PROBLEMS

118. What is the present value of Rs. 8,000 to be received at the end of six years, if the
required
rate of return is 15%?
Answer
Rs. 8,000 0.!"#" $ Rs. ",!58.!0
11%. What is the present value of Rs. 8,000 per year for four years if the required rate of return
is 10%?
Answer
Rs. 8,000 ".1&%% $ Rs. #5,"5%.#0
1#0. 'ssu(e a required rate of return of 8%. What is the present value of
a) Rs. ##,000 to be received at the end of 1# years?
b) Rs. 18,000 per year for 10 years?
Answer
a) Rs. ##,000 0."%*1 $ Rs. 8,*"&.#0
b) Rs. 18,000 &.*101 $ Rs. 1#0,*81.80
1#1. ' pro+ect ,ill require an initial invest(ent of Rs. *50,000 and ,ill return Rs. #00,000
each
year for five years. -f taxes are i.nored and the required rate of return is %%, ,hat is the
pro+ect/s net present value? 0ased on this analysis, should the co(pany proceed ,ith the
pro+ect?
Answer
1Rs. #00,000 ".88%*) 2 Rs. *50,000 $ Rs. #*,%!0
3es, since the net present value is .reater than 4ero, the co(pany should proceed ,ith the
pro+ect.
1##. ' pro+ect ,ill require an initial invest(ent of Rs. &00,000 and is expected to .enerate the
follo,in. cash flo,s5
3ear 1 Rs. 100,000
3ear # Rs. #50,000
Test Bank to acco(pany 6ia(balvo Managerial Accounting, 2
nd
edition
3ear " Rs. #50,000
3ear ! Rs. #00,000
3ear 5 Rs. 100,000
a) What is the pro+ect/s paybac7 period?
b) -f the required rate of return is #0% and taxes are i.nored, ,hat is the pro+ect/s
net present value?
Answer
a) Rs. 100,000 8 Rs. #50,000 8 Rs. #50,000 $ Rs. &00,000, so the paybac7 period is
three
years.
b) 1Rs. &00,000) 1.000 $ 1Rs. &00,000)
Rs. 100,000 0.8""" $ 8",""0
Rs. #50,000 0.&%!! $ 1*",&00
Rs. #50,000 0.5*8* $ 1!!,&*5
Rs. #00,000 0.!8#" $ %&,!&0
Rs. 100,000 0.!01% $ !0,1%0
9et present value 1Rs. &1,*!5)
1#". 'n invest(ent of Rs. 185,5*5 is expected to .enerate returns of Rs. &5,000 per year for
each
of the next four years. What is the invest(ent/s internal rate of return?
Answer
Rs. 185,5*5 : Rs. &5,000 $ #.855 at ! years $ 15%
1#!. ;7i <o(pany had revenues of Rs. %00,000 and expenses of Rs. *00,000 last year. =he
expenses included Rs. 1#0,000 of depreciation expense. =he co(pany pays taxes at the
"5% rate. What is the co(pany/s cash flo,?
Answer
Rs. %00,000 2 Rs. *00,000 > ?10."5) 1Rs. %00,000 > Rs. *00,000)@ 8 Rs. 1#0,000 $ Rs.
#50,000
1#5. ;un <o(pany is considerin. an invest(ent that ,ill .enerate cash revenues of Rs.
100,000 per year for 8 years, and have cash expenses of Rs. *0,000 per year for 8 years.
=he cost of the asset is Rs. 80,000, and it ,ill be depreciated usin. strai.ht2line
depreciation over its 8 year life. ;un pays inco(e taxes at a rate of "0%. =he cost of
capital is 1#%
a) Arepare a schedule sho,in. the annual after tax cash flo, associated ,ith this
asset.
b) <o(pute the net present value of this invest(ent usin. the cash flo, you
co(puted in a above.
c) <o(pute the accountin. rate of return on avera.e invest(ent for this pro+ect.
Answer
a)
Cash Revenues Rs. 100,000
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Chapter 9 <apital 0ud.etin. Becisions

-Cash Expenses Rs. 70,000
-Depreciation Rs. 10,000
Income before tax Rs. 20,000
-Tax Rs. ,000
!et income Rs. 1",000
#Depreciation Rs. 10,000
Cash f$o% Rs. 24,000
b) 280,000 8 1#!,000 !.%&*&) $ Rs. 39,222
c) 1!,000:1180,000 8 0):#) $ 35%
SHORT-ANSWER ESSAYS
1#&. What are capital bud.etin. decisions?
Answer
-nvest(ent decisions involvin. the acquisition of lon.2lived assets ,hich require that the
co(pany expend si.nificant a(ounts of capital 1co(pany funds) are considered capital
bud.etin. decisions.
1#*. What is (eant by Cthe ti(e value of (oneyD concept?
Answer
=he ti(e value of (oney concept reco.ni4es that it is better to receive a dollar today than
it is to receive a dollar at any ti(e in the future. =he dollar that is received today can be
invested so that it is ,orth (ore than a dollar in the future.
1#8. What is the (ost si.nificant difference bet,een the net present value and internal rate of
return (ethods and the paybac7 period and accountin. rate of return (ethods?
Answer
=he net present value and internal rate of return (ethods use the ti(e value of (oney
concept and are therefore superior to the paybac7 period and accountin. rate of return
(ethods, ,hich i.nore the ti(e value of (oney.
1#%. Eo, does a fir( deter(ine its required rate of return?
Answer
Fana.e(ent (ust esti(ate the fir(/s required rate of return, re(e(berin. that ris7ier
invest(ents de(and hi.her rates of return. =he required rate of return is based on the
fir(/s cost of capital, the ,ei.hted avera.e of the fir(/s cost of debt and cost of equity.
1"0. =he paybac7 period (ethod of evaluatin. capital bud.etin. alternatives has t,o
si.nificant dra,bac7s. What are they?
%2"
Test Bank to acco(pany 6ia(balvo Managerial Accounting, 2
nd
edition
Answer
=he paybac7 period i.nores any cash flo,s that occur after the end of the paybac7 period.
-t also does not (a7e use of the ti(e value of (oney concept.
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Chapter 9 <apital 0ud.etin. Becisions

1"1. What are CsoftD benefits? What effect do CsoftD benefits have in capital bud.etin.
decisions?
Answer
;oft benefits are the benefits that are difficult to quantify. Gften, soft benefits are i.nored
,hen capital bud.etin. decisions are (ade. =his leads co(panies to pass up invest(ents
that are of strate.ic i(portance.
1"#. Hxplain the i(portance of depreciation in a capital bud.etin. analysis.
Answer
<apital bud.etin. focuses on cash flo, and depreciation is not a cash flo, but does
reduce taxable inco(e, and thereby taxes paid. =his reduction in taxes is referred to as
the depreciation tax shield and represents a cash inflo, ,hich should be included in the
analysis. -f there are no taxes present, depreciation is not relevant.
1"". Why is the i(pact of acceptin. a sound capital pro+ect often ne.ative in ter(s of short
ter( profits?
Answer
=he inflo,s are often lo,er in the initial sta.es of a pro+ect, and there (ay be start up
expenses. 'dditionally, accelerated depreciation can cause lo, initial inco(es.
1"!. Why is it i(portant to ad+ust future cash flo,s for inflation? What is the i(pact of
failin. to do so?
Answer
=he cost of capital includes a factor for inflation to the extent that the rates used reflect
(ar7et rates. =hus, is the cash flo,s are not inflated, invest(ent returns ,ill be
understated, resultin. in le.iti(ate opportunities bein. for.one.
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