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Chapter 14

Chapter 14

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Published by 'Jemuel Vales

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Categories:Types, Business/Law
Published by: 'Jemuel Vales on Feb 18, 2011
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03/12/2012

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CHAPTER 14CAPITAL BUDGETING
[Problem 1]Purchase priceP140,000Trade-in allowance( 7,000)Saving from repairs( 25,000)Additional tax on savings
(P25,000 x 40%)
10,000Net cost of investment for decision analysisP118,000[Problem 2]Purchase priceP4,800,000Freight and installation 45,000Trade-in allowance( 200,000)Salvage value of other assets 12,000Tax savings other assets( 8,000)Savings from repairs( 400,000)Add’l tax on savings from repairs
(P400,000 x 40%)
160,000Additional working capital 350,000Net cost of investment for decision analysisP4,759,000[Problem 3]Purchase priceP900,000Freight charge 25,000Installation costs 22,000Special attachment 55,000Addl working capital 110,000Proceeds from sale of old assets( 22,000)Tax savings (P38,000 x 25%)( 9,500)Savings from repairs( 120,000)
Add’l tax on savings from repairs (P120,000 x 25%)
30,000Net cost of investment for decision analysisP990,500[Problem 4]Furnishing and equipmentP 500,000Rental deposits 200,000Accounts receivable (P9M x 1/3 x 2/3) 2,000 000Inventory 400,000Cash 120,000Net cost of investment for decision analysisP5,020,000[Problem 5]1.SalesP6,000,000Materials( 800,000)Labor( 1,200,000)Factory overhead( 540,000)Selling and administrative expenses( 700,000)Depreciation expense (P1,200,000
÷
5 yrs)( 240,000)Income before income tax 2,520,000Tax (30%)( 756,000)Net income 1,764,000
 
Add back: Depreciation expense 240,0002.Annual net cash flowsP2,004,000[Problem 6]1.Weighted Average Cost of Capital (WACOC) = ?
Sources of capitalMarket valuesIndividual Cost of Capital Mix WACOCCapitalFractionMortgage bonds(P300,000 x 105%) = P315,000(10% x 55%) = 5.5%315 / 1.0071.72%Preferred equity(2000 sh x P96) = 192,000(P12 / P96) = 12.5192 / 1.0072.38%Common equity(50,000 sh x P10) = 500,000P1.50 / P10 = 15.0500 / 1.0077.45%TotalP1,007,00011.55%Preferred dividends = 12% x P100 = P12 / shEarnings per share = P75,000 / 50,000 sh = P1.50
2.ProposedInvestmentROIWACOCAdviseA7%11.55%RejectB10%11.55%RejectC14%11.55%AcceptInvestments are to be accepted if the WACOC is higher than the ROI.[Problem 7]1.New WACOC = ?
Cost ofPackage 1Package 2Package 3Sources of MoneyCapitalAmountWACOCAmountWACOCAmountWACOCLong-termdebt6%P10,000,0003%P 2,000 0000.60%P 6,000,0001.80%Preferredequity11%3,000,0001.65% 11,000 0006.05%5,000,0002.75%Commonequity14%7,000,0004.90%7,000,0004.90%9,000,0006.30%TotalP20,000,0009.55%P20,000,00011.55%P20,000,00010.85%
2.Package 1 gives the invest WACOC at 9.55%.[Problem 8]
Before Bonds RetirementAfter Bonds RetirementAmountWACOCAmountWACOCBondsP 5,000,000(8% x 60% x 5/10) = 2.4%P4,000,000(8% x 60% x 4/10) = 1.92%Preferredequity1,000,000 (9% x 1/10) = 0.9%1,000,000 (9% x 1/10) = 0.90%Commonequity4,000,000 (12.5% x 4/10) = 5%4,000,000 (12.5% x 4/10) = 5.0%
 
Lease1,000,000 10% x 60% x 1/10) = 0.60%TotalsP10,000,0008.30%P10,000,0008.42%
[Problem 9]a.WACOC = ?
FundsAmountIndividual Cost of CapitalWACOCMortgage bondsP20,000,000[(6.5% x 50%) / 95%] 3.42%0.684%Common stock25,000,000[(P4 x 105%) /P94 + 5%] 9.472.3675%Ret earnings 55,000,0009.475.2085%TotalP100,000,0008.26%
b.The weighted average cost of capital is used as a benchmark in evaluating the acceptability or rejection of proposed investment because it measures the point of expected return where theminimum required return of each class of investor is met by reason of cross-subsidizing fromone class of security to another.[Problem 10]a.WACOC under each alternative
Alternative AAlternative BDebt(9% x 50% x 2/6) = 1.5%(12% x 50% x 4/6) = 4.0%Equity {[(P1/P20) + 7%] x 4/6} = 8.0% {[(P0.90/P20) + 12%] x 2/6} = 5.5%WACOC9.5%9.5%
 b.
In alternative B, the amount of debt increases thereby increasing the debt equity ratiosignalling the firm is highly leveraged and more risky for investment. This tends to increase thenominal rate of the bonds.c.Yes; it is logical for stockholders to expect a higher dividend growth rate under alternative B tocompensate the higher rate implied by an increase in the debt exposure of the firm and tovalidate the theory that the more debt is used in the financing portfolio, the higher theprofitability rate of the firm, thereby, the higher the growth rate.[Problem 11]1.Marginal Cost of Capital for each fund2.WACOC = ?[a]CapitalMix[b]SourcesIndividual COCRateWACOCMortgage bonds(14% x60%) = 8.4%15.00%1.26%Debentures(145% x 60%) = 8.7%25.00%2.175%Preferred stock(P13.50/ P99.25) =
13.60%
10.00%1.36%Common stock
(P1.80 / P67.50 + 10%)=12.67%
16.67%2.11%Retained earnings 
= 12.67%
33.33%4.22%100.00%11.125%3.Maximum point of expansion for retained earnings:Net income (P4.50 x 15 million shares)P67,500,000Common dividends (P67,000,000 x 40%

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