capital projects projects 4. A proj project ect that that when accepte accepted d or rej reject ected ed will not aect aect th the e ca cash sh ows o another another project. Indepe epende ndent nt pro projec jects ts C. Mutually Mutually exc exclusi lusive ve pr projec ojects ts A. Ind B. Dependent projects D. Both b and c

Capital budgeting process 7. The norma normall methods methods o analyz analyzing ing inves investment tments s A. cann cannot ot be used used by not-or not-or-pr -proft oft entities entities.. B. do not app apply ly i the projec projectt will not produc produce e revenues. revenues. C. cannot cannot be used used i the compan company y plans plans to fnance fnance the project project with unds unds already already available internally. D. requir require e orecasts orecasts o cash cash ows expected expected rom rom the project. project. Investments Sale o old asset 38.When disposing o an old asset and replacing replacing it with a new one, tax eect on A. gain on sale sale o the old asset asset reduces reduces the basis basis o the new asset asset B. gain on sale sale o the old asset asset increases increases the basis basis o the the new asset asset C. loss on sale o the the old asset asset reduces reduces the basis basis o the new asset asset D. b and c Working capital 18.A major dierence between an investment in working capital and one in depreciable assets is that A. an invest investment ment in working working capital is never return returned, ed, while most deprecia depreciable ble assets assets have some residual value. B. an investme investment nt in worki working ng capital capital is return returned ed in u ull ll at the end o a proje project’ ct’s s lie, lie, while an investment in deprecia depreciable ble assets has no residual residual value. C. an inv invest estmen mentt in working working ca capit pital al is not tax-dedu tax-deducti ctibl ble e wh when en mad made, e, nor taxable taxable when wh en ret etur urne ned, d, wh whil ile e an in inve vest stme ment nt in de depr prec ecia iabl ble e as asse sets ts do does es al allo low w ta tax x deductions. D. because an inves investment tment in working working capital is usually returned returned in ull at the end end o the project’s lie, it is ignored in computing the amount o the investment required or the project. 30.The proper treatment o an investment investment in receivables receivables and inventory inventory is to A. ig igno norre it it B. add it to th the e requir required ed investme investment nt in fxed fxed assets assets C. add it to the requir required ed investme investment nt in fxed fxed asse assets ts and subtra subtract ct it rom rom the annua annuall cash ows assets and add the present present value o the the recovery recovery to D. add it to the investment in fxed assets the present value o the annual cash ows 31.In connection with a capital budgeting project, an investment in working capital is normally recovered A. at the the end o the the proj project’s ect’s lie B. in th the e frst frst year o the the projec project’s t’s lie lie C. evenly evenly through through the pro project’ ject’s s lie lie D. when the the company company goes goes out o busine businessA ssA 32.XYZ Co. is adopting just-in-time principles. principles. When investment project that would reduce inventory, how should XYZ treat the evaluating reduction? an investment A. Ig Ign nore it. it. B. Decre Decrease ase the cost cost o the investm investment ent and decre decrease ase cash cash ows at the end o the project’s lie. 228

 

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C. Decrease Decrease the the cost cost o the invest investment. ment. D. Decrease Decrease the cost cost o the investment investment and increa increase se the cash ow at the end o the project’s lie.

Relevant cash fows 72.Which o the ollowing represents the biggest challenge in the decision to purchase new equipment? A. B. C. D.

Esti Estimatin mating g employee employee trainin training g or the new proj project. ect. Estimating Estimatin g cash cash ows ows or or the utu uture. re. Estimatin Estimating g transport transportatio ation n costs o the new equipmen equipment. t. Estimatin Estimating g maintenanc maintenance e costs or the new equipm equipment. ent.

51.When a frm has the opportunity to add a project that will utilize act actory ory capacity that is currently not being used, which costs should be used to determine i the added project should be undertaken? A. Opportunity costs C. Net present costs B. Hi Hist stor oric ical al cos costs ts D. Inc Incrreme ementa ntall cost costs s 11.The only uture costs that are relevant to deciding whether to accept an investment are those that will A. be dierent dierent i the project project is accepted rather than than rejected. rejected. B. be saved i tthe he project project is accepte accepted d rather rather than reject rejected. ed. C. be deduct deductible ible or tax purposes purposes.. D. aect net in income come in the the period that that they are are incurred. incurred. Cash inow 66.Which o the ollowing is not a typical cash inow in capital investment decisions? A. Incremental revenues C. Salvage value B. Cost Cost red reduc ucti tion ons s D. Add Addition itional al worki working ng capit capital al Out-o-pocket costs 45.Which o the ollowing is a cost that requires a uture outlay o cash that is which relevant or uture decision-makin decision-making? g? A. Opportunity cost C. Sunk costs B. Out Out-o -o-po -pock cket et co cost st D. Relevan elevantt bene benefts fts Depreciation & Tax Tax 22.I there were no income taxes, depreciat eciation ion would would be ignored ignored in capital capital budgeting. budgeting. A. depr B. the NPV NPV meth method od would would not not work. work. C. income income would be be discounted discounted instea instead d o cash ow. ow. D. all potential potential investme investments nts would would be desirable. desirable. 21.Relevant cash ows or net present value (NPV) models include all o the ollowing except A. outo outows ws to purchas purchase e new equipment equipment B. depreciat depreciation ion expense expense on the newly newly acquired acquired piece piece o equipment C. reductio reductions ns in operating operating cash cash ows as a result result o using using the new new equipment. equipment. D. cash outows rrelated elated to purchasing purchasing additional additional inventories or or another retail retail store. 55.When evaluating depreciation methods, managers who are concerned about capital investment decisions will: A. choose straight straight line depreciation depreciation so there there is minimum impact impact on the decision. B. use units o pro product duction ion so more depreciat depreciation ion expense expense will be allocated allocated to the later years. C. use accele accelerat rated ed methods methods to hav have e as much depreci depreciati ation on in the early early years o an asset’s lie. D. choice o depr depreciation eciation method has has no impact impact on the capital investment decision. decision. 70.The taxinvestment consequences should be considered under which circumstances when making capital decisions? A. Positive net income C. Depreciation B. Dispos Disposal al o an ass asset et D. All All o the the abo above ve

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Irrelevant cash fows Loan fnancing 43.In addition addition to increment incremental al revenue revenues, s, cash inows rom capital capital investment investments s can be generated rom all o the ollowing sources except: debt bt fn fnan anci cing ng A. de B. co cost st sa savi ving ngs s C. sa salv lvag age e valu value e D. reducti reduction on in the amount amount o working working capita capitall 10.I Helena 10.I Helena Company Company expects expects to get a one-y one-year ear bank loan loan to help help cover cover the initial initial fnancing o one o its capital projects, the analysis o the project should A. oset the loan aga against inst any investmen investmentt in inventory inventory or receivable receivables s required required by the project. B. show th the e loan as an an increase increase in the the investmen investment. t. C. show the loan as a cash outow outow in the second year o the project’s project’s lie. lie. D. ign ignor ore e the the loa loan n Sunk cost 29.In deciding whether to replace a machine, which o the ollowing is NOT a sunk cost? A. The expected expected resale resale price price o the existi existing ng machine. machine. B. The b book ook value value o the exist existing ing m machi achine. ne. C. The origina originall cost o the the existin existing g machine. machine. D. The deprec depreciate iated d cost o the existin existing g machine. machine.

Accounting rate o return 54.Th 54 .The e pr prim imar ary y adva advant ntag ages es o th the e aver averag age e ra rate te o ret etur urn n meth method od ar are e it its s ease ease o  computation and the act that: A. It is especially especially useul useul to managers managers whose whose primary concern concern is liquidity B. Th Ther ere e is le less ss poss possib ibil ilit ity y o loss loss r rom om chan change ges s in econ econom omic ic cond condit itio ions ns and and obsolescence obsolescenc e when the commitment is short-term short-term C. It emphasizes the amount o income earned over over the lie lie o the propo proposal sal D. Rankings Rankings o propos proposals als are are necessary necessary Nondiscounted cash fow method Payback method 36.There are several capital budgeting decision models that do not use discounted cash ows. What is the name o the simple technique that calculates the total time it will take to recover, using cash inows rom operations, the amount o cash invested in a project? A. Recovery period C. External rate o return B. Pay ayba back ck mo mode dell D. Account Accounting ing rate rate o o retur return n 34.The technique most concerned with liquidity is ayba back ck met metho hod. d. A. Pay B. Net prese present nt value value techni technique que.. C. Inter Internal nal rate rate o o retur return. n. D. book book rate rate o retu return rn.. 73.Which o the ollowing is a potential use o the payback method? A. Help man manager agers s control control the risks risks o estimatin estimating g cash ows ows B. Help min minimize imize the the impact impact o the investment investment on liqui liquidity dity C. Help contr control ol the risk risk o obsol obsolesce escence nce D. All o the the answers answers are are corr correct ect 47.The cash payback technique: A. shou should ld be used used as as a fnal fnal screenin screening g tool. tool. B. can be the on only ly basis basis or the capital capital budget budgeting ing decisio decision. n. C. is relativ relatively ely easy easy to compute compute and under understan stand. d. D. considers the expected expected proftabil proftability ity o a project. project. 33.Which o the ollowing is NOT a deect o the payback method? A. It ignores ignores cash cash ows ows because because it uses uses net income. income. B. It ig ignor nores es prof proftabil tability ity.. C. It ignores ignores the the present present values values o cash cash ows. ows. 230

 

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D. It ignor ignores es the pattern pattern o cash ows ows beyond the the payback period. period. 48.The payback method, as a capital budgeting technique, assumes that all intermediate cash inows are reinvested to yield a return equal to: C. The Disco Discount unt Rate Rate A. Zero B. The The Time Time-A -Adj djus uste tedd-R Rat ate-o e-o-R -Ret etur urn n D. Th The e Cost-o Cost-o-Capi -Capita tall 52.Which o the ollowing capital budgeting methods is the least theoretically correct? A. pa payb ybac ack k me meth thod od C. inter internal nal rate rate o o retur return n B. net present value D. none o the above

Discounted cash fow method 49.Which o the ollowing methods o evaluating capital investment projects incorporates the time value o money? A. Payback Payback period, accounting accounting rate o return, return, and internal rate o return return B. Accounting Accounting rate o return, return, net present present value, and and interna internall rate o return return C. Paybac Payback k period and and accountin accounting g rate o retur return n D. Net presen presentt value and inter internal nal rate rate o return return Net present value 69.Discounted cash ow analysis is used in which o the ollowing techniques? techniques? A. Ne Nett pres presen entt valu value e C. Co Cost st o capi capita tall B. Payback period D. All o the above 8. The primary primary capital budgeting budgeting method method that uses uses discounted discounted cash cash ow techniques techniques is the A. net pre presen sentt value value metho method. d. B. cash cash payba payback ck techn techniqu ique. e. C. annual annual rate rate o retur return n method method.. D. proftabi proftability lity index index method method.. 20.The net present value (NPV) model can be used to evaluate and rank two or more proposed propo sed projects. The approach that computes the total impact on cash ows or each option and then converts these total cash ows to their present values is called the A. dierential approach C. contribution approach D. tota totall pro project ject appr approach oach.. B. incre incremen mental tal appr approac oach. h. 40.The discount rate commonly used in present present value calculations is the A. treas treasur ury y bill bill rate rate B. weig weighted hted average average retur return n on assets assets adjusted adjusted or or risk C. risk ree ree rate rate plus plus inat ination ion rate D. sharehold shareholders’ ers’ expected expected retur return n on equity 44.Which is true o the net present value method o determining the acceptability o an investment? A. The initial initial cost o the investment investment is subtract subtracted ed rom the present present value value o net cash ows B. The net c cash ash ows ows are not not adjusted adjusted to present present value value C. A negative n net et present present value indicates indicates the the investment should be be undertaken undertaken D. The net pr present esent value method requires requires no subjective subjective judgments judgments Proftability index 35.The proftability proftability index A. does no nott take into into account account the discoun discounted ted cash cash ows. B. Is calcu calculated lated by dividin dividing g total cash cash ows by the initial initial investment investment.. C. allows comparison comparison o the relative relative desirability desirability o projects projects that require require diering diering initial investments. D. will never be greater greater than 1.0. Internal rate o return 56.According to the reinvestment rate which assumes cash ows are reinvested at assumption, the project’s rate o method return? o capital budgeting C. int inter ernal nal rate rate o o retur return n A. payb paybac ack k per perio iod d B. net present value D. none o the above

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62.The rate o interest that produces a zero net present value when a project’s discounted cash operating advantage is netted against its discounted net investment is the: A. Cost o capital C. Cuto rate D. Inter Internal nal rate o ret return urn B. Disc Discou ount nt ra rate te 57.A weakness o the internal rate o return method or screening investment projects is that it: A. Does not consi consider der the the time time value value o money money B. Implic Implicitl itly y ass assume umes s that that the compa company ny is able able to to rein reinves vestt cas cash h ows ows ro rom m the the project at the company’s discount rate C. Impli Implicitl citly y assumes that that the company is able to reinvest reinvest cash ows rom rom the project project at the internal rate o return D. Fails to consid consider er the timing timing o cash cash ows Comprehensive 50.Which o the ollowing methods o evaluating capital investment projects do not use a percentage as a measurement unit? A. Pa Paybac yback k period period and net net presen presentt value value B. Acc Account ounting ing rate rate o retur return n and payback payback period period C. Net presen presentt value and inter internal nal rate rate o return return D. Internal Internal rate rate o return return and payback payback period period

Relationships among NPV, PI & IRR 24.I a company’s required rate o return is 12 percent and in using the proftability index method, a project’s index is greater than 1.0, this indicates that the project’s rate o  return is A. equal to 12 percent. C. less than 12 percent. great eater er than than 12 per percen cent. t. D. dependent dependent on on the size size o the investm investment. ent. B. gr 25.I the present value o the uture cash ows or an investment equals the required investment, the IRR is A. equ equal al to to the the cuto cuto rat rate. e. B. equal to the cost cost o borro borrowed wed capita capital. l. C. eq equa uall tto o zer zero. o. D. lower than than the compan company’s y’s cuto cuto rate retur return. n. 27.The relationship between payback period and IRR is that A. a paybac payback k period period o less than than one-hal one-hal the lie lie o a proje project ct will will yield yield an IR IRR R lower lower than the target rate. B. the payback payback period period is the presen presentt value actor actor or the the IRR. IRR. C. a pr proj ojec ectt whos whose e payb paybac ack k peri period od does does not not meet meet th the e comp compan any’ y’s s cuto cuto  ra rate te o orr payback will not meet the company’s criterion or IRR. D. no none ne o o the the abov above. e. 67.When comparing NPV and IRR, which is not true? A. With NPV, the discount rate rate can be adjusted to take into into account increased increased risk risk and the uncertainty o cash ows B. Wit With h IRR, cash cash ows can be adjust adjusted ed to account account or risk risk C. NPV can be be used to compar compare e investments o various size or magnitude D. Both NPV an and d IRR can can be used or screening screening decisions decisions

Sensitivity analysis 13.In capital budgeting, sensitivity sensitivity analysis is used A. to deter determine mine whether whether an an investment investment is proftab proftable. le. B. to see how a decisio decision n would be aecte aected d by changes changes in variable variables. s. C. to test the relati relationsh onship ip o the IRR IRR and NPV. NPV. D. to evaluate evaluate mutually mutually exclusi exclusive ve investment investments. s. 15.An approach that uses a number o outcome estimates to get a sense o the variability among potential returns is techn A. the d disco iscounted unted cash ow technique. ique. B. the net net prese present nt value value metho method. d. C. ri risk sk anal analys ysis is.. D. sen sensit sitivi ivity ty analysi analysis. s. 232

 

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42.Sensitivity analysis is the study o how the outcome o a decision making process process A. chan changes ges as one one or more more o the assump assumption tions s change change B. remains the same even even though one or more more o the assumptions assumptions change change C. changes even though one one or more more o the assumptions do not change change D. does not change as as the assumptions assumptions do not change change either 64.Sensitivity analysis is: A. An appropriate appropriate response response to uncertaint uncertainty y in cash cash ow projecti projections ons B. Use Useul ul in measurin measuring g the variance variance o the Fish Fisher er rate C. Typically conducted conducted in the post investment investment audit audit D. Useul to co compare mpare projects projects requiring requiring vastly vastly dierent levels levels o initial initial investment IRR = 0 58.i the internal rate o return on an investment is zero: A. its NPV is positi positive. ve. annual cash cash ows equal equal its requi required red invest investment. ment. B. its annual C. it is generally generally a wise wise inves investment tment.. D. its cash cash ows ows decrease decrease over over its lie. lie. Change in NPV 59.Which o the ollowing would decrease the net present value o a project? A. A dec decrea rease se in the income income tax tax rate rate B. A dec decrea rease se in the the initia initiall investme investment nt C. An increa increase se in the useu useull lie o the the project project D. An increa increase se in the the discoun discountt rate Eect o change in cost o capital 26.All other things being equal, as cost o capital increases A. mor more e capital capital projects projects will will probably probably be acceptab acceptable. le. B. ewer capita capitall projects projects will will probably probably be acceptab acceptable. le. C. the number o capital capital projects projects that are are acceptab acceptable le will change, change, but the directio direction n o  the change is not determinable just by knowing the direction o the change in cost o capital. D. the company wil willl probab probably ly want to borrow borrow money rather rather than issue issue stock. Eect o change in residual value 23.Assuming that a project has already been evaluated using the ollowing techniques, the evaluation under which technique is least likely to be aected by an increase in the estimated residual residual value o the project? A. Pay ayba back ck Per Perio iod. d. C. Net Prese Present nt Valu Value. e. B. Internal Rate o Return. D. Proftability Index.

Decision rules – independent projects 68.What 68.W hat type type o decisi decision on involv involves es decidi deciding ng i an invest investmen mentt meets meets a prede predeter termin mined ed standard? A. Investment decisions C. Management decisions B. Scr Screen eening ing dec decisi ision ons s D. Pr Preer eerence ence decision decisions s Payback period 46.I a payback period or a project is greater than its expected useul lie, the A. pro project ject will will always always be proftab proftable. le. entire e initial initial investment investment will will not be recove recovered red.. B. entir C. project wo would uld only be acceptable acceptable i the the company’s cost cost o capital wa was s low. low. D. project’s rreturn eturn will will always exceed exceed the company’s company’s cost o capital. Net present value 61.An analysis o a proposal by the net present value method indicated that the present value val ue o utur uture e ca cash sh inows inows exceed exceeded ed the amount amount to be invest invested. ed. Which Which o the ollowing statements best describes results o this A. The proposal propo sal is desirable desirab le and thethe rate o return return expanalysis? expected ected rom rom the proposal proposal exceeds the minimum rate used or the analysis B. The pro proposa posall is desirabl desirable e and the rate o return return expected expected rom the proposal proposal is less than the minimum rate used or the analysis 233

 

Capital Budgeting

C. The prop proposal osal is undesirable undesirable and the rate rate o return return expected rom rom the proposal proposal is less than the minimum rate used or the analysis D. The proposa proposall is undesi undesira rable ble and the rate o retur return n expec expected ted rom the propo proposal sal exceeds the minimum rate used or the analysis 63.NPV indicates a project is deemed desirable (acceptable) when the NPV is A. gre greater ater than or equal equal to zero zero B. le less ss th than an ze zerro C. greater greater than than or equal to the the risk-adjus risk-adjusted ted cost cost o capital capital D. less tha than n or equal equal to the risk-adjusted risk-adjusted cost o capital Internal rate o return 12.I Arbitrary Company wants to use IRR to evaluate long-term decisions and to establish a cuto rate o return, it must be sure that the cuto rate is A. at least least equal equal to to its cost o capita capital. l. B. at leas leastt equal to to the rate rate used by simila similarr companies companies.. C. greater greater than than the IRR on projec projects ts accepted accepted in the past. past. D. greater than the the current current book book rate o return. return. NPV & IRR 19.The NPV and IRR methods give A. the same decision (accept or or reject) reject) or any single single investment. investment. B. the same cho choice ice rom rom among mutually mutually exclus exclusive ive investment investments. s. C. dierent dierent rankings rankings o projec projects ts with unequal unequal lives. lives. D. the same rrankings ankings o projects projects with dierent dierent required required investments.

Decision rule – mutually exclusive projects 71.Mutually exclusive projects are those that: A. i accepted, accepted, preclude preclude the the acceptance acceptance o o competing competing projects. projects. B. i acce accepted, pted, can can have a negative negative eect eect on the company’ company’s s proft. proft. C. i accepted, can also lead lead to the the acceptance acceptance o a competing competing project. project. D. requir require e all managers managers to consider consider.. 28.In choosing rom among mutually exclusive investments the manager should normally select the one with the highest A. Ne Nett pres presen entt value value.. C. Proft Proftabi abilit lity y inde index. x. B. Internal rate return. D. Book rate o return. 53.Why do the NPV method and the IRR method sometimes produce dierent rankings o  mutually exclusive investment projects? A. The NPV metho method d does not assume assume reinvestm reinvestment ent o cash ows while while the IRR method assumes the cash ows will be reinvested at the internal rate o return. method assumes assumes a reinvestm reinvestment ent rate equal equal to the discount discount rate rate while the B. The NPV method IRR method assumes a reinvestment rate equal to the internal rate o return. C. The IRR method method does not assume assume rei reinve nvest stmen mentt o the cash cash ows ows while while the NPV assumes the reinvestment rate is equal to the discount rate. D. The NPV method method assume assumes s a reinves reinvestment tment rate rate equal to the bank loan interest interest rate while the IRR method assumes a reinvestment rate equal to the discount rate.

Post-audit 16.Post-audit o capital projects A. is usua usually lly conclu conclusiv sive. e. B. is done using die dieren rentt evaluation evaluation techniques techniques than than were used in making the original original capital budgeting decision. C. pr prov ovid ides es a o orrma mall me mech chan anis ism m by wh whic ich h th the e co comp mpan any y ca can n de dete term rmin ine e wh whet ethe herr existing projects should be supported or terminated. D. al alll o the the abo above ve.. 17.A th thor orou ough gh evalua evaluatio tion n o how how well well a proje project’ ct’s s ac actua tuall pero perorm rmanc ance e matche matches s the projections when the projectCwas isacalled A . pre-auditmade . . seproposed nsitivity an lysis. a post st-a -aud udit it.. D. risk risk a ana naly lysi sis. s. B. po 37.A o ollo llow-u w-up p evalua evaluatio tion n o a ca capit pital al proje project ct is pero perorm rmed ed to see that that invest investmen mentt 234

 

Capital Budgeting

expenditures are proceeding on time and on budget, to compare actual cash ows with expenditures those originally predicted, and to evaluate continuation o the project. This ollow-up is called a post stau audi dit. t. C. ma mana nage geme ment nt aud audit it A. po B. perormance evaluation D. project review 65.Companies use post audits to: A. chastise managers whose project project does not exceed exceed projections. projections. B. pr prov ove e to mana manage gers rs th that at th they ey sh shou ould ld have have ac acce cept pted ed proj projec ects ts th they ey prev previo ious usly ly rejected. C. have the manager managers s revise poorly perorming perorming projects projects so the the projects projects will have larger larger return in the uture. D. provide eedback eedback that enables enables managers managers to improve improve the accuracy accuracy o the projections projections o u utu turre ca cash sh o ows ws,, th ther ereb eby y ma maxi ximi mizi zing ng th the e qu qual alit ity y o th the e fr frm’ m’s s ca capi pita tall investments.

PROBLEMS: Net Investment i . Br Bruel uelll Compan Company y is cons conside iderin ring g to repla replace ce its its old equ equipm ipment ent with with a new new one. one. The The old equipment had a net book value o P100,000, 4 remaining useul lie with P25,000 depr de prec ecia iati tion on each each year year. The The old old equip equipme ment nt can can be sold sold at P80,0 P80,000 00.. The The new new equipment equi pment costs costs P160,000, P160,000, have a 4-year 4-year lie. Cash savings savings on operating operating expenses expenses beore 40% taxes taxes amount to P50,000 per year. year. What is the amount o inves investment tment in the new equipment? A. P1 P160,000 C. P 80,000 B. P 72,000 D. P 68,0 68,000 00 Operating Cash Flow Cash Flow Beore tax ii . Taal aal Comp Compan any y is cons consid ider erin ing g th the e pur purchas chase e o a mach machin ine e th that at prom promis ises es to red educ uce e operating costs by equal equal amounts every year o its 6-year useu useull lie. The machine will costt P840,000 cos P840,000 and has no salvage salvage value value.. The machine machine has a 20% intern internal al rate o  return. retur n. Taal Company is subject to 40% income tax tax rate. The present present value o 1 or 6 periods at 20% is 3.326, and at the end o 6 periods is 0.3349.  The approximate approximate annual annual cash savings savings beore beore tax is closest closest to: A. P2 P252,555 C. P1 P187,592 D. P3 P327 27,5 ,592 92 B. P11 P112,55 2,555 5 Increase in Annual Income Tax . Mayon Mayon Company Company is consideri considering ng replaci replacing ng its old machin machine e with a new and more more ecient ecient one. The old machine has has book value o P100,000, P100,000, a remaining useul useul lie o 4 years, years,

iii

and annual straight-line depreciation o P25,000. The existing machine has a current market value o P80,000. The replacement machine would cost P160,000, have a 4year lie, and will save P50,000 per year in cash operating costs. I the replacement machine would be depreciated using the straight-line method and the tax rate is 40%, what should be the increase in annual income taxes? A. P14,000 C. P40,000 B. P28,000 D. P 4,000

Depreciation & Taxes Taxes . Prime Prime Consulti Consulting, ng, Inc. Inc. operates operates consu consultin lting g oces oces in Manila Manila,, Olongapo Olongapo,, and Cebu. Cebu. The frm frm is pr pres esen entl tly y cons consid ider erin ing g an in inve vest stme ment nt in a new new main mainr ram ame e comp comput uter er and and communication communicatio n sotware. sotware. The computer would would cost P6 million and have an expected expected lie lie o 8 years years.. For tax purpos purposes, es, the compute computerr can be depreci depreciate ated d using using either either straight stra ight-line -line method or Sum-o-theSum-o-the-Y Years’-Dig ears’-Digits its (SYD) method method over fve years. years. No salvage value is recognized in computing depreciation depreciation expense and no salvage value is expected at the the end o the lie o the equipment. The company’s cost cost o capital is 10 percent and its tax rate is 40 percent.

iv

 The present value annuity o period 1 or 5 are: periods is 3.791 and or 8 periods is 5.335. The present values o 1o end o each 1 0.9091 5 0.6209 2 0.8264 6 0.5645 3 0.6513 7 0.5132 235

 

Capital Budgeting

4 0.6830 8 0.4665  The present value o the net advantage o using SYD method o depreciation depreciation with a fve-year lie instead o straight-line method o depreciating the equipment is: A. P 86,224 C. P2 P215,560 B. P1 P11 15, 5,16 168 8 D. P287 P287,8 ,893 93 v

.

For For P450,0 P450,000, 00, Maleen Maleen Corporat Corporation ion purchas purchased ed a new machine machine with an es estimat timated ed useul useul lie o fve years with no salvage salvage value. The machine is expected expected to produce produce cash ow rom operations, net o 40 percent income taxes, as ollows: First year P160,000 Second year 140,000  Third year 180,000 Fourth year 120,000 Fith year 100,000 Maleen will use the sum-o-the-years-digits’ method to depreciate the new machine as ollows: First year P150,000 Second year 120,000  Third year 90,000 Fourth year 60,000 Fith year 30,000  The present value o 1 or 5 periods at 12 percent is 3.60478. The present values o 1 at 12 percent at end o each period are: End o: Period 1 0.89280 Period 2 0.79719 Period 3 0.71178 Period 4 0.63552 Period 5 0.56743 Had Maleen used straight-line method o depreciation instead o declining method, what is the dierence in net present value provided by the machine at a discount rate o 12 percent? A. Increase o P 9, 9,750 C. Decrease o P24,376 B. Dec Decre rease ase o P 9,7 9,750 50 D. Incr Increase ease o P24,37 P24,376 6

Accounting rate o return Based on initial investment vi . A piece piece o labor labor saving saving equipm equipment ent that Marube Marubeni ni Electro Electronic nics s Compan Company y could could use to reduc reduce e costs costs in one one o its plants plants in Angele Angeles s City City has just come ont onto o the market. market. Relevant data relating to the equipment ollow: Purchase cost o the equipment P432,000 Annual cost savings that will be provided by the equipment90,000 Lie o the equipment 12 years What is the simple rate o return to be provided by the equipment? A. Between 15% and 18%. C. 20.83%. D. 12.5 12.50 0%. B. 25.00%. Based on average investment . The BIBO BIBO Compan Company y has made an in inves vestme tment nt in video video and reco record rding ing equipme equipment nt that costs P106,700. P106,700. The equipment is expected to generate cash cash inows o P20,000 P20,000 per year.. How many years will year will the equipment equipment have to be used to provide provide the company with a 10 percent average accounting rate o return on its investment? A. 7. 7.2 28 yea yearrs C. 9.0 9.05 yea yearrs B. 5.55 years D. 4. 4.75 years

vii

viii

. Show Company Company is negotiating negotiating to purc purchase hase an equipment equipment that would cos costt P200,000, P200,000, with the expectation that P40,000 per year could be saved in ater-tax cash operating costs cos ts i the equipment equipment were were acquired. acquired. The equipment’ equipment’s s estimated estimated useul lie lie is 10 years, with no salvage value, and would be depreciated by the straight-line method. Show Company’s mi desired desir o return retu rn 5. is 12 per percent. cent. The presen value o  an annuity o 1 atminimum 12nimum percent percent ored 10rate periods is 5.65. 5.6 The present value valupresent e o 1 tdue in 10 periods, at 12 percent, is 0.322.  The average accrual accounting accounting rate o return (ARR) duri during ng the frst year o asset’s use is: 236

 

Capital Budgeting

A. 20.0 percent B. 10 10.5 .5 per perce cent nt

C. 10.0 percent D. 40 40.0 .0 per percent cent

ix

. An asset asset was purchas purchased ed or P66,000. P66,000. The The asset is expec expected ted to last or or 6 years and will will have a salvage value o P16,000. The company expects the income beore tax to be P7,200 and the tax rate applicable to the company is 30%. What is the average return on investment (accounting rate o return)? A. 17.6% B. 7.6%

C. 10.9% D. 12.3%

Net Investment x . The The Ma Mak kabay abayan an Comp Compan any y is plan planni ning ng to pur purch chas ase e a new new mach machin ine e whic which h it will will depreciate, or book purposes, on a straight-line basis over a ten-year period with no salvage value and a ull ull year’s depr depreciation eciation taken taken in the year o acquisition. acquisition. The new machine is expected to produce cash ows rom operations, net o income taxes, o  P66,000 P66, 000 a year in each o the next ten years. The accountin accounting g (book value) value) rate o  return retur n on the initial investment is expected expected to be 12 percent. percent. How much will the new machine cost? A. P3 P30 00, 0,00 000 0 C. P550 P550,,000 000 B. P6 P660,000 D. P792,000 xi

. The Fields Fields Company Company is planning planning to purchase purchase a new machine which which it will depreciate, depreciate, or book purposes, on a straight-line basis over a ten-year period with no salvage value and a ull year’s depreciat depreciation ion taken taken in the year o acquisition. acquisition. The new machine machine is expected to produce cash ow rom operations, net o income taxes, o P66,000 a year in each o the next ten years. years. The accounting (book (book value) rate o return return on the initial initial investment is expected expected to be 12%. How much will the new machine machine cost? P30 00, 0,00 000 0 C. P660 P660,,000 000 A. P3 B. P5 P550,000 D. P792,000

CFAT . The Hills Hills Company, Company, a calendar calendar company, company, purchase purchased d a new machine machine or P280,000 P280,000 on  January 1. Depreciation Depreciation or tax purposes will be P35,000 annually or eight years. The ac accou counti nting ng (book (book value) value) rate o retur return n (ARR) (ARR) is expec expected ted to be 15% on the initial initial increase incr ease in require required d investment. investment. On the assumption assumption o a uniorm uniorm cash inow, this investment is expected to provide annual cash ow rom operations, net o income taxes, o  A. P35,000 C. P42,000 B. P40,250 D. P7 P77, 7,0 000

xii

Payback Period . I an asset costs costs P35,000 and is expected expected to have a P5,000 P5,000 salvage value at the end end o 

xiii

its ten-year lie, and generates annual net cash inows o P5,000 each year, the cash payback period is A. 8 years C. 6 years B. 7 years D. 5 ye years xiv

. Consider a pr project oject that requires requires cash outow outow o P50,000 with a lie lie o eight years and a salvage value o P5,000. Annual beore-tax cash inow amounts to P10,000 assuming a tax rate o 30% and a requi require red d rate rate o return return o 8%. Salvage Salvage value value is ig ignor nored ed in computing depreciation. The project has a payback period o  A. 5. 5.0 years C. 6. 6.0 years B. 5. 5.6 6 ye yea ars D. 6.6 6.6 year years s

xv

. The ollowing ollowing incomplete incomplete inormation inormation is provided provided or an investment decision. decision. Cumulative Discounte Discount Cash Flows d Cash  Year  Year Cash Flow Factor Flows (10%) 0 P(450,000) 1.000 P(450,000) P(450,000) 1 21 80 0,,0 00 00 0 92 06 9 254,520 2 2 ..8 3 140,000 .751 Using break-even time (BET) analysis, when will the investment be recovered? 237

 

Capital Budgeting

A. In 2.73 years B. Lo Longe ngerr than than thre three e years years

C. At the end o year 2 D. In 2.21 2.21 ye year ars s

xvi

. Orla Orlando ndo Corporatio Corporation n is considerin considering g an investment investment in a new cheese-cut cheese-cutting ting machine machine to repla replace ce its existin existing g cheese cheese cutter cutter.. Inor Inormat mation ion on th the e exist existing ing mach machine ine and the replacement machine ollow: Cost o the new machine P400,000 Net annual savings in operating costs 90,000 Salvage value now o the old machine 60,000 Salvage value o the old machine in 8 years 0 Salvage value o the new machine in 8 years 50,000 Estimated lie o the new machine 8 years What is the expected payback period or the new machine? A. 4.44 years C. 2.67 years B. 8.5 8.50 yea yearrs D. 3. 3.78 78 ye year ars s

xvii

. For P4,500 P4,500,00 ,000, 0, Sinilo Siniloan an Corpor Corporati ation on purcha purchased sed a new machin machine e with with an estima estimated ted useu useull li lie e o fve years with with no salvage salvage value value at its retir retireme ement. nt. The machin machine e is expected to produce cash ow rom operations, net o income taxes, as ollows: First year P 900,000 Second year 1,200,000  Third year 1,500,000 Fourth year 900,000 Fith year 800,000 Siniloan will use the sum-o-the-years-dig sum-o-the-years-digits’ its’ method to depreciate the new machine as ollows: First year P1,500,000 Second year 1,200,000  Third year 900,000 Fourth year 600,000 Fith year 300,000 What is the payback period or the machine? A. 3 years C. 5 years B. 4 years D. 2 ye years

xviii

. Paz Paz Insuranc Insurance e Company’s Company’s management management is consider considering ing an advertis advertising ing program program that would require an initial expenditure o P165,500 and bring in additional sales over the next fve fve years. years. The cost cost o advertisi advertising ng is immediat immediately ely recogn recognized ized as expen expense. se. The projected additional sales revenue in Year 1 is P75,000, with associated expenses o  P25,000. The additional sales sales revenue and expenses expenses rom the advertising advertising program program are projected project ed to increase by 10 percent each year. year. Paz Insurance Insurance Company’s tax rate is 40 percent.  The payback period period or the advertising advertising program program is 3.0 0 ye yea ars A. 4.6 4.6 ye yea ars C. 3. B. 1. 1.9 years D. 2.5 years

xix

. The Leisu Leisure re Company is considering considering the purchase purchase o electro electronic nic pinball pinball machines machines to place plac e in amusement houses. houses. The machines machines would would cost a total o P300,000, P300,000, have an eight-year useul useul lie, and have a total total salvage value o P20,000. P20,000. Based on experience experience with other equipmen equipment, t, the company company estimates estimates that annual annual revenue revenues s and expenses expenses associated with the machines would be as ollows: Revenues orm use P200,000 Less operating expenses   Commissio Commissions ns to amusement amusement houses houses P100,000 P100,000   Insurance 7,000   De Depreciation 35,000   Maintenance 18,000 160,000 Net income P 40,000 Ignoring the eect o income taxes, the payback period or the pinball machines would be A. 3.7 3.73 yea yearrs B. 3. 3 .23 years

C. 4.0 4.0 yea yearrs D. 7. 7.5 years

Net Present Value 238

 

Capital Budgeting

xx

. It is the star startt o the year year and Agud Agudel elo o Comp Compan any y pl plan ans s to repla eplace ce its old old grin grindi ding ng equipment. The ollowing ollowing inormation inormation are made available by the the management: Old New Equipment cost P70,000 P120,000 Current salvage value 14,000 Salvage value, end o  5,000 16,000 useul lie Annual operating costs 44,000 32,000 Accumulated 55,300 depreciation Estimated useul lie 10 years 10 years  The company is not subject to tax and its cost o capital is 12%. What is the present value o all the relevant cash ows at time zero? A. (P 54, 54,000 000) C. (P (P10 106, 6,00 000) 0) B. (P120,000) D. (P ( P124,700)

xxi

. Cons Consider ider a project project that requir requires es an initial initial cash outow outow o P500,000 P500,000 with a lie o eight years and a salvage value o P20,000 upon its retirement. Annual cash inow beore tax amounts to P100,000 and a tax rate o 30 percent will be applicable. The required minimum rate o return return or this type o investment is 8 per percent. cent. The present present value o 1 and the annui annuity ty o 1, disc discoun ounted ted at 8 percen percentt or 8 period periods s are are 0.54 0.54 and and 5.747, 5.747, respect res pectively ively. Salvage Salvage value is ignored ignored in computing computing deprecia depreciation tion.. The net pr presen esentt value amounts to 17,606 A. P 7,560 C. P 17 B. P 10,050

D. P 20,050

xxii

. Zap Manuacturing Manuacturing has an investment opportunity opportunity to embark on a project project where yearly yearly reven revenues ues or fve years years ar are e to be P400,0 P400,000 00 and operatin operating g costs costs o P104,8 P104,800. 00. The equipment costs P1 million, and straight-line depreciation depreciation will be used or book and tax purposes. No salvage value is expected at the end o the project’s lie. The company has a 40 percent marginal tax rate and a 10 percent cost o capital. The equipment manuacturer has oered a delayed payment plan o P560,500 per year at the end o  the frst and second years. There will be no changes in working capital.  The present present value o annuity annuity o 1 or 5 periods periods is 3.7908 3.7908 at 10 percent. percent.  The present present values o 1 end o each period period at 10 percent percent are: Period 1 0.9091 Period 2 0.8264 Period 3 0.7513 Period 4 0.6830 Period 5 0.6209  The net present present value i the the equipment were were purchased purchased is A. P (87,977) C. P 1,922 B. P (25 (25,3 ,310 10)) D. P (61 (61,0 ,094 94))

xxiii

. Paz Paz Insuranc Insurance e Company’s Company’s management management is consider considering ing an advertis advertising ing program program that would require an initial expenditure o P165,500 and bring in additional sales over the next fve fve years. years. The cost cost o advertisi advertising ng is immediat immediately ely recogn recognized ized as expen expense. se. The projected additional sales revenue in Year 1 is P75,000, with associated expenses o  P25,000. The additional sales sales revenue and expenses expenses rom the advertising advertising program program are projected project ed to increase by 10 percent each year. year. Paz Insurance Insurance Company’s tax rate is 40 percent.  The present present value o 1 at 10 percen percent, t, end o each period: period: Period Present value o 1 1. 0.90909 2. 0.82645 3. 0.75131 4. 0.68301 5. 0.62092  The net present present value o the the advertising program program would be A. P 37,064 C. P 29 29,136 B. P(37,064) D. P( P(29,136)

xxiv

. Mario Hernandez plans to buy a haymaker. haymaker. It costs P175,000 and is expected to last or 239

 

Capital Budgeting

fve years. He presently hires 6 workers at P10,000 per month or each o the three harves har vestin ting g months months each each year year. The equipm equipment ent would would elimin eliminate ate the need need or two workers. work ers. Hernand Hernandez ez uses straight-lin straight-line e deprecia depreciation tion and pr project ojects s a salvage salvage value o  P25,000. His tax rate is 25% and and opportunity cost cost o unds is 12.0%. The present present value o 1discounted at 12 percent at the end o 5 periods is 0.56743 and the present value o an annuity o 1 or 5 periods is 3.60478. Which o the ollowing is true? A. The pr present esent value value o cash cash ows ows in year year 5 is P22,710 P22,710 B. NPV NPV is P2 P28, 8,43 436 6 C. NP NPV V is P15, P15,25 250 0 D. NP NPV V is is P14 P14,1 ,186 86 xxv

. Tabucol Aggrega Aggregates, tes, Inc. plans to replace one o its machines with a new ecient one.  The old machine has a net book value o P120,000 with remaining remaining economic lie o 4 years. This old machine can can be sold sold or P80,000. I the new machine machine were were acquired, acquired, the cash operating expenses will be reduced rom P240,000 to P160,000 or each o the our years, the expected expected economic lie o the new machine. machine. The new machine will cost cost  Tabucol  Tabucol a cash payment to the dealer o P300,000. The company is subject to 32 percent tax and or this kind kind o investment, a marginal cos costt o capital o 9 percent. The present value o annuity o 1 and the present value o 1 or 4 periods using 9 percent are 3.23972 and 0.70843, respectively.  The net present present value to be be provided by the replacement replacement o the old old machine is A. P28,493 C. P46,794 B. P15,693 D. P59, P59,5 594

xxvi

.Zambales Mines, Inc. is contemplating the purchase o equipment to exploit a mineral depo de posi sitt th that at is locat located ed on land land to which which th the e comp compan any y has has mine minera rall righ rights ts.. An engineering and cost analysis has been made, and it is expected that the ollowing cash ows would be associated with opening and operating a mine in the area. Cost o new equipment and timbers 2,750,000 Working capital required 1,000,000 Net annual cash receipts* 1,200,000 Cost to construct new road in three years 400,000 Salvage value o equipment in 4 years 650,000 *Receipts rom sales o ore, less out-o-pocket costs or salaries, utilities, insurance, etc. It is estimated that the mineral deposit would be exhausted ater our years o mining. At that point, the working working capital would would be released or reinvestment reinvestment elsewhere. elsewhere. The company’s discount rate is 20%.  The net present present value or the the project project is: A. P 454,620. C. P(561,553) B. P (7 (79, 9,30 303) 3).. D. P( P(20 204, 4,68 688) 8)..

With ination xxvii . By the the end o Dece Decembe mberr 31, 2005, 2005, Alay Alay Fou Founda ndatio tion n is consid consideri ering ng the the purcha purchase se o a copying machine or P80,000. P80,000. The expected expected annual annual cash cash savings savings are are expected to be P32,000 in the next our years. At the end o the our years, the machine will be discarded without any salvage value. All the cash savings are stated in number o  pesos pes os at Decemb December er 31, 2006. The The co compa mpany ny expecte expected d that that the inati ination on rate is constantly 5 percent percent each year year.. Hence, the frst year’s cash cash inow was adjusted adjusted or 5 percent ination. For simplicity, simplicity , all cash inows are assumed to be at year year-end. -end.  The present value value at 14 % o 1 or 4 periods is 2.91371. The present present value o 1 at end o each period are: Period 1 0.87719 Period 2 0.76947 Period 3 0.67497 Period 4 0.59208 Using the nominal rate o return o 14 percent, the net present value or this machine is A. P12,239 C. P13,419 B. P19,670 D. P27, P27,9 936 xxviii

. Perpe Perpetua tuall Founda Foundatio tion, n, Inc., Inc., a nonpr nonproft oft organ organiza izatio tion, n, has one o its activi activitie ties, s, the production o cookies or its snack ood store. Several years ago, Perpetual Foundation, Foundation, Inc.. purcha Inc purchased sed a speci special al co cooki okie-c e-cutt utting ing machine machine.. As o Decemb December er 31, 2006, 2006, this this machine will have been used or three years. years. Management is consider considering ing the purchase purchase 240

 

Capital Budgeting

o a newer, more ecient ecient machine. I purchased, purchased, the new machine would would be acquired on December 31, 2006. 2006. Management expects expects to sell 300,00 300,000 0 dozen cookies in each o  the next six years. years. The selling selling price o the cookies cookies is expected expected to average P1.15 P1.15 per dozen. Perpetual Perpetu al Foundation, Foundation, Inc. has two options: options: continue to operate operate the old machine, or sell the old machine machine and purchase purchase the new machine. machine. No trade-in trade-in was oered oered by the seller sell er o the new machine. machine. The ollowin ollowing g inormatio inormation n has been assembled assembled to help management decide which option is more desirable. Old New Machine Machine Original cost o machine at P80,000 P120,000 acquisition Remaining useul lie as o  6 years 6 years 12/31/06 Expected Expe cted annual annual cash cash operatin operating g expenses:   Variable cost per dozen P0.38 P0.29   Total fxed costs P21,000 P 11,000 Estimated cash value o   machines:   December 31, 2006 P40,000 P120,000   December 31, 2012 P 7,000 P 20,000 Assume all operating revenues and expenses occur at the end o the year.  The net advantage advantage in present present value o the the better alter alternative native is: A. B. C. D.

Re Retain tain Old Machine, Machine, P61,675. P61,675. Buy New New Machi Machine, ne, P61, P61,675 675.. Retain Retain Old Machine, Machine, P16,345. P16,345. Buy New New Machin Machine, e, P16,34 P16,345. 5.

Protability index xxix . The Pambansan Pambansang g Kamao Kamao Corporat Corporation ion has to replace replace its completel completely y damaged damaged boiler boiler machine with a new one. one. The old machine has a net net book value o P100,000 with with zero market value; thereore it will give a tax shield, based on 35% tax rate i replaced, by P35,000. P35, 000. The compa company ny has a 10 10 percent percent cost cost o capital capital.. Underst Understanda andably, bly, the the new machine, through a uniorm decrease in cash operating costs, will give a positive net prese present nt value, value, becaus because e this this machin machine e will will provi provide de an inter internal nal rate rate o retur return n o 12 percent.  The present present values at 10% 10% and 12%, respectively, respectively, are: are: 10% 12% Annuity o 1, 6 periods 4.35526 4.11141 1 end o 6 periods 0.56447 0.50663 I the machine were toestimated be depreciated using straight-line method or 6 years without any salvage value, the proftability proftab ility index is: A. 1.20 B. 1.06 C. 1.07 D. Cannot Cannot be determined determined rom rom the inorma inormation tion xxx

. The Mejicano Mejicano Company is planning planning to purchas purchase e a piece o equipment equipment that will reduce reduce annual cash expenses expenses over its 5-year useul useul lie by equal amounts. amounts. The company will depre dep recia ciate te the equipm equipment ent using using straig straightht-lin line e metho method d o depre deprecia ciatio tion n based based on estimated esti mated lie lie o 5 years withou withoutt any salvage salvage value. The company company is subject subject to 40 percent tax. The marginal marginal cost cost o capital or or this acquisition is 11.055 11.055 percent. percent. The manag man ageme ement nt accoun accountan tantt calcul calculate ated d that that the inter internal nal rate rate o retur return n based based on th the e estimated ater-tax cash ows is 12.386 percent and a net present value o P10,000.  The president, president, however, however, wants to kno know w the proftability proftability index index beore he he fnally decides. decides. What is the proftability proftability index or this investment? A. 1.011 C. 1.022 B. 1.034 D. 1.044

Internal Rate o Return xxxi . Diamond Company Company is planning planning to buy a coin-operated machine costing costing P400,000. For book and tax purposes, this machine will be depreciated P80,000 each year or fve 241

 

Capital Budgeting

years.. Diamon years Diamond d estima estimates tes that that this this machin machine e will will yield yield an annual annual inow, inow, net o  depreciation deprecia tion and income taxes, taxes, o P120,000. Diamond’s desired desired rate o return on its investments is 12%. 12%. At the ollowing ollowing discount rates, rates, the NPVs o the investment investment in this machine are: Discount Rate NPV 12% +P3,258 14% + 1,197 16% 708 18% - 2,474 Diamond’s expected IRR on its investment in this machine is A. 3.25% C. 16.00% B. 12.00% D. 15.30% Required investment xxxii . Ki Kip pli lin ng Comp ompany has inves nvestted in a pro proje jec ct th tha at has has an ei eig ghtht-year year lie. It is expected that the annual cash inow rom the project will be P20,000. Assuming that the project has a internal rate o return o 12%, how much was the initial investment in the project i the present value o annuity o 1 or 8 periods is 4.968 and the present value o 1 is 0.404? A. P1 P160,000 C. P 80,800 B. P 99,360 D. P 64,6 64,640 40 xxxiii

. Katol Katol Compa Company ny inves invested ted in a mach machine ine with with a useu useull lie lie o six years years and and no salv salvage age value. The machine machine was depreciated depreciated using using the straight-line method. It was expected to produce produce annual annual cash inow rom operatio operations, ns, net o income income taxes, taxes, o P6,000. P6,000. The present value value o an ordinary annuity annuity o P1 or six periods at 10% is 4 4.355. .355. The present present value o P1 or six periods at 10% is 0.564. 0.564. Assuming that Katol Katol used a time- adjusted rate o return o 10%, what was the amount o the original investment? A. P10,640 C. P22,750 B. P29,510 D. P2 P26, 6,1 130

xxxiv

. The The For Forest est Comp Compan any y is plann plannin ing g to inves investt in a mach machin ine e with with a us use eul ul lie lie o fve years yea rs and no salvage salvage value. value. The machine machine is expect expected ed to produ produce ce cash ow rom rom operations, net o income taxes, o P20,000 in each o the fve years. Forest’s expected rate o return return is 10%. Inorma Inormation tion on present present value and uture uture amount amount actors actors is as ollows: PERIOD 1 2 3 4 5 Present value o P1 at 10% .909 .826 .751 .683 .621 Present value o an annuity o  .909 1.73 2.48 3.17 3.79 P1 at 10% 6 7 0 1 Future amount o P1 at 10% 1.10 1.21 1.33 1.46 1.61 0 0 1 4 1 Future amount o an annuity 1.00 2.10 3.31 4.64 6.10 o P1 at 10% 0 0 1 5 How much will the machine cost?

A. P 32,220 B. P 62,100

C. P 75 75,8 ,820 20 D. P122,100

Required unit sales xxxv . Paper Paper Pro Product ducts s Company Company is is consid considerin ering g a new new produc productt that will sell or P100 and and has has a variab variable le co cost st o P60. P60. Expect Expected ed volume volume is 20,000 20,000 units units.. New equipm equipment ent costin costing g P1,500,000 and having a fve-year useul lie and no salvage value is needed, and will be depreciated using the straight-line method. The machine has fxed cash operating costs o P200,000 per year. The frm is in the 40 percent tax bracket and has cost o  capital o 12 percent. percent. The present present value o 1, end o fve periods periods is 0.56743; present present value o annuity o 1 or 5 periods is 3.60478. How many units per year the frm must sell or the investment to earn 12 percent internal rate o return? A. 17,338 B. 28,897

C. 9,838 D. 12,338

Required selling price 242

 

Capital Budgeting

xxxvi

. Bughaw Bughaw Pro Produc ducts ts Compan Company y is conside considerin ring g a new prod product uct that that will will sell or or P100 and and has a variable variable cost o P60. Expected sales sales volume is 20,000 20,000 units. New equipment equipment costing P1,500,000 with a fve-year useul lie and no terminal salvage value is needed.  The machine will be depreciated using the straight-line method. The machine has cash operating costs o P200,000 per year. year. The frm is in the 40 percent tax bracket and has costt o capital cos capital o 12 percent. percent. The presen presentt value o 1, end o fve periods periods is 0.56743; 0.56743; present value o annuity o 1 or 5 periods is 3.60478. Suppose the 20,000 estimated sales volume is sound, but the price is in doubt, what is the selling price (rounded to nearest peso) needed to earn a 12 percent percent internal rate o  return? A. P81.00 C. P70.00 B. P95.00 D. P90.00

Required CFBT xxxvii . Al Aloh oha a Co. Co. is consi conside deri ring ng the purch purchas ase e o a new new oc ocea eann-go goin ing g vess vessel el that that coul could d potentially reduce labor costs o its operation by a considerable margin. The new ship would cost P500,000 and would be ully depreciated by the straight-line method over 10 years. At the end o 10 years, the ship will have no value and will be sunk in some already polluted harbor. The Aloha Co.’s cost o capital is 12 percent, and its marginal tax rate is 40 percent. I the ship produces equal annual labor cost savings over its 10year lie, how much do the annual savings in labor costs need to be to generate a net present value o P0 on the project? Use the ollowing ollowing PV: PV: annuity annuity o 1, 10 periods at 12% - 5.6502; end o 10th perio period d– 0.32197. A. P 68,492 C. P1 P114 14,,15 154 4 B. P1 P147,487 D. P 88,492 Required CFAT CFAT xxxviii . Prudu Prudu Compa Company ny has has decid decided ed to invest invest in some new equipment equipment.. The equipment equipment will have a three-ye three-year ar lie and will produc produce e a uniorm uniorm series series o cash savings. savings. The net pr present esent value value o the equipment equipment is P1,750, P1,750, using a discount discount rate o 8 percent percent.. The internal rate o return is 12 percent. Present values at 8% and 12% respectively: 8%: Annuity – 2.5771; end o 3 periods, 0.7938 12%: Annuity – 2,4018; end o 3 periods, 0.7118 What is the amount o annual cash inow? A. P 9,980 C. P23,240 B. P21,342 D. P12,351 xxxix

. An asset asset is purch purchase ased d or P120,00 P120,000. 0. It is expect expected ed to provid provide e an additio additional nal P28,0 P28,000 00 o annual net cash inows. The asset has a 10-year lie and an expected salvage value o P12,000. The hurdle rate is 10%. The present value o an annuity actor o 10% or 10 years is 6.1446, and the present value o P1, discounted or 10 years at 10% is 0.3855. Given Giv en the data data provi provided ded,, the minimu minimum m amount amount o annual annual cash cash inows inows that that would would provide the 10% time-adjusted return is approximately C. P24,400 A. P18,776 B. P26,600 D. P22,535

Required Increase in CF C FAT . The ollowi ollowing ng data pertain pertain to Julian Julian Corp. whose whose management management is planning planning to purchas purchase ea unit o equipment. 1. Econ Economic omic lie o equip equipment ment – 8 years. years. 2. Disp Disposal osal value ater ater 8 years years – Zero. Zero. 3. Esti Estimated mated net net annual annual cash inows inows or or each o the the 8 years – P81,000. P81,000. 4. Ti Time-adj me-adjuste usted d internal internal rate rate o retur return n – 14% 5. Cost o capital capital o Bayan Bayan Muna – 16% 6. The table o present present values values o P1 received received annually annually or 8 years years has these these actors: at 14% = 4.639, at 16% = 4.344

xl

7.the Depreciation Depreci ationincrease is is appro approximately ximately annually Find required in annualP46,970 cash inows in .order to have the time-adjusted rate o return approximately equal the cost o capital. A. P6,501 C. P4,344 B. P5,501 D. P5,871 243

 

Capital Budgeting

Required CFAT or a certain year . A company company is consid considerin ering g putting putting up P50,00 P50,000 0 in a three-y three-year ear projec project. t. The compan company’s y’s expected expe cted rate rate o return return is 12%. The presen presentt value o P1.00 at 12% or one year is 0.893, 0.8 93, or two years years is 0.797, 0.797, and or three three years is 0.712. 0.712. The The cash cash ow, ow, net o  income taxes will be P18,000 (present value o P16,074) or the frst year and P22,000 (presen (pr esentt value o P17,534) P17,534) or the second second year. year. Assuming Assuming that the rate o return return is

xli

exactly 12%, the cash ow, net o income taxes, or the third year would be C. P10,000 A. P23,022 B. P 7,120 D. P16,392 Required salvage value . The Caravan Caravan Company is contemplat contemplating ing to purchase purchase a machine machine that costs P800,000. P800,000.  The machine is expected to last or 5 years with a salvage value o P50,000 at the end o the fth fth year. year. I the machine machine were purchas purchased, ed, beore-tax beore-tax annual annual cash savings on operatin oper ating g expenses expenses will be realize realized. d. Caravan Caravan Company Company will deprecia depreciate te the machine machine using straight-line depreciation or 5 years, with the salvage value considered in the computation.  The company has has a 12 per percent cent cost o capital capital and is subject subject to 40 percent percent tax rate. rate.  The present present values using using 12 percent percent are: Annuity o 1 or 5 periods 3.60478 Present value o 1, end o 5 periods 0.56743  The initial analysis indicated a net present value o P7,003. You believe the estimated beore-tax cash savings are airly determined but you are in doubt o the expected salvage value o the machine. How much is the estimated salvage value required i the investment has to yield an IRR o 12 percent? A. P41,800 C. P25,100 B. P24,900 D. P44, P44,6 600

xlii

Required value o intangible benefts . Solidum Solidum Company Company is investigatin investigating g the purchas purchase e o a piece piece o automated automated equipment equipment that will save P100,000 each year in direct labor and inventory carrying costs. This equipm equ ipment ent costs costs P750,0 P750,000 00 and is expecte expected d to have a 10-yea 10-yearr useul useul lie lie with with no sa salv lvag age e valu value. e. The The comp compan any y requi equirres a mini minimu mum m 15% 15% ret etur urn n on all all equi equipm pmen entt purchases. Management anticipates that this equipment will provide intangible benefts such as greater exibility and higher quality output.  The PV o annuity annuity o 1, 15% or or 10 periods 5.01877  The PV o 1, end 10 period 0.24718 What peso value per year would these intangible benefts have to have in order to make the equipment an acceptable investment? A. P2 P248,123 C. P 61,331

xliii

B. P 49,440

D. P 55,0 55,000 00

xliv

. Altas, Altas, Inc., Inc., is considering considering investing investing in automated automated equipment equipment with a ten-year ten-year useul useul lie. Managers at Altas have estimated the cash ows associated with the tangible costs and benefts o automation, but have been unable to estimate the cash ows associated with the intangible benefts. Using the company’s 10% discount rate, the net prese present nt value value o the ca cash sh ows ows as assoc sociat iated ed with with just just the tangi tangible ble co costs sts and benefts is a negative P184,350. The present value o annuity o 1 at 10 percent or ten years is 6.145 while while the present present value o 1 is 0.386. 0.386. How large would would the annual net cash inows rom the intangible benefts have to be to make this a fnancially acceptable investment? A. P1 P18,435. C. P3 P35,000. B. P3 P30 0,0 ,000 00.. D. P37, P37,23 236. 6.

Indierence Point . Mo Moon on Comp Compan any y us uses es a 10% 10% disc discou ount nt ra rate te and and th the e to tota tall cost cost appr approa oach ch to capi capita tall budgeting analysis. analysis. Both alternatives alternatives are Akda Investments Investments which has a marg marginal inal cost

xlv

o capital o 12 percent is evaluating two mutually exclusive projects (X and Y), which have the ollowing projections: PROJECT X PROJECT Y Investment P48,000 P83,225 Ater-tax cash 12,000 15,200 244

 

Capital Budgeting

inow Asset lie 6 years  The indierence indierence point or or the two projects projects is A. 12.64% C. 12.00% B. 16.01% D. 19.33%

10 years

xlvi

. Silky Products Products is considering two pieces o machinery machinery. The frst machine costs P50,000 more than the second machine. During the two-year lie o these two alternatives, the frst machine has a P155,000 more cash ow in year one and a P110,000 less cash ow in year two than the seconds machine. All cash ows occur at year-end. The present value o 1 at 15 percent end o 1 period and 2 periods are 0.86957 and, 0.75614, respectively respec tively.. The present value o 1 at 8 percent end o period 1 is 0.92593, and Period 2 is 0.85734. At what discount rate would Machine 1 be equally acceptable as machine 2’s? A. 9% C. 11% B. 10% D. 12%

Decision Rule – Independent Projects xlvii . Sylvia Products Products is considering two types o machinery. machinery. The frst machine costs P50,000 more than the second machine. During the two-year lie o these two alternatives, the frst machine has a P155,000 more cash ow in year one and a P110,000 less cash ow in year two than the seconds machine. All cash ows occur at year-end. The present value valu e o 1 at 15 percent percent end o o 1 period period and 2 periods periods are are 0.86957 0.86957 and, 0.7561 0.75614, 4, respectively.. The present value o 1 at 8 percent end o period 1 is 0.92593, and Period respectively 2 is 0.85734. Which machine should be purchased i the relevant discount rates are 15 percent and 8 percent, respectively? 15% Discount 8% Discount A. Machine 1 Machine 1 B. Machine 2 Machine 2 C. Machine 1 Machine 2 D. Machine 2 Machine 1

Comprehensive Payback, NPV, ARR Question Nos. 71 through 73 are based on the ollowing: Cayco Medical Center is considering considering purchasing purchasing an ultrasound ultrasound machine or P950,000. The machine has a 10 – year lie and an estimated salvage value o P55,000. Installation costs and reight charges will be P24,200 and P800, respectively. Newman uses straight-line depreciation.  The medical center estimates that the machine will be used fve times a week with the average charges charges to the patient or ultrasound ultrasound o P800. There There are P10 in medical supplies supplies and P40 o technician costs or each procedure procedure perormed using the machine. The present value o an annuity o 1 or 10 years at 9% is 6.418 while the present value o 1 or 10 years at 9% is 0.42241 xlviii

. The The cas ash h payb payba ack per perio iod d is: is: A. 3.0 3.0 ye yea ars B. 4. 4.5 years

C. 5.0 5.0 ye yea ars D. 6.0 years

xlix

. The project project is expected to generate generate net present valu value e o: A. P2 P276,510 C. P3 P331,510 B. P2 P29 99, 9,74 743 3 D. P253 P253,2 ,277 77

l

.

What is the the account accounting ing rate rate o return return provided provided by the project? project? 20.0 .0 per perce cent nt C. 11.2 11.2 per perce cent nt A. 20 B. 10.6 percent D. 38.0 percent

NPV, CFAT, Maximum lost unit sales Question Nos. 75 through 77 are based on the ollowing: Kabalikat Company Company has the opportunity to intr introduce oduce a new product. product. Kabalikat Kabalikat expects the product to sell or P75 with variable cost per unit o P50. The annual fxed costs, excluding 245

 

Capital Budgeting

the amount o depreciation depreciation is P4,500,000. P4,500,000. The company expects expects to sell 300,000 units. To produce the new product line, the company needs to purchase a new machine that costs P6,000,000 P6,00 0,000.. The new machine machine is expec expected ted to last or our years with with a very negligib negligible le salvage value. The company has a policy policy o depreciating depreciating its machine or both both book and tax purposes or our years. years. The company has a marginal co cost st o capital o 13.75 percent and is subject to tax rate o 40 percent. li

.

The amou amount nt o ann annual ual at ater er-tax -tax cas cash h ows ows is: A. P2 P2,4 ,400 00,0 ,000 00 C. P 900,0 00,00 00 B. P3,000,000 D. P1 P 1,500,000

lii

. The machin machine’s e’s net pre presen sentt value value is: is: A. P2,7 P2,786 86,1 ,100 00 C. P1 P1,0 ,028 28,9 ,900 00 B. P 928,500 D. P 150,270

liii

. Assuming Assuming that that some o the 300,000 300,000 units that that are expecte expected d as sales would would be to group o customers customers who curren currently tly buy K-Z, another product product o Kabalik Kabalikat at Company. This Produ Product ct K-Z K-Z sells sells or P35 P35 with vari variabl able e cost o P20. P20. How many many units units o K-Z K-Z can Kabalikat aord to lose beore the purchase o the new machine becomes unattractive? 39,0 ,000 00 un unit its s C. 16,7 16,714 14 unit units s A. 39 B. 23,400 units D. 10,029 units

ARR, NPV, PI, Payback Questions 1 through 4 will be based on the ollowing data:  The management o Arleen Corporation is considering the purchase purchase o a new machine costing P400,000. The company’s desired rate o return is 10%. The present value o P1 at compound interest o 10% or 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively, and the present value o annuity o 1 or 5 periods at 10 percent is 3.79. In addition addition to the oregoing oregoing inormatio inormation, n, use the the ollowing data in determining the acceptability in this situation:  Year  Year 1 2 3 4 5

Income rom rom Operations P100,000 40,000 20,000 10,000 10,000

Net Cash Flow Flow P180,000 120,000 100,000 90,000 90,000

liv

. The average average rate rate o retur return n or this this investm investment ent is: A. 18 per perc cen entt C. 58 per percent cent B. 6 percent D. 1 10 0 percent

lv

. The net pres present ent value value or this this investmen investmentt is: A. Positive P 36,400 C. Negative P 99,600 B. Pos osit itiv ive e P 55 55,2 ,200 00 D. Negati Negative ve P126,8 P126,800 00

lvi

. The presen presentt value inde index x or this this investment investment is: is: C. 1.14 A. 0.88 B. 1.45 D. 0.70

lvii

. The cash cash payback payback period period or this invest investment ment is: A. 4 years C. 20 years D. 3 years B. 5 years

Payback, NPV, ARR, IRR Use the ollowing inormation or questions 67 - 70 Pillo Company is considering two capital investment proposals. Estimates regarding each project are provided below:

Initial investment Annual net income

Project MA P2000,000 10,000 246

Project PA P300,000 21,000

 

Capital Budgeting

Net annual cash inow Estimated useul lie Salvage value

50,000 5 years -0-

71,000 6 years -0-

 The company requires requires a 10% rate o return return on all new investments. investments. Present Value o an Annuity o 1 Period 5 6 lviii

9% 3.890 4.486

10% 3.791 4.355

11% 3.696 4.231

12% 3.605 4.111

. The cash payback payback period or or Project Project MA is A. 20 years C. 5 years B. 10 years D. 4 y ye ears

lix

. The net net present present value value or or Projec Projectt PA PA is A. P3 P309,204 C. P 50,000 B. P 91,456 D. P 9,205

lx

. The annua annuall rate rate o retur return n or Pr Projec ojectt MA is A. 5% C. 25% D. 50% B. 10%

lxi

. A The inter return or Project Project PA PA is closest closest to . 1internal 0% nal rate o return C. 1 2% D. no none ne o th thes ese e B. 11% Depreciation tax shield, CCFAT, Payback, NPV, IRR Question Nos. 86 through 90 are based on the ollowing: Consider a project that requires cash outow o P50,000 with a lie o eight years and a salvage value o P2,000. Annual cash inow amounts to P10,000 assuming a tax rate o  30% 30 % and and a requi equirred ra rate te o ret etur urn n o 8%. 8%. Salv Salvag age e valu value e is ig igno norred in comp comput utin ing g depreciation. lxii

. Annual Annual deprecia depreciation tion tax shield shield amounts amounts to A. P1,875 C. P8,875 B. P7,000 D. P10,000

lxiii

. Annual cash cash ow ater ater tax amounts to C. P 8, 8,875 A. P 1,875 B. P 7,000 D. P10,000

lxiv

. Paybac Payback k amounts amounts to A. 5. 5.0 years 5.6 6 ye yea ars B. 5.

C. 6. 6.0 years D. 6.6 6.6 year years s

. Net p pres resent ent value value amoun amounts ts to A. P 756 B. P1,005

C. P1,756 D. P2,005

lxv

lxvi

. Internal rate o return return on this project project is approximatel approximatel C. 9.0% A. 8.0% B. 8.5% D. 9.5%

CFAT, NPV, IRR Questions 46 rough 51 are based on the ollowing: Home’s Pizza’s, Inc., operates pizza shops in several cities. One o the company’s most proftable shops is located adjacent to the large CPA review center in Manila. A small bak ba ker ery yunity next ne xt to to lease th the e sh shop op vacate has hasated ju just go ne or out outP18,00 o ,000 busi bu0 sine ness ss,,year and and under Home Hoder me’s ’s Pizza izzas s rhas ha s se. an opp opport ortuni ty lea se the vac dstspace spgone ace P18 per un a 15-yea 15year lease. lea Home’s management is considering two ways in which the available space might be used.

247

 

Capital Budgeting

Alternative 1. The pizza shop in this location is currently selling 40,000 pizzas per year. Management is confdent that sales could be increased by 75% by taking out the wall between the pizza shop and the vacant space and expanding the pizza outlet. Costs or remodeling and or new equipment would be P550,000. Management estimates that 20% o the new sales would be small pizzas, 50% would be medium pizzas, and 30% would be large pizzas. Selling prices and costs or ingredients or the three sizes o pizzas ollow (per pizza):   Small Medium Large

Sell Sellin ing g Pr Pric ice e P 6.70 8.90 11.00

Cost Cost o In Ingr gred edie ient nts s P1.30 2.40 3.10

An additional P7,500 o working capital would be needed to carry the larger volume o  busine bus iness ss.. This This worki working ng capita capitall would would be relea released sed at the end o the lease lease term. term. The equipment would have a salvage value o P30,000 in 15 years, when the lease ends. Alternati Alte rnative ve 2. Hom Home’s e’s sales manager manager eels eels that that the co compa mpany ny needs needs to di diver versi siy y its operations. He has suggested that an opening be cut in the wall between the pizza shop and the vacant space and that video games be placed in the space, along with a small snack bar. Costs or remodeling and or the snack bar acilities would be P290,000. The games would be leased rom a large distributor o such equipment. The distributor has stated that based on the use o game centers elsewhere, Home’s could expect about 26,000 people to use the center each year and to spend an average o P5 each on the machines. In addition, it is estimated that the snack bar would provide a net cash inow o  P15,00 P15 ,000 0 per year year. An invest investmen mentt o P4,000 P4,000 in workin working g capita capitall would would be needed needed.. This This working capital investment would be released at the end o the lease term. The snack bar equipment would have a salvage value o about P12,000 in 15 years. Home’s management is unsure which alternative to select and has asked you to help in making the decision. You have gathered the ollowing inormation relating to added costs that would be incurred each year under the two alternatives:

Rent- building space Rent- video games Salaries Utilities Insurance and other

Expand the Pizza Shop P18,000 --54,000 13,200 7,800

Install the Game Center P18,000 30,000 17,000 5,400 9,600

 The company is currently currently using a 16 percent minimum acceptable rate o return return or its capital investment. The present value value o annuity o 1 at 16 percent or 15 periods is 5.575 and end o 15 periods is is 0.108. The company is not liable liable to pay income taxes. taxes. lxvii

. The incremental expected expected annual cash inows rom Alternative 1 is: A. P 90,000 C. P1 P100,200 B. P1 P10 08, 8,00 000 0 D. P201 P201,0 ,000 00

lxviii

. The incr increme ementa ntall expect expected ed annu annual al cas cash h inows inows rom rom Al Alter ternat native ive 2 is: A. P 17,000 C. P 59,600 D. P145 P145,0 ,000 00 B. P 65,000

lxix

. The net present present value or Alternative Alternative 1 is: is: C. P45,000 A. P48,650 B. P4 P47,840 D. P32,500.

lxx

. The net pr present esent value value or Alter Alternativ native e 2 is: A. P21,021 C. P68,375 D. P12, P12,8 807 B. P70,103

lxxi

. Assume that the company company decides to accept accept alternative 2. At At the end o the frst year, the company fnds that only 21,000 people used the game center during the year (each person spent P5 on games). Also, the snack bar provided a net cash inow o only 248

 

Capital Budgeting

P13,000. In light o this inormation, what is the net present value or alternative 2? A. P( P(8 80, 0,4 422 22)) C. P(8 P(82,15 2,150) 0) B. P(76,422) D. P( P(80,854) lxxii

. The sales manager has suggested suggested that an advertisi advertising ng pr progra ogram m be initiated initiated to draw another 5,000 people into the game center each year. Assuming that another 5,000 people can be attracted into the center and that the snack bar receipts increase to the level originally estimated, how much can be spent on advertising each year and still allow the game center to provide a 16% rate o return? A. P70,103.00 C. P58,953.00 P12, 2,57 574. 4.53 53 B. P 4, 4,673 673.53 .53 D. P1

Net Income, CFBT, ARR, Payback Period Questions 52 through 56 are based on the ollowing inormation: Pinewood Crat Company is considering the purchase o two dierent items o equipment, as described below:

Machine A. A compacting compacting machine machine has just come come onto the marke markett that would permit permit Pinewood Crat Crat Company to compress compress sawdust into various shelving shelving produc products. ts. At present present the sawdust is disposed disposed o as a waste waste product. product. The ollowing inormation inormation is available available on the machine: a. The machine machine would would cost P420,000 P420,000 and and would have have a 10% salvage salvage value at the end o its 12-year useul lie. The company uses straight-line straight-line depreciation depreciation and considers salvage value in computing depreciation deductions. b. The shel shelvin ving g produ products cts manuac manuactur tured ed r rom om use o the machin machine e would would genera generate te revenues rev enues o P300,000 P300,000 per year. year. Variable ariable manuactur manuacturing ing costs would would be 20% o  sales. c. Fix ixed ed expen expenses ses associa associated ted with th the e new new shelv shelvin ing g produ products cts would would be (p (per er year): year): advertising, P40,000; salaries, P110,000; utilities, P5,200; and insurance, P800.

Machine B. A secon second d machine machine has come onto the market market that that would allow allow Pinewood Pinewood Cratt Company to automate Cra automate a sanding sanding process process that is now done largely largely by hand. The ollowing inormation is available: a. The new sandin sanding g machine machine would cost cost P234,000 P234,000 and would would have have no salvage salvage value at the end o its 13-year useul useul lie. The company would use use straight-line straight-line depreciation depreciation on the new machine. b. Seve Severa rall ol old d piec pieces es o sa sand ndin ing g equi equipm pmen entt th that at ar are e u ull lly y depr deprec ecia iate ted d woul would d be disposed o at a scrap value o P9,000. c. The The new new sa sand ndin ing g mach machin ine e woul would d pr prov ovid ide e su subs bsta tant ntia iall annu annual al sa savi ving ngs s in cash cash operating oper ating costs. costs. It would require require an operator operator at an annual salary salary o P16,350 and P5,4 P5 ,400 00 in annu annual al main mainte tena nanc nce e cost costs. s. The The curr curren ent, t, hand hand-op -oper erat ated ed sa sand ndin ing g procedure costs the company P78,000 per year in total. Pi Pinew newood ood Cra Cratt Compan Company y requi require res s a simple simple rate rate o retur return n o 15% 15% on all equip equipmen mentt purchases. purcha ses. Also, the company will not purchas purchase e equipment unless the equipment equipment has a payback period o 4.0 years or less. (In all the ollowing questions, questions, please ignore income tax eect) lxxiii

. The exp expect ected ed inco income me each each year year rom rom the the new shel shelvin ving g prod product ucts s (Machi (Machine ne A) is: is: A. P 52,500 C. P 84 84,000 B. P2 P240,000 D. P 92,500

lxxiv

. The annual annual savin savings gs in co cost st i i Mach Machine ine B is is pur purcha chased sed is A. P56,250 C. P38,250 B. P43,250 D. P21,750

lxxv

. The simple rate (%) o return return or Machine A is: A 12.5 12 pe per erce cent ntt B.. 2 0..5 0p rc en

C. 25 per pe erce cent ntt D. 25.0 18.0 .0 p rc en

lxxvi

. The The sim simpl ple e rat rate e o o rret etur urn n or or Mach Machin ine e B is: is: A. 16.3 percent C. 25.0 percent 249

 

Capital Budgeting

B. 17 17.0 .0 per perce cent nt

D. 34 34.0 .0 per percent cent

lxxvii

. The The pay payba back ck peri period od o orr Mac Machi hine ne A is: is: A. 3.0 3.0 ye yea ars C. 5. 5.0 0y yea earrs B. 4. 4.5 years D. 7.5 years

lxxviii

.

The The pay payba back ck peri period od o orr Mac Machi hine ne B is: is:

A. 4.0 4.0 yea yearrs. B. 4.2 years.

C. 6.1 6.1 y yea earrs. D. 5. 5.9 years.

Net Investment, CFBT, Tax Benefts, NPV, Depreciation Tax Shield, Question Nos. 58 through 63 are based on the ollowing:  Turkey  Turkey Company’s average production production o valve stems over the past three years has been 80,000 units each year. year. Expectations are are that this volume will remain co constant nstant over the next our years. Cost records records indicate that unit product product costs or the valve stem over the last several years have been as ollows: Direct materials Direct labor Variable manuacturing overhead Fixed manuacturing overhead* Unit product cost

P 3.60 3.90 1.50 9.00 P18.00

*Depreciation o tools (that must now be replaced) accounts or one-third o the fxed overhead over head.. The balance balance is or other other fxed overhead overhead costs o the actor that requir require e cash expenditures. I the specialized tools are purchased, they will cost P2,500,000 and will have a disposal value o P100,000 at the end o their our-year our-year useul lie. Turkey Company has a 30% tax rate,, and management rate management requir requires es a 12% ater-tax ater-tax return return on investment. investment. Straight Straight-lin -line e depreciation would be used or fnancial reporting purposes, but or the tax purposes, the ollowing variable depreciation each year will be used.

 Year  Year  Year  Year  Year  Year  Year  Year

1 2 3 4

P

832,500 1,112,500 370,000 185,000

 The sales representative representative or the manuacturer manuacturer o the specialized tools has stated, “The new tools will allow direct labor and variable overhead to be reduced by P1.60 per unit.” Data r rom om another another company company using using identica identicall tools tools and experien experiencing cing similar operating operating conditions, except that annual production generally averages 100,000 units, confrms the direct labor labor and variable overhead overhead cost savings. savings. However, the other company company indicates that it experienced an increase in raw material cost due to the higher quality o material that had to be used with the new tools. The other company indica indicates tes that its unit product product costs have been as ollows: Direct materials Direct labor Variable manuacturing overhead Fixed manuacturing overhead Unit product cost

P 4.50 3.00 0.80 10.80 P19.10

Reerring to the fgures above, the production Reerring production manager stated, “These numbers look great until you consider consider the dierenc dierence e in volume. Even with the reduction reduction in labor and va variable riable overhead cost, I’ll bet our total unit cost fgure would increase to over P20 with the new tools.” Although old tools being areinow they have a salva salvage gethe value o P45,00 P45 ,000. 0.used These Thby eseTurkey tools tools Company will will be sold theully newdepreciated, tools tools are are pu purc rchas hased; ed; however i the new tools are not purchased, then the old tools will be retained as standby equipment equi pment.. Turkey urkey Company’s Company’s accounting accounting department department has confrmed confrmed that total fxed manuacturing overhead costs, other than depreciation, will not change regardless o the 250

 

Capital Budgeting

decision made concern decision concerning ing the valve stems. However, However, the accounting accounting departmen departmentt has estima est imated ted that that worki working ng ca capit pital al needs needs will will incre increase ase by P60,00 P60,000 0 i the new tools tools are are purchased due to the higher quality o material required in the manuacture o the valve stems.  The present present values o 1 at the end o each each period using using 12 percent percent are: Period 1 0.89286 Period 2 Period 3 Period 4 PV o annuity o 1, 4 periods

0.79719 0.71178 0.63552 3.03735

lxxix

. The The net net in inve vest stme ment nt in new new too tools ls am amou ount nted ed to to:: A. P1,8 P1,873 73,3 ,300 00.. C. P2 P2,5 ,528 28,5 ,500 00.. B. P2,515,000. D. P2,546.500.

lxxx

. How much annual cost savings will be generated i the Turkey Turkey Company purchases purchases the new tools? 36,0 ,00 00 A. P 128, 28,000 000 C. P 936 B. P 216,000 D. P P1 1,008,000

lxxxi

. The pre presen sentt value value o tax tax benef benefts ts expe expecte cted d rom rom the the use o o the new new machi machine ne tools tools is: A. P 603,333 C. P1,407,777 B. P 804,444 D. P P2 2,011,111

lxxxii

. The pres present ent value value o o the salvage salvage value value o o the new tools tools to be received received at the the end o  ourth year is A. P 63,5 63,55 52. C. P 44 44,4 ,486 86.. B. P 19,065. D. P2 P212,615.

lxxxiii

. Using Using the minim minimum um accepta acceptable ble rate rate o retur return n o 12 percent, percent, the net net present present value value o  o  the investment in new tools is C. P1 P147 47,,07 073. 3. A. P10 P108,91 8,913 3. B. P127,979. D. P1 P166,139.

lxxxiv

. The The net net adva advant ntag age e o the the use use o decli eclini ning ng meth method od o depr deprec ecia iati tion on in inst stea ead d o  straight-line straight-lin e method is A. P 33 33,8 ,83 30. C. P112 P112,,767. 767. B. P 56,610. D. P1 P147,731.

Net Investment, CFAT, Depreciation tax shield, NPV Question Nos. 77 through 82 are based on the ollowing: Franzen Company manuactures three dierent models o paper shredders including the waste container, which which serves as the base. While the shredder shredder heads are are dierent or all three thr ee models, models, the waste container container is the same. The number number o waste containers containers that that Franzen will need during the next fve years is estimated as ollows: 2007 50,000 2008 50,000 2009 52,000 2010 55,000 2011 55,000  The equipment used to manuacture manuacture the waste container must be replaced because it is broken bro ken and cannot cannot be repair repaired. ed. The new equipment equipment would have a purchase purchase price o  P945,000 with terms 2/10, n/30; the company’s policy is to take all purchase discounts.  The reight reight on the equipment would be P11,000, and installation costs would total P22,900. The equipment would would be purchased purchased in December December 2006 and plac placed ed into service on January 1, 2007. 2007. It would have a fve-year fve-year economic lie lie and would have have the ollowing depreciation. deprecia tion. The in equipment is eexpected exnew pected toipment have salvage P12,0 P12,000 00 at the endold o  its economic econom ic lie 2011. 2011. The Th equipm equ entawould wou ld bevalue more moreoecien ec ient t than tha n the equipm equ ipment ent,, resu resulti lting ng in a 25 percen percentt reduc reductio tion n in both both direct direct materi material al and variab variable le overhead. The savings in direct direct material would result result in an additional one-time decr decrease ease in working capital requirements o P2,500, resulting rom a reduction in direct material 251

 

Capital Budgeting

inventories. This working capital capital reduction reduction would be recognized recognized at the time o equipment equipment acquisition.  The old equipment is ully deprecia depreciated ted and is not included in the fxed overhead. The old equipm equ ipment ent rom rom the plant plant can be sold sold or a salva salvage ge amou amount nt o P1,500 P1,500.. Rathe Ratherr than than replace the equipment, one o Franzen’s production managers has suggested that the waste wast e containe containers rs be purchas purchased. ed. One supplier supplier has quoted a pric price e o P27 per container container..  This price is P8 less than Franzen’s curren currentt manuacturing manuacturing cost, which which is presented presented below. below. Direct materials Direct labor Variable overhead Fixed overhead:   Su Supervision   Facilities   General  Total  Total unit cost cost

P10 8 6 P2 5 4

11 P35

Franzen uses a plantwide fxed overhead rate in its operations. I the waste containers are purchase outside, the salary and benfts o one supervisor, included in fxed overhead o  P45,000 P45,0 00 would be eliminated. eliminated. There There would be no other changes changes in the other other cash and noncash items included in fxed overhead except depreciation on the new equipment.  The new equipment equipment will be d depreciat epreciated ed according according to the ollowing ollowing declining declining amounts:  Year  Y ear 20 07 2008 2009 2010 2011

Depreciation Deprecia P319,96tion 8 426,720 142,176 71,136 0

Franzen ranzen is subject subject to a 40 percent percent tax rate. Managemen Managementt assumes assumes that all cash ows occur at the end o the year and uses a 12 percent ater-tax discount rate. lxxxv

. The initi initial al net net cash cash outows outows i the the compa company ny decide decides s to contin continue ue makin making g the wast waste e containers is: A. P 956 56,,60 600 0 C. P 978,9 78,90 00 B. P 975,500 D. P P1 1,455,613

lxxxvi

. The The to tota tall a ate terr-t -tax ax cash cash out outow ows, s, excl exclud udin ing g th the e in init itia iall cash cash out outow ows, s, i the new new equipment is purchased are: A. P 956,600 C. P2,918,300 B. P2, P2,887 887,80 ,800 0 (dee (deecti ctive) ve) D. P3,2 P3,279 79,0 ,000 00

lxxxvii

. The pr present esent value o the total total depr depreciat eciation ion shield shield is: is: P30 08, 8,92 920 0 C. P307 P307,,826 826 A. P3 B. P3 P313,500 D. P321,303

lxxxviii

. The total total relevan relevantt ater-tax ater-tax costs costs to buy buy the waste waste contain containers ers are: are: C. P4,243 P4,243,50 ,500 0 (de (deect ective ive A. P2,8 P2,829 29,2 ,240 40 B. P3,039,662 D. P7 P 7,074,000

lxxxix

. What What is the the net pre presen sentt value value o the the purcha purchase se alter alternat native ive? ? P3,039 039,66 ,662 2 (dee (deecti ctive) ve) C. P2,0 P2,083 83,0 ,062 62 A. P3, B. P2,730,742 D. P2 P 2,718,359

xc

. What is is the net net present present value value o the the make alter alternati native? ve? A. P2,036,603 C. P2,996,603 D. P2, P2,993 993,20 ,203 3 (d (dee eecti ctive) ve) B. P3 P3,0 ,039 39,6 ,662 62

ANSWER EXPLANATIONS

252

 

i

.

Answer: B Initial amount o investment 160,000 Less Cash inow (decrease in outow) at period 0:   MV o old equipment 80,000   Tax benefts on loss on sales (20,000 x .4) 8,000 88,000 Net investment 72,000

ii

.

Answer: D ATCF = Net investment ÷ Payback period ATCF (840,000 ÷ 3.326) Net income (252,555 – 140,000) Beo Be orre-tax e-tax in inco come me

252,555 112,555 (1 (112 12,5 ,555 55 ÷ 0. 0.60 60))

187, 187,59 592 2

Beo orre-tax e-tax sa savi ving ngs s (1 (187 87,5 ,592 92 + 140, 140,00 000) 0) 327. 327.59 592 2 internal  TheBe computation o ater-tax cash ows, given the amount o investment and rate o return or PV o annuity o 1 discounted at IRR is the reverse o the computation o payback payback period. period. Remember emember that the payback payback method, though though a nondisco nondiscounted unted technique, is closely related to internal rate o return because the payback period is exactly the present value o annuity o 1 i they are discounted using the internal rate o return. iii

.

iv

10.Answer: B  YearSYDStraig  YearSYDStraight ht LineDierencePr LineDierencePresent esent Value12,000,0001 Value12,000,0001,200,000800,000 ,200,000800,000 727,28021,600,0001,200,000400,000330,56031,200,0001,200,000 -04 800,0001,200,000(400, 800,0001,20 0,000(400,000) 000) (273,200)5 400,0001,200,000(800, 400,0001,2 00,000(800,000) 000) (496,720)Total (496,720)Total present value o dierence in depreciation287,920Tax Rate40%Present value o net advantage115,168 . Answer: B SYDSLD SYD SLDie iere rence ncePr Prese esent nt Value1 alue1 150,00 150,00090 090,00 ,00060 060,00 ,00053 053,56 ,5682 82 120,00090,00030,00023,9163 90,00090,000-04 60,00090,000(30,000) (19,06 (19 ,066)5 6)5 30, 30,000 00090, 90,000 000(60 (60,00 ,000)(3 0)(34,0 4,046) 46)T Total otal o prese present nt values values o  deprecia depr eciation tion24,37 24,372T 2Tax rate40%P rate40%Pres resent ent value value o net advantag advantage e 9,749SYD 9,749SYD method method provides a higher present value on tax benefts because o less amount o tax during year 1 & 2. In year 4 and 5, the use o SYD requires higher taxes but their equivalent present values are lower already.

v

vi

.

Answer: A Annual savings on expenses P50,000 Less: Les s: Addi Additio tional nal depre deprecia ciatio tion n (40,00 (40,000 0 – 25,000 25,000)) 15,000 15,000 Additional taxable income 35,000 Additional tax (35,000 x 40%) P14,000 Additionall depreciation can be easily calculated by subtracting the book value o the Additiona old machine rom the cost o new machine and then the dierence divided by the useul lie (160,000 – 100,000) ÷ 4 = 15,000.

Answer: D Annual cost savings Less depreciation

(432,000 ÷ 12)

Annual income Simple Rate o Return: 54 54,000 ÷ 432,000 vii

.

viii

.

90,000 36,000 54,000 12.5 %

Answer: A  The useul lie o the project can be calculated by using the computational computational pattern or Accounting Rate o Return: Net investment 106,700 Divide by Depreciation expense CFAT 20,000 Less: Ne Net income (1 (106,700 x 5%) 14,665 5,335 Average lie (in years) 7.28 * 10% ARR based on average investment = 5% ARR based on initial investment Answer: B ARR = Average annual net income ÷ Average Investment Annual ater-tax cash ow 40,000 Less Depreciation 20,000

Net Incby omAverage e 20,000 Divide Investment (200,000 + 180,000)/2190,000 ARR: 10.5%  The problem asked or the average accounting rate o return return or the frst year o  asset’s lie.

 

ix

x

. Answer: D  The average (accounting) rate o return is determined determined by dividing the annual ater-tax ater-tax net income by the average cost o the investment, (beginning book value + ending book value)/2. Ater tax income (P7,200 - (P7,200 x 30%)) P 5,040 Average investment: (P66,000 + 16,000) ÷ 2 P41,000 Accounting Accounti ng rate o return: return: P5,040/P41,000) 12.3% .

Answer: A  (ATCF  (A TCF – Depreciation) ÷ Initial investment investmen t = Accounting Rate o Return Let X = Initial investment – 0.10X)- .10X ÷X  (66,000 66,000   .22X   X

= = 0.12 .12X = 66,000 = 300,000

xi

.

Answer: A Net Income: = 66,000 - .10X AAR = NI/ Investment .12 = (66,000 - .10X) / X .12X = 66,000 - .10X .22 X = 66,000   X = 300,000

xii

.

Answer: D Net Income (280,000 x 15%)42,000 Add back ack depr eprecia eciati tion on 35,0 35,000 00 ATCF 77,000

xiii

. Answer: B Payback period = Initial amount o investment ÷ Annual ater-tax cash ows P35,000 ÷ P5,000 = 7 years

xiv

.

Answer: B Net investment Divide by CFAT Payback period

50,000 (10,000 x 0.7) ÷ (50,000 ÷ 8 x 0.3) 5.6 years

8,875

xv

.

Answer: D Cumula Cum ulativ tive e cash cash ows ows end o Year 1 (450,0 (450,000) 00) – 254,52 254,520 0 (195,4 (195,480) 80) Discounted cash ow or Year 2 173,460 Cumulative cash ows, end o Year 2 ( 22,020) Break-even time 2 + (22,020 ÷ 105,140)2.21 years

xvi

.

Answer: D Cost o the new machine Salvage value o old machine at period zero Net investment (Outows) Divide by cash ow ater tax Payback period

400,000 60,000 340,000 90,000 3.78 years

xvii

. Answer: B   Cash InowUnrecovered OutowOutows(4,500,000)First year900,000(3,600,000)Second year1,200,000(2,400,000)Thi year1,200,000 (2,400,000)Third rd year1,500,000( 900,000)F 900,000)Fourth ourth year 900,0000 Payback Period: At the end o 4 periods, the initial outows are ully recovered. Note to the CPA CPA Candidates: A modifed question question or this problem problem is to compute the Present Value o the net advantage o using sum-o-the-years’ digits o depreciation instead o straight-line method.

xviii

.

Answer: C Cash inowsInvestmentPeriod inowsInvest mentPeriod 0(99,300)Period 1 (75,000 – 25,000) x .6 30,000(69,300)Period 30,000(69,300 )Period 2 ( 30,000 x 1.10) 33,000(36,300)Period 33,000(36,300)Period 3 (33,000 x 1.10) 36,300 -0-At the end o the third year, investment is ully recovered.

 The net investment investment o 99,300 is net o tax ben beneft, eft, (165,500 x .6) .6) xix

.

Answer: C Beore-tax cash ow = 40,000 + 35,000 Payback period: 30 300,000 ÷ 75,000

75,000 4 years

 

xx

.

xxi

. Answer: C Computation o Cash Flow Ater-tax CFBT 100,000 x 0.7 Depreciation tax shield CFAT Computation o Net Present Value: PV o ATCF: 88,750 x 5.747

Answer: C  There are are two cash ows at time zero: zero: P120,000 outow outow and P14,000 inow inow.. Net cash outow (120,000 – 14,000) = 106,000

70,000 62,500 x 0.3 88,750

18,750

510,046

PV o A Ater ter-ta -tax x Salvag Salvage e Value: alue: 20,000 20,000 x 0.70 0.7517,606 0 x 0.54 0.54 7,560 7,560  Total  T otal Investment 500,000 Net Present Value 17,606  The problem assumed that the salvage value is ignored in the computation o annual depre dep recia ciatio tion n so that the annual annual cash ows ows will will be great greater er.. The proble problem m did not include among the choices the assumption that salvage value will be deducted rom the cost in computing the amount o annual depreciation. xxii

.

Answer: B Annual revenues Less cash operating costs Cash ow beore tax Less Depreciation (1M ÷ 5) Income beore tax Less income tax (40%) Net income Add back depreciation ATCF PV o ATCF, n=5; k=10% Investment Negative Net Present Value

257,120 x 3.7908

400,000 104,800 295,200 200,000 95,200 28,080 57,120 200,000 257,120 974,690 1,000,000 ( 25 25,310)

 The manner o fnancing the project is not considered considered in the analysis o capital in inve vest stme ment nt.. In Inve vest stme ment nt must must be separ separat ate e rom rom fnanc fnancin ing. g. It is a nor norma mall lly y committed error in the application o capital budgeting techniques where fnancing strategy is considered. considered. The explicit or implicit implicit cost o fnancing the projec projectt is taken care o the discounting process. xxiii

.

Answer: A Pr Presen esentt value value o cash cash retur returns: ns: (30,000 (30,000 x 0.909 0.90909) 09)

x 5 period periods s 136,364 Net investment 99,300 Net present value 37,064 Note:: Because Note Because the constant constant growth growth rate rate and the discount discount rate are both both 10%, the present value or each period is constant. xxiv

.

xxv

.

Answer: B Savings (2 workers, workers, each P10,000 P10,000 or 3 months)2 x P10,000 P10,000 x 3 P60,000 Deprecia Depr eciation tion (175,000 (175,000 – 25,000) 25,000) ÷ 5 years P30,000 P30,000 Ater-tax Ater -tax cash savings: (60,000 x 0.75) + (30,000 x 0.25)P52,500 0.25)P52,500 Present value o ater-tax cash savings (52,500 x 3.60478)P189,250 3.60478) P189,250 Presentt value o Salvage Value (25,000 x 0.56743) 14,186 Presen  Total  Total 203,436 Investment 175,000 Net Present Value P 28,436 Answer: B Computation o net investment: Cash purchase price 300,000 Less: MV o old machine 80,000   Tax shield on loss on sale (40,000 x 0.32)12,800 0.32) 12,800 92,800 Net investment

207,200

Annua Ann uall ca cash sh saving savings s beor beore e tax (240,0 (240,000 00 – 160,00 160,000) 0) Additi Addi tion onal al depr deprec ecia iati tion on (3 (300 00,0 ,000 00 – 120, 120,00 000) 0) ÷ 4 45,0 45,000 00 Additional taxable income 35,000

80,000 80,000

 

Less Additional tax (35,000 x 0.32) Net income Add back depreciation Ater-tax cash ow Alternative computation or ATCF: (80,000 x 0.68) + (45,000 x 0.32) Present value o ATCF (68,800 x 3.23972) Investment Net Present Value xxvi

.

Answer: B PV o annual cash receipts

1,200,000 x 2.58872

11,200 23,800 45,000 68,800 68,800 222,893 207,200 15,693

3,106,463

PV x 0.48225x 0.48225 313,462 PV o o salvage return return ovalue working capital650,0001,000,000 482,250 Cost o new equipment and timbers (2,750,000) Working capital (1,000,000) (1,000,00 0) PV o cost o construction construction o road 400,000 x .5787 ( 231,480) 231,480) Negative net present value (79,303) xxvii

.

Answer: B PeriodNominal Cash SavingsPV FactorPresent Value132,000 0.8779028,070.08232,000 0.8779028,070 .08232,000 x 1.0533,600 1.0533,600 0.7694725,854.19332,000 0.7694725,854.19332,000 x 1.05235,280 1.05235,280 0.6749723,812.94432,000 0.6749723,81 2.94432,000 x 1.05337,044 0.5920821,933.01Total99,670.22Investment80,000.00NPV19,670.22Note that all the annual cash inows are adjusted by one period.

xxviii

. Answer: B  The solution used total analysis analysis approach approach in computing computing present present value. Retain the Old Machine: Present value o annual cash outlay   CFA CFAT (300,000 x P0.38) + P21,000 = P135,000   PVCF PVCFA AT (135 (135,0 ,000 00 x 3. 3.68 6847 47)) P497 P497,4 ,435 35 Pres esen entt val value o salv alvage age valu value e (7,00 7,000 0 x 0.4 0.41044 1044)) ( 2,8 2,873) 73)   Total P494,562 Buy New machine: Present Value o Annual cash outlay CFA CF AT (3 (300 00,0 ,000 00 x P0.2 P0.29) 9) + P11, P11,00 000 0 = P98, P98,00 000 0   PVCFAT P98,000 x 3.6847) P361,100   Salvage value o new machine, end o 6 years(P20,000 years(P20,000 x 0.41044) (   Inve In vest stme ment nt in new new mach machin ine e (1 (120 20,0 ,000 00 – 40,0 40,000 00)) 80,0 80,000 00   Total P432,891

xxix

8,209)

. Answer: B  The purpose o proftability index is to compare two projects’ proftability proftability by reducing the present present value per 1 peso o investment. investment. Thereore, Thereore, the ratio o 4.35526 @ 10% 10% to 4.11141 @ 12% indicated the profta proftability bility index. Proftability Proft ability index: index: 4.35526/4.11141 = 1.06

xxx

xxxi

.

Answer: B PV o annuity o 1 at IRR ∑(1 ÷ 1.12386)5 3.57057 PV o annuity o 1 at MCC ∑(1 ÷ 1.11055)5 3.69079 A Ater ter-ta -tax x cash cash ows ows 10, 10,000 000 ÷ (3.690 (3.69079 79 – 3.5705 3.57057) 7) Investment: 83,180.84 x 3.57057 297,000 Proftability in index (297,000 + 10,000) ÷ 297,000 1.034 A shorter calculation o the Proftability Index can be made by: 3.69079 ÷ 3.57057 3.57057 = 1.034

83,180 83,180.84 .84

. Answer: D In discounting the annual cash inow by the IRR, the NPV = P0  The net present value o ZERO is 14% and 16%. For better time management, the candidate is expected not to do detailed calculation o fnding out the exact rate.  The use o interpolation interpolation indicated indicated that the the IRR is 15.3%: 15.3%: Discount RateNet Present Value0.141,197IRR00.16-708 (0.14 (0.14 –– IRR) IRR) (0.14 – IRR) (0.14 – IRR) 0.14 – IRR

÷ (0.14 1,197 ÷ -.02 -.02 =– 0.16) 1,197 = ÷ 1905 190 5 ÷ ( 1,197 + 708) ÷ - .02 = 0.628 = 0.628 x -0.02 = 0. 013

 

IRR = 0.153 0.153 or 15.30% Note: Since at the IRR, NPV is zero, zero, the answer can only only be between 14% & 16%, since only one o the choices, satisy satisy the criteria, the answer is (D). xxxii

. Answer: B  The payback period that corresponds corresponds to the project’s project’s internal rate o return return o 12 percent is 4.968. 4.968. Thereore, Thereore, the amount o investment must must equal the product product o the payback period and the net cash ows: Investment: (4.968 x 20,000) = P99,360

xxxiii

. Answer: D  The amount o investment: investment: the PV o annuity annuity at IRR 4.355 x 6,000 = 26,130

xxxiv

. Answer: C Present value o cash inows equals amount o investment at 10% IRR. P20,000 x 3.791 = P75,820

xxxv

.

xxxvi

.

Answer: A ATCF: P1 P1,500,000/3.60472 416,121 Depreciation 300,000 Net income: 416,121 – 300,000 116,121 Beo Be orre-tax e-tax in inco come me:: 116, 116,12 121/ 1/0. 0.60 60 Fixed costs 500,000 Cont Co ntri ribu buti tion on mar margin: gin: 193, 193,53 535 5 + 500, 500,00 000 0 Unit sales 693,535 ÷ (100 - 60) 17,338 Answer: B Contribution margin (per No. 23) Divide by sales volume Contribution margin per unit Add variable cost per unit Selling price per unit

193, 193,53 535 5 693, 693,53 535 5

693,535 ÷ 20,000 P34.68 60.00 P94.68

Alternative Solution: Cash inow beore beore tax based on present present price: (20,000 x 40) – 200,000 600,000 Ater-tax Ater -tax cash inow (600,000 x 0.6) + (300,000 x 0.4)480,000 Present value o ATCF (480,000 x 3.60478)1,730,294 3.60478) 1,730,294 Investment 1,500,000 Net present value (present price) 230,294 Annual excess ATCF due to excess price (230,294 ÷ 3.60478)63,885 Beore-tax excess cash inow (63,885 ÷ 0.6) 106,475 Excess selling price: 106,475 ÷ 20,000 5.32 Reduced selling price to achieve IRR o 12% (100 – 5.32)94.68 5.32)94.6 8 xxxvii

.

Answer: C Annual ater-tax cash ow 500,000/5.6502 Depreciation 500,000/10 Net income Income beore tax 38,492/0.6 Depreciation Cash Ca sh sa savi ving ngs s beo beorre tax: tax: 64,1 64,154 54 + 50 50,0 ,000 00

88,492 50,000 38,492 64,154 50,000 114, 114,15 154 4

xxxviii

. Answer: A  The amount o annual annual cash cash ows can be solved solved by equation: equation: NPV = PV o annual CF – Investment 1,750 = 2.4771CF – 2.4018CF 1,750 = 0.1753CF CF = 9,980

xxxix

.

Answer: A Investment Less Present value o salvage value

120,000 (12,000 x 0.3855)

P enutm vaAn l lC n1 5 o,w Mriensim Alu ne nuoa lACnansuhaF oa wssh (I1 3s74 ÷ 6.1446) xl

.

Answer: B Prese Present nt val value ue o annual annual cash cash ows ows at IR IRR R

4,626

11 15 8,,3 77 74 6

(81,00 (81,000 0 x 4.639) 4.639)

375,75 375,759 9

 

Inve Invest stme ment nt Dierence Annual increase increase in cash ows xli

.

xlii

.

81 81,0 ,000 00 x 4. 4.34 344 4 23,895/4.344

351, 351,86 864 4 23,895 5,501

Answer: A Investment Investme nt (Total (Total o present value @ IRR o 12%) 50,000 Less PV, year 1 & 2 (16,074 + 17,534) 33,608 PV o the 3rd cash ow 16,392 Ater-tax cash ow, third year 16,392/0.712

23,022

Answer: B  The net present present value = PV o o excess salvage value less less PV o decr decrease ease in ater ater-tax -tax cash Let ow X = the excess salvage value 7,003 = 0.56743X – [3.60478 x (0.2X * 0.4) 7,003 = 0.56743X – 0.2883824X 7,003 = 0.2790476X   X = 25,096 Required Requ ired salvage value: 50,000 – 25,096 25,096 = 24,904

xliii

xliv

.

Answer: B Cost o equipment 750,000 Les ess s PV o ta tang ngiible ble benef enefts ts 100, 100,0 000 x 5.018 .01877 77 501, 501,8 877 PV o annual intangible benefts 248,123 Amount o annual intangible benefts 248,123/5.01877

49,440

. Answer: B  To  To be acceptable, the projec projectt should yield a net present present value o zero. zero. The negative net present value must be oset by the present value o annual intangible benefts. Present value o intangible benefts P184,350 PV o annuity o 1 at 10% or 10 years ÷ 6.145 Annual net intangible benefts P30,000

xlv

. Answer: A  The indierence indierence rate (crossover (crossover or fsher fsher rate) reers reers to the rate rate at which the net present values o the 2 alternatives are indierent or equal.  The easier test o the rate is to look or IRR (using trial and error error technique) o the investment dierence. dierence. Dierence 80,000 – 48,000 35,225 PV inows ∑(3,200 ÷ 1.1264)6 (12,922) PV inows ∑(15,200 ÷ 1.1264)10-6 (22,303)  Dierence NIL Alternative Solution: Project XProject YPV o ater-tax cash ows   ∑(12,000 ÷ 1.1264)6

48,455 ∑(15,200 ÷ 1.1264)1083,680In 1.1264)1083,680Investment48, vestment48,00083,225Net 00083,225Net Present Value 455 455 xlvi

. Answer: B  The determination determination o the indieren indierence ce point, which which is 10%, or or the two projects projects can be be made through the use o trial and error estimation. Machine 1Machine 2PV o Dierence in ATCF Year 1 155,000 ÷ 1.10 140,909.10(140,909.10) 140,909.10(14 0,909.10) Year 2 (110,000 ÷ 1.10)2( 90,909.10) 90,909.10Net dierence dierenc e 50,000.00( 50,000.00)Dierence 50,000.00)Dierence in investment( 50,000.00) 50,000.00NPV NIL NIL xlvii . Answer: C 15% Discount Rate Mach Ma chin ine e 1Mac 1Machi hine ne 2PV 2PV o Die Dierrence ence in ATCF Year ear 1 155, 155,00 000 0 x 0. 0.86 8695 957 7 134,783.35(134,783.35) 134,783.35(13 4,783.35) Year 2 110,000 x 0.75614( 83,175.40) 83,175.40) 83,175.40Net dier di erenc ence e 51,607 51,607.95 .95(( 51,607 51,607.95 .95)Di )Dier erenc ence e in invest investmen ment( t( 50,000 50,000.00 .00)) 50,000.00NPV 1,607.95( 1,607.95) At 15 percent discount rate, Machine 1 is more acceptable. 8% Discount Rate Machine 1Machine 2PV o Dierence in ATCF Year 1

155,000 x 0.92593

143,519.15 (143,519.15) 143,519.15(143,519.1 5) Year 2 110,000 x 0.85734( 0.85734 ( 94,307.40) 94,307.40Net 94,307.40 Net dierence dierenc e 49,211.75( 49,211.75)Dierence 49,211.75)Dierence in investment( 50,000.00) 50,000.00NPV ( 788.25) 788.25 At 8 percent discount rate, Machine 2 is more acceptable.

 

xlviii

. Answer: C Cost o Investment: Invoice price Installation cost Freight charge   Total investment

950,000 24,200 800 975,000

Annual Cash Flow: Number o procedures: (52 x 5) 260 Contri Con tribu butio tion n margin margin per proc procedu edure res: s: (P800 (P800 – P10 – P40) P40)  Total  Total annual cash cash ow: ow: (260 x P750) P195,000 Cash payback period: (975,000 ÷ 195,000) 5 years xlix

l

li

lii

.

.

.

.

Answer: B Pr Pres esen entt valu value e o cash cash ow ow Prese Present nt val value ue o salva salvage ge value value  Total  Total Capital investment Net present value Answer: A Average investment: Annual depreciation: Annual net income: Average annual Rate o

(1 (195 95,0 ,000 00 x 6. 6.41 418) 8) (55,00 (55,000 0 x 0.4224 0.42241) 1) P1,274,743 975,000 P 299,743

(975,000 + 55,000) ÷ 2 515,000 (975,000 – 55,000) ÷ 10 92,000 195,000 – 92,000 103,000 Return: P103,000 ÷ P515,000

Answer: A Cont Co ntri ribu buti tion on marg margin in:: Less Fixed costs Cash ow beore tax Less: Depreciation (6,000,000 ÷ 4) Income beore tax Less: Income tax (1,500,000 x 0.4) Net income Add back: Depreciation Ater-tax Cash Flow Answer: C PV o Ater-tax Cash Flows Cost o investment Net Present Value

P750 P750

P1,2 P1,251 51,5 ,510 10 23,233 23,233

20%

300, 300,00 000 0 x (7 (75 5 – 50) 50) 4,500,000 3,000,000 1,500,000 1,500,000 600,000 900,000 1,500,000 2,400,000

7, 7,50 500, 0,00 000 0

(2,400,000 x 2.9287) 6,000,000 1,028,900

7,028,900

liii

.

liv

.

lv

. Answer: B Cash FlowPV FactorPV o annual net cash ows:180,0000.909163,620120,0000.826 99,120100,0000.751 75,10090,0000.683 61,47090,0000.621 55,890Total455,200 55,890T otal455,200Amount Amount o investment400,00 investmen t400,000Net 0Net Present Value 55,200 . Answer: C Present Value Index (Proftability Index)

lvi

Answer: A Annu An nual al exce excess ss pr pres esen entt valu value e (1 (1,0 ,028 28,0 ,000 00 ÷ 2. 2.92 9287 87)) P351 P351,0 ,000 00 Exces Ex cess s ca cash sh beor beore e tax (351,0 (351,000 00 ÷ 0.6) 0.6) P585,0 P585,000 00 Maximum number o units as decrease decrease (585,000 ÷ 15) 39,000

Answer: A Average Annual net income: (100,000 + 40,000 + 20,000 + 10,000 + 10,000) ÷ 5 = 36,000 Divide by average investment (400,000 ÷ 2) 200,000 Accounting rate o return 18% Accounting Accoun ting rate o return return or unadjusted rate o return return computes the proftability o the pr proj ojec ectt in te term rm o ac accr crua uall pr prof oft. t. Net Net prof proftt unde underr ac accr crua uall meth method od cons consid ider ers s depre dep recia ciatio tion, n, a subs substan tantia tiall amount amount that understa understates tes the averag average e proft proft.. This This understatement o amount that is used in the computation necessarily requires that preerably, average investment should be used, instead o the initial investment, in the determination o accounting rate o return.

Present Value o ATCF ÷ Net Investment(455,200 ÷ 400,000) = 1.14  The present value index computes net present value in terms o P1 investment.  Thereore,  Thereor e, the index o 1.14 means the net present value per P1 o investment is P0.14. This concept concept makes the present present value index better better than the net present present value technique because the index indicates which one is the most proftable on a per P1

 

investment. lvii

lviii

.

Answer: D  Cash InowUnrecovered Investme InvestmentPeriod ntPeriod 0 Outows(400,000)Period Outows(400 ,000)Period 1180,000(220,000)Period 2120,000(100,000)Period 3100,000Zero  The total outows outows are ully ully recovered recovered by the end end o period 3. 3.  The analyst should be careul in computing the payback period when the project project has uneven cash inows. inows. The common error error in handling uneven uneven cash ows is usin using g the average cash ows instead o reducing the unrecovered outows. .

Answer: D Payback Payba ck period: Investment ÷ Net Annual Annual Cash IInow now P200,000 ÷ P50,000 = 4 years

lix

lx

lxi

lxii

.

Answer: D Pr Pres esen entt valu value e o o Net Net Cas Cash h In Inow ow (7 (71, 1,00 000 0 X 4.3 4.355 55)) Investment Net Present value

309, 309,20 205 5 300,000 9.205

. Answer: B Average Investment: Investment: (200,000 ÷ 2) = 100,000 100,000 Accounting Rate o Return = Net Income ÷ Average Investment (10,000 ÷ 100,000) = 10 percent percent . Answer: B  The payback or PA is 4.225. This is closest closest to the present present value o annuity annuity o 1 discounted at 11 percent or 6 periods which is 4.231. .

Answer: A A iald ti:on(:P6((P 0.3 ÷) 8) An nn nu ua all d taexprsehcie ,P25500,0x00

P1 6,,8 27 55 0 P

lxiii

Answer: C Beore-tax cash inow P10,000 Less depreciation 6,250 Income beore tax 3,750 Less income tax (3,750 x 0.3) 1,125 Net income 2,625 Add back depreciation 6,250 Ater-tax Ater -tax cash inow P 8,875 A quicker calculation o ater tax cash ow can be made by adding the tax shield to ater-tax cash inow without any tax beneft on depreciation.  (P10,000 × .70) + P1,875 = P8,875

lxiv

.

Answer: B Payback Payba ck period: (P50,000 ÷ P8,875) P8,875) = 5.6 years

lxv

.

Answer: C Present value o annual ATCF (P8,875 x 5.747) P51,000 Presentt value o ater-tax Presen ater-tax salvage value (P1,400 x 0.54) 756   Total 51,756 51,7 56 Investment 50,000 Net present value P 1,756

lxvi

. Answer: C At the discount rate rate o 8 percent, there is a net pr present esent value o P1,756. Thereore, Thereore, the IRR is higher than 8 percent. Using trial and error error approach, approach, the frst try should use 9 percent. I the present value o the inows exceeds P50,000, then the IRR is lower than 9 percent, otherwise it should be 9.5 percent. Using 9.0 percent in discounting the inows, there is a net present value o P(174); thereore the IRR is slightly lower than but very close to 9.0 percent. (P8,875 x 5.535) + (P1,400 x 0.5019) – P50,000 = P(174)

.

lxvii

.

Answer: B Additional contribution margin: Small 6,000 x 5.40 Medium 15,000 x 6.50 Large 9,000 x 7.90

32,400 97,500 71,100

 

 Total  Total Less Cash Fixed Expenses: Rent Salaries Utilities Insurance, etc. Annual Cash Inows lxviii

.

lxx

lxxi

.

.

.

18,000 54,000 13,200 7,800

Answer: B Additional rental income Additional cash ow, snack bar  Total  Total Less ReCash nt Fixed Expenses: Salaries Utilities Insurance, etc. Annual Cash Inow

lxix

201,000

130,000 15,000 145,000 48,000 17,000 5,400 9,600

Answer: B PV o annual cash inow (65,000 x 5.575) PV o salvage value PV o working capital return  Total  Total Investment: Remodeling cost 290,000 Working capital 4,000 Net Present Value Answer: A Rental income 21,000 x 5 Additional cash inow, snack bar  Total  Total Less fxed expenses Annual cash inow

602, 602,10 100 0 810 810

362,375 1,296 432 364,103

294,000 70,103

105,000 13,000 118,000 80,000 38,000 (3 (38, 8,00 000 0 x 5, 5,57 575) 5)

PV o salvage value PV o working capital return  Total  Total Investment Negative Net Present Value

lxxiii

80,000 65,000

Answer: A PV o annu annual al cash cash in ino ow w (1 (108 08,0 ,000 00 x 5. 5.57 575) 5) PV o salvage value (70,000 x 0.108) 3,240 PV o work workin ing g capi capita tall ret etur urn n (7 (7,5 ,500 00 x 0. 0.10 108) 8)  Total  Total 606,150 Investment: Remodeling cost 550,000 Working capital 7,500 557,500 Net Present Value 48,650

PV o annu annual al cash cash in ino ow w

lxxii

93,000 108,000

211, 211,85 850 0

1,296 432 213,578 294,000 ( 80,422)

. Answer: D  The annual cost o advertising can be easily calculated by dividing the net present value o alternative 2, at 16% by the present value o annuity o 1. 70,103 ÷ 5,575 = 12,574.53 .

Answer: A Annual revenues Variable expenses Contribution margin Fixed expenses Advertising Sa U tillaitriieess Insurance Annual cash income Less Le ss Depr Deprec ecia iati tion on

300,000 60,000 240,000 40,000 110 5,,0 20 00 0 800

156,000 84,000 42 420, 0,00 000 0 x 0. 0.90 90 ÷ 12

31,5 31,500 00

 

Annual Income lxxiv

.

52,500

Answer: A Current operating costs – old machine Deduct Operating costs – Machine B Annual salary o operator Annual maintenance cost Annual cash savings

78,000 16,350 5,400

21,750 56,250

lxxv

. Answer: A Simple Rate o Return = Net Income ÷ Initial Investment 52,500 ÷ 420,000 = 12.50 %

lxxvi

.

Answer: B Savings Less Depreciation 234000 ÷ 13 years Annual income Simple Annual Return

56,250 18,000 38,250 38,250 ÷ 225,000

lxxvii

. Answer: C Payback period = Initial Investment ÷ Annual Cash Inow 420,000 ÷ 84,000 = 5 years

lxxviii

.

Answer: A 225,000 ÷ 56,250 = 4 years

lxxix

.

Answer: C Purchase price o new tools Add increase in working capital

2,500,000 60,000

 Total  T otal  D educt Salvage value o the old tools Net investment lxxx

.

lxxxi

.

lxxxii

.

lxxxiii

.

lxxxiv

.

2,560,000 45,000 2,528,500

Answer: C Purchase price o valve stem 80,000 x 20 1,600,000 Cost to make: Direct Dir ect materi materials als 80,000 80,000 x 4.50 4.50 360,00 360,000 0 Direct Dir ect labor labor 80, 80,000 000 x 3.90 3.90 312,00 312,000 0 Variable ariable overhead overhead 80,000 80,000 x 1.50 120,000 120,000 Decrease Decr ease in directs directs labor labor and variable variable costs costs 80,000 80,000 x 1.60(128, 1.60(128,000) 000) Cost savings 936,000

.

664,000 664,000

Answer: A PV o annual depreciation PeriodDepreciationPV PeriodDepreciationP V FactorPresent ValueY ValueYear ear 1 832,5000.89286743,30 832,5000. 89286743,305.95 5.95 2 112,5000.79719886,873.88 112,5000.79719 886,873.88 3 370,0000.71178263,358.60 370,0000.71178263,358.60 4 185,0000.63552117,571.20Total2,011,109.63Tax rate0.30PV o tax benefts rom depreciation603,332.89 Answer: C Ater tax salvage value 100,000 x .7 70,000 PV o 1 end o 4 periods 0.63552 PV o ater – tax salvage value 44,486.4 Answer: C PV o a ate terr cash cash sa savi ving ngs s PV o tax benefts rom depreciation PV o ater tax salvage value PV o work workin ing g capi capita tall ret etur urn n Investment Net present value

93 936, 6,00 000 0 x .7 x 3. 3.03 0373 735 5 603,333 44,486 60,0 60,000 00 x 0. 0.63 6355 552 2 (2528,500) 147,522

Answer: A PV o tax benefts, declining - balance PV o tax benefts, straight-line straight-line method

1990 199007 072 2

38,1 38,131 31

603,333 2,500,000 ÷ 4 x .3 x 3.03735 569,503

Net advantage lxxxv

17 %

Answer: A Invo Invoic ice e pri price ce o new new equi equipm pmen entt (945 (945,0 ,000 00 x 0.98 0.98))

33,830 P926 P926,1 ,100 00

 

Freight 11,000 Installation cost 22,900   Total 960,000   Less: Sa Salvage value o old equipment (0 (0.6 x 1,500) 900   Reduction in working capital 2,500 3,400 Net initial outows P956,600 lxxxvi

.

Answer: B  Total  Total variable costs costs Avoidable fxed costs  Total  Total

(262,000 units units x P20*)P5,240,000 (P45,000 x 5 years) 225,000 5,465,000

Ater-tax outows OperatingCash expenses (5,465,000 x 0.6) P3,279,000 Depre Dep recia ciatio tion n (960,0 (960,000 00 x 0.4) 0.4) ( 384,00 384,000) 0) At ter er-ta -tax x salva salvage ge value value o new equipm equipment ent (12,00 (12,000 0 x 0.60) 0.60)   Net outows P2,887,800 *Variable cost per unit Direct material (10.00 x 0.75) Direct labor Variable overhead (6.00 x 0.75)   To Total

(

7,200) 7,200)

P 7.50 8.00 4.50 P20.00

lxxxvii

. Answer: A  The present present value o the the tax shield ba based sed on declining-depr declining-depreciation eciation is:  Y  YearDeprec earDepreciationT iationTax Shield (40%)PV FactorPV FactorPV o Tax Shield2007P319,968P127,9870.893P114,2922008 426,720 170,6880.797 136,0382009 142,176 56,8700.712 56, 8700.712 40,4922010 71,136 28,4550.636 28 ,4550.636 18,098TotalP308,92 18,098TotalP308,920 0 lxxxviii . Answer: C Purchase Cost  Year  Year ATCF200750,000 x 27 x 0.6 810,000200850,000 810,000200850,000 x 27 x 0.6 810,000200952,000 810,00020095 2,000 x 27 x 0.6 842,400201055,000 842,400201055,000 x 27 x 0.6 891,000201155,000 891,000201155,000 x 27 x 0.6 891,0002006(1,500 891,00020 06(1,500 x 0.6) ( 900) Total 4,243,500 lxxxix . Answer: A Present value o ater-tax cash ows 2007 (810,000 x 0.893) P 723,330 2008 (810,000 x 0.797) 645,570 2009 (842,400 x 0.712( 599,789 2010 (891,000 x 0.636) 566,676 2011 (891,000 x 0.567) 505,197 Salvag Sal vage e value value o old equipm equipment ent (1,500 (1,500 x 0.60) 0.60) (900) (900) Net present value P3,039,662 xc

. Answer: D CFBTCFATPV FactorPVCFAT2006Initial outow(P956,600)2007(50,000 x 20) + 45,000 (1,045,000 x 0.6) - (319,968 x 0.4)1,045,000 499,013 0.893 445,6192008(1,045,000 x 0.6) – (426,720 x 0.4)456,3120.797363,6812009(52,000 x 20) + 45,000 (1,085,000 x 0.6) – (142,176 x 0.4)1,085,000 594.130 0.712 423,0212010(55,000 423,0212010(55 ,000 x 20) + 45,000 (1,145,000 x 0.6) – (71,136)1,145,000 (71,136)1,145,000 658,546 0.636 418,8352011(55,000 418,8352011(55 ,000 x 20) + 45,000 (1,145,000 x 0.6)1,145,000 687,000 0.567 385,447Salvage 385,447Salvag e value (12,000 x 0.6)7,200P2,993,203 0.6)7,200P2,993,203