Capital Budgeting

MODULE 9
CAPITAL BUDGETING
THEORIES:
Basic Concepts
Decision Making Process
2. The first step in the decision-making process is to
A. determine and evaluate possible courses of action.
B. identify the problem and assign responsibility.
. make a decision.
D. revie! results of the decision.
"trategic planning
#$. "trategic planning is the process of deciding on an organi%ation&
A. minor programs and the appro'imate resources to be devoted to them
B. ma(or programs and the appro'imate resources to be devoted to them
. minor programs prior to consideration of resources that might be needed
D. ma(or programs prior to consideration of resources that might be needed
apital budgeting defined
). The long-term planning process for making and financing investments that affect a company&s
financial results over a number of years is referred to as
A. capital budgeting . master budgeting
B. strategic planning D. long-range planning
#. apital budgeting is the process
A. used in sell or process further decisions.
B. of determining ho! much capital stock to issue
. of making capital e'penditure decisions
D. of eliminating unprofitable product line
*. A capital investment decision is essentially a decision to+
A. e'change current assets for current liabilities.
B. e'change current cash outflo!s for the promise of receiving future cash inflo!s.
. e'change current cash flo! from operating activities for future cash inflo!s from investing
activities.
D. e'change current cash inflo!s for future cash outflo!s.
,isk - return
.. The higher the risk element in a pro(ect/ the
A. more attractive the investment is.
B. higher the net present value is.
. higher the cost of capital is.
D. higher the discount rate is.
$. ost of capital is the
A. amount the company must pay for its plant assets.
B. dividends a company must pay on its e0uity securities.
. cost the company must incur to obtain its capital resources.
D. cost the company is charged by investment bankers !ho handle the issuance of e0uity or
long-term debt securities.
)1. 2o! should the follo!ing pro(ects be listed in order of increasing risk3
A. 4e! venture/ replacement/ e'pansion.
B. ,eplacement/ ne! venture/ e'pansion.
. ,eplacement/ e'pansion/ ne! venture.
D. 5'pansion/ replacement/ ne! venture.
1). Problems associated !ith (ustifying investments in high-tech pro(ects often include discount
rates that are too
A. lo! and time hori%ons that are too long
B. high and time hori%ons that are too long
. high and time hori%ons that are too short
D. lo! and time hori%ons that are too short
.6. 7n evaluating high-tech pro(ects/
A. only tangible benefits should be considered.
B. only intangible benefits should be considered.
. both tangible and intangible benefits should be considered.
D. neither tangible nor intangible benefits should be considered.
Types of capital pro(ects
1. A pro(ect that !hen accepted or re(ected !ill not affect the cash flo!s of another pro(ect.
A. 7ndependent pro(ects . Mutually e'clusive pro(ects
B. Dependent pro(ects D. Both b and c
227
Capital Budgeting
Capital b!"etin" p#ocess
8. The normal methods of analy%ing investments
A. cannot be used by not-for-profit entities.
B. do not apply if the pro(ect !ill not produce revenues.
. cannot be used if the company plans to finance the pro(ect !ith funds already available
internally.
D. re0uire forecasts of cash flo!s e'pected from the pro(ect.
In$est%ents
"ale of old asset
#9. :hen disposing of an old asset and replacing it !ith a ne! one/ ta' effect on
A. gain on sale of the old asset reduces the basis of the ne! asset
B. gain on sale of the old asset increases the basis of the ne! asset
. loss on sale of the old asset reduces the basis of the ne! asset
D. b and c
:orking capital
)9. A ma(or difference bet!een an investment in !orking capital and one in depreciable assets is
that
A. an investment in !orking capital is never returned/ !hile most depreciable assets have
some residual value.
B. an investment in !orking capital is returned in full at the end of a pro(ect&s life/ !hile an
investment in depreciable assets has no residual value.
. an investment in !orking capital is not ta'-deductible !hen made/ nor ta'able !hen
returned/ !hile an investment in depreciable assets does allo! ta' deductions.
D. because an investment in !orking capital is usually returned in full at the end of the
pro(ect&s life/ it is ignored in computing the amount of the investment re0uired for the
pro(ect.
#6. The proper treatment of an investment in receivables and inventory is to
A. ignore it
B. add it to the re0uired investment in fi'ed assets
. add it to the re0uired investment in fi'ed assets and subtract it from the annual cash flo!s
D. add it to the investment in fi'ed assets and add the present value of the recovery to the
present value of the annual cash flo!s
#). 7n connection !ith a capital budgeting pro(ect/ an investment in !orking capital is normally
recovered
A. at the end of the pro(ect&s life
B. in the first year of the pro(ect&s life
. evenly through the pro(ect&s life
D. !hen the company goes out of businessA
#2. ;<= o. is adopting (ust-in-time principles. :hen evaluating an investment pro(ect that !ould
reduce inventory/ ho! should ;<= treat the reduction3
A. 7gnore it.
B. Decrease the cost of the investment and decrease cash flo!s at the end of the pro(ect&s
life.
. Decrease the cost of the investment.
D. Decrease the cost of the investment and increase the cash flo! at the end of the pro(ect&s
life.
Rele$ant cas& 'lo(s
82. :hich of the follo!ing represents the biggest challenge in the decision to purchase ne!
e0uipment3
A. 5stimating employee training for the ne! pro(ect.
B. 5stimating cash flo!s for the future.
. 5stimating transportation costs of the ne! e0uipment.
D. 5stimating maintenance costs for the ne! e0uipment.
*). :hen a firm has the opportunity to add a pro(ect that !ill utili%e factory capacity that is
currently not being used/ !hich costs should be used to determine if the added pro(ect should
be undertaken3
A. >pportunity costs . 4et present costs
B. 2istorical costs D. 7ncremental costs
)). The only future costs that are relevant to deciding !hether to accept an investment are those
that !ill
A. be different if the pro(ect is accepted rather than re(ected.
B. be saved if the pro(ect is accepted rather than re(ected.
. be deductible for ta' purposes.
D. affect net income in the period that they are incurred.
ash inflo!
... :hich of the follo!ing is not a typical cash inflo! in capital investment decisions3
228
Capital Budgeting
A. 7ncremental revenues . "alvage value
B. ost reductions D. Additional !orking capital
>ut-of-pocket costs
1*. :hich of the follo!ing is a cost that re0uires a future outlay of cash that is !hich relevant for
future decision-making3
A. >pportunity cost . "unk costs
B. >ut-of-pocket cost D. ,elevant benefits
Depreciation - Ta'
22. 7f there !ere no income ta'es/
A. depreciation !ould be ignored in capital budgeting.
B. the 4P? method !ould not !ork.
. income !ould be discounted instead of cash flo!.
D. all potential investments !ould be desirable.
2). ,elevant cash flo!s for net present value @4P?A models include all of the follo!ing e'cept
A. outflo!s to purchase ne! e0uipment
B. depreciation e'pense on the ne!ly ac0uired piece of e0uipment
. reductions in operating cash flo!s as a result of using the ne! e0uipment.
D. cash outflo!s related to purchasing additional inventories for another retail store.
**. :hen evaluating depreciation methods/ managers !ho are concerned about capital
investment decisions !ill+
A. choose straight line depreciation so there is minimum impact on the decision.
B. use units of production so more depreciation e'pense !ill be allocated to the later years.
. use accelerated methods to have as much depreciation in the early years of an asset&s
life.
D. choice of depreciation method has no impact on the capital investment decision.
86. The ta' conse0uences should be considered under !hich circumstances !hen making capital
investment decisions3
A. Positive net income . Depreciation
B. Disposal of an asset D. All of the above
I##ele$ant cas& 'lo(s
Boan financing
1#. 7n addition to incremental revenues/ cash inflo!s from capital investments can be generated
from all of the follo!ing sources e'cept+
A. debt financing
B. cost savings
. salvage value
D. reduction in the amount of !orking capital
)6. 7f 2elena ompany e'pects to get a one-year bank loan to help cover the initial financing of
one of its capital pro(ects/ the analysis of the pro(ect should
A. offset the loan against any investment in inventory or receivables re0uired by the pro(ect.
B. sho! the loan as an increase in the investment.
. sho! the loan as a cash outflo! in the second year of the pro(ect&s life.
D. ignore the loan
"unk cost
2$. 7n deciding !hether to replace a machine/ !hich of the follo!ing is 4>T a sunk cost3
A. The e'pected resale price of the e'isting machine.
B. The book value of the e'isting machine.
. The original cost of the e'isting machine.
D. The depreciated cost of the e'isting machine.
Accontin" #ate o' #et#n
*1. The primary advantages of the average rate of return method are its ease of computation and
the fact that+
A. 7t is especially useful to managers !hose primary concern is li0uidity
B. There is less possibility of loss from changes in economic conditions and obsolescence
!hen the commitment is short-term
. 7t emphasi%es the amount of income earned over the life of the proposal
D. ,ankings of proposals are necessary
Non!isconte! cas& 'lo( %et&o!
Payback method
#.. There are several capital budgeting decision models that do not use discounted cash flo!s.
:hat is the name of the simple techni0ue that calculates the total time it !ill take to recover/
using cash inflo!s from operations/ the amount of cash invested in a pro(ect3
A. ,ecovery period . 5'ternal rate of return
B. Payback model D. Accounting rate of return
#1. The techni0ue most concerned !ith li0uidity is
229
Capital Budgeting
A. Payback method.
B. 4et present value techni0ue.
. 7nternal rate of return.
D. book rate of return.
8#. :hich of the follo!ing is a potential use of the payback method3
A. 2elp managers control the risks of estimating cash flo!s
B. 2elp minimi%e the impact of the investment on li0uidity
. 2elp control the risk of obsolescence
D. All of the ans!ers are correct
18. The cash payback techni0ue+
A. should be used as a final screening tool.
B. can be the only basis for the capital budgeting decision.
. is relatively easy to compute and understand.
D. considers the e'pected profitability of a pro(ect.
##. :hich of the follo!ing is 4>T a defect of the payback method3
A. 7t ignores cash flo!s because it uses net income.
B. 7t ignores profitability.
. 7t ignores the present values of cash flo!s.
D. 7t ignores the pattern of cash flo!s beyond the payback period.
19. The payback method/ as a capital budgeting techni0ue/ assumes that all intermediate cash
inflo!s are reinvested to yield a return e0ual to+
A. =ero . The Discount ,ate
B. The Time-Ad(usted-,ate-of-,eturn D. The ost-of-apital
*2. :hich of the follo!ing capital budgeting methods is the least theoretically correct3
A. payback method . internal rate of return
B. net present value D. none of the above
Disconte! cas& 'lo( %et&o!
1$. :hich of the follo!ing methods of evaluating capital investment pro(ects incorporates the time
value of money3
A. Payback period/ accounting rate of return/ and internal rate of return
B. Accounting rate of return/ net present value/ and internal rate of return
. Payback period and accounting rate of return
D. 4et present value and internal rate of return
4et present value
.$. Discounted cash flo! analysis is used in !hich of the follo!ing techni0ues3
A. 4et present value . ost of capital
B. Payback period D. All of the above
9. The primary capital budgeting method that uses discounted cash flo! techni0ues is the
A. net present value method.
B. cash payback techni0ue.
. annual rate of return method.
D. profitability inde' method.
26. The net present value @4P?A model can be used to evaluate and rank t!o or more proposed
pro(ects. The approach that computes the total impact on cash flo!s for each option and then
converts these total cash flo!s to their present values is called the
A. differential approach . contribution approach
B. incremental approach. D. total pro(ect approach.
16. The discount rate commonly used in present value calculations is the
A. treasury bill rate
B. !eighted average return on assets ad(usted for risk
. risk free rate plus inflation rate
D. shareholders& e'pected return on e0uity
11. :hich is true of the net present value method of determining the acceptability of an
investment3
A. The initial cost of the investment is subtracted from the present value of net cash flo!s
B. The net cash flo!s are not ad(usted to present value
. A negative net present value indicates the investment should be undertaken
D. The net present value method re0uires no sub(ective (udgments
Profitability inde'
#*. The profitability inde'
A. does not take into account the discounted cash flo!s.
B. 7s calculated by dividing total cash flo!s by the initial investment.
. allo!s comparison of the relative desirability of pro(ects that re0uire differing initial
investments.
230
Capital Budgeting
D. !ill never be greater than ).6.
7nternal rate of return
*.. According to the reinvestment rate assumption/ !hich method of capital budgeting assumes
cash flo!s are reinvested at the pro(ect&s rate of return3
A. payback period . internal rate of return
B. net present value D. none of the above
.2. The rate of interest that produces a %ero net present value !hen a pro(ect&s discounted cash
operating advantage is netted against its discounted net investment is the+
A. ost of capital . utoff rate
B. Discount rate D. 7nternal rate of return
*8. A !eakness of the internal rate of return method for screening investment pro(ects is that it+
A. Does not consider the time value of money
B. 7mplicitly assumes that the company is able to reinvest cash flo!s from the pro(ect at the
company&s discount rate
. 7mplicitly assumes that the company is able to reinvest cash flo!s from the pro(ect at the
internal rate of return
D. Cails to consider the timing of cash flo!s
omprehensive
*6. :hich of the follo!ing methods of evaluating capital investment pro(ects do not use a
percentage as a measurement unit3
A. Payback period and net present value
B. Accounting rate of return and payback period
. 4et present value and internal rate of return
D. 7nternal rate of return and payback period
Relations&ips a%on" NP)* PI + IRR
21. 7f a company&s re0uired rate of return is )2 percent and in using the profitability inde' method/
a pro(ect&s inde' is greater than ).6/ this indicates that the pro(ect&s rate of return is
A. e0ual to )2 percent. . less than )2 percent.
B. greater than )2 percent. D. dependent on the si%e of the investment.
2*. 7f the present value of the future cash flo!s for an investment e0uals the re0uired investment/
the 7,, is
A. e0ual to the cutoff rate.
B. e0ual to the cost of borro!ed capital.
. e0ual to %ero.
D. lo!er than the company&s cutoff rate return.
28. The relationship bet!een payback period and 7,, is that
A. a payback period of less than one-half the life of a pro(ect !ill yield an 7,, lo!er than the
target rate.
B. the payback period is the present value factor for the 7,,.
. a pro(ect !hose payback period does not meet the company&s cutoff rate for payback !ill
not meet the company&s criterion for 7,,.
D. none of the above.
.8. :hen comparing 4P? and 7,,/ !hich is not true3
A. :ith 4P?/ the discount rate can be ad(usted to take into account increased risk and the
uncertainty of cash flo!s
B. :ith 7,,/ cash flo!s can be ad(usted to account for risk
. 4P? can be used to compare investments of various si%e or magnitude
D. Both 4P? and 7,, can be used for screening decisions
Sensiti$it, anal,sis
)#. 7n capital budgeting/ sensitivity analysis is used
A. to determine !hether an investment is profitable.
B. to see ho! a decision !ould be affected by changes in variables.
. to test the relationship of the 7,, and 4P?.
D. to evaluate mutually e'clusive investments.
)*. An approach that uses a number of outcome estimates to get a sense of the variability among
potential returns is
A. the discounted cash flo! techni0ue.
B. the net present value method.
. risk analysis.
D. sensitivity analysis.
12. "ensitivity analysis is the study of ho! the outcome of a decision making process
A. changes as one or more of the assumptions change
B. remains the same even though one or more of the assumptions change
. changes even though one or more of the assumptions do not change
D. does not change as the assumptions do not change either
231
Capital Budgeting
.1. "ensitivity analysis is+
A. An appropriate response to uncertainty in cash flo! pro(ections
B. Dseful in measuring the variance of the Cisher rate
. Typically conducted in the post investment audit
D. Dseful to compare pro(ects re0uiring vastly different levels of initial investment
7,, E 6
*9. if the internal rate of return on an investment is %ero+
A. its 4P? is positive.
B. its annual cash flo!s e0ual its re0uired investment.
. it is generally a !ise investment.
D. its cash flo!s decrease over its life.
hange in 4P?
*$. :hich of the follo!ing !ould decrease the net present value of a pro(ect3
A. A decrease in the income ta' rate
B. A decrease in the initial investment
. An increase in the useful life of the pro(ect
D. An increase in the discount rate
5ffect of change in cost of capital
2.. All other things being e0ual/ as cost of capital increases
A. more capital pro(ects !ill probably be acceptable.
B. fe!er capital pro(ects !ill probably be acceptable.
. the number of capital pro(ects that are acceptable !ill change/ but the direction of the
change is not determinable (ust by kno!ing the direction of the change in cost of capital.
D. the company !ill probably !ant to borro! money rather than issue stock.
5ffect of change in residual value
2#. Assuming that a pro(ect has already been evaluated using the follo!ing techni0ues/ the
evaluation under !hich techni0ue is least likely to be affected by an increase in the estimated
residual value of the pro(ect3
A. Payback Period. . 4et Present ?alue.
B. 7nternal ,ate of ,eturn. D. Profitability 7nde'.
Decision #les - in!epen!ent p#o.ects
.9. :hat type of decision involves deciding if an investment meets a predetermined standard3
A. 7nvestment decisions . Management decisions
B. "creening decisions D. Preference decisions
Payback period
1.. 7f a payback period for a pro(ect is greater than its e'pected useful life/ the
A. pro(ect !ill al!ays be profitable.
B. entire initial investment !ill not be recovered.
. pro(ect !ould only be acceptable if the company&s cost of capital !as lo!.
D. pro(ect&s return !ill al!ays e'ceed the company&s cost of capital.
4et present value
.). An analysis of a proposal by the net present value method indicated that the present value of
future cash inflo!s e'ceeded the amount to be invested. :hich of the follo!ing statements
best describes the results of this analysis3
A. The proposal is desirable and the rate of return e'pected from the proposal e'ceeds the
minimum rate used for the analysis
B. The proposal is desirable and the rate of return e'pected from the proposal is less than
the minimum rate used for the analysis
. The proposal is undesirable and the rate of return e'pected from the proposal is less than
the minimum rate used for the analysis
D. The proposal is undesirable and the rate of return e'pected from the proposal e'ceeds
the minimum rate used for the analysis
.#. 4P? indicates a pro(ect is deemed desirable @acceptableA !hen the 4P? is
A. greater than or e0ual to %ero
B. less than %ero
. greater than or e0ual to the risk-ad(usted cost of capital
D. less than or e0ual to the risk-ad(usted cost of capital
7nternal rate of return
)2. 7f Arbitrary ompany !ants to use 7,, to evaluate long-term decisions and to establish a
cutoff rate of return/ it must be sure that the cutoff rate is
A. at least e0ual to its cost of capital.
B. at least e0ual to the rate used by similar companies.
. greater than the 7,, on pro(ects accepted in the past.
D. greater than the current book rate of return.
4P? - 7,,
232
Capital Budgeting
)$. The 4P? and 7,, methods give
A. the same decision @accept or re(ectA for any single investment.
B. the same choice from among mutually e'clusive investments.
. different rankings of pro(ects !ith une0ual lives.
D. the same rankings of pro(ects !ith different re0uired investments.
Decision #le - %tall, e/clsi$e p#o.ects
8). Mutually e'clusive pro(ects are those that+
A. if accepted/ preclude the acceptance of competing pro(ects.
B. if accepted/ can have a negative effect on the company&s profit.
. if accepted/ can also lead to the acceptance of a competing pro(ect.
D. re0uire all managers to consider.
29. 7n choosing from among mutually e'clusive investments the manager should normally select
the one !ith the highest
A. 4et present value. . Profitability inde'.
B. 7nternal rate return. D. Book rate of return.
*#. :hy do the 4P? method and the 7,, method sometimes produce different rankings of
mutually e'clusive investment pro(ects3
A. The 4P? method does not assume reinvestment of cash flo!s !hile the 7,, method
assumes the cash flo!s !ill be reinvested at the internal rate of return.
B. The 4P? method assumes a reinvestment rate e0ual to the discount rate !hile the 7,,
method assumes a reinvestment rate e0ual to the internal rate of return.
. The 7,, method does not assume reinvestment of the cash flo!s !hile the 4P? assumes
the reinvestment rate is e0ual to the discount rate.
D. The 4P? method assumes a reinvestment rate e0ual to the bank loan interest rate !hile
the 7,, method assumes a reinvestment rate e0ual to the discount rate.
Post0a!it
).. Post-audit of capital pro(ects
A. is usually conclusive.
B. is done using different evaluation techni0ues than !ere used in making the original capital
budgeting decision.
. provides a formal mechanism by !hich the company can determine !hether e'isting
pro(ects should be supported or terminated.
D. all of the above.
)8. A thorough evaluation of ho! !ell a pro(ect&s actual performance matches the pro(ections
made !hen the pro(ect !as proposed is called a
A. pre-audit. . sensitivity analysis.
B. post-audit. D. risk analysis.
#8. A follo!-up evaluation of a capital pro(ect is performed to see that investment e'penditures are
proceeding on time and on budget/ to compare actual cash flo!s !ith those originally
predicted/ and to evaluate continuation of the pro(ect. This follo!-up is called a
A. postaudit. . management audit
B. performance evaluation D. pro(ect revie!
.*. ompanies use post audits to+
A. chastise managers !hose pro(ect does not e'ceed pro(ections.
B. prove to managers that they should have accepted pro(ects they previously re(ected.
. have the managers revise poorly performing pro(ects so the pro(ects !ill have larger
return in the future.
D. provide feedback that enables managers to improve the accuracy of the pro(ections of
future cash flo!s/ thereby ma'imi%ing the 0uality of the firm&s capital investments.
PROBLEMS:
Net In$est%ent
)
. Bruell ompany is considering to replace its old e0uipment !ith a ne! one. The old
e0uipment had a net book value of P)66/666/ 1 remaining useful life !ith P2*/666
depreciation each year. The old e0uipment can be sold at P96/666. The ne! e0uipment costs
P).6/666/ have a 1-year life. ash savings on operating e'penses before 16F ta'es amount
to P*6/666 per year. :hat is the amount of investment in the ne! e0uipment3
A. P).6/666 . P 96/666
B. P 82/666 D. P .9/666
Ope#atin" Cas& 1lo(
ash Clo! Before ta'
2
. Taal ompany is considering the purchase of a machine that promises to reduce operating
costs by e0ual amounts every year of its .-year useful life. The machine !ill cost P916/666
and has no salvage value. The machine has a 26F internal rate of return. Taal ompany is
sub(ect to 16F income ta' rate. The present value of ) for . periods at 26F is #.#2./ and at
the end of . periods is 6.##1$.
The appro'imate annual cash savings before ta' is closest to+
233
Capital Budgeting
A. P2*2/*** . P)98/*$2
B. P))2/*** D. P#28/*$2
7ncrease in Annual 7ncome Ta'
#
. Mayon ompany is considering replacing its old machine !ith a ne! and more efficient one.
The old machine has book value of P)66/666/ a remaining useful life of 1 years/ and annual
straight-line depreciation of P2*/666. The e'isting machine has a current market value of
P96/666. The replacement machine !ould cost P).6/666/ have a 1-year life/ and !ill save
P*6/666 per year in cash operating costs. 7f the replacement machine !ould be depreciated
using the straight-line method and the ta' rate is 16F/ !hat should be the increase in annual
income ta'es3
A. P)1/666 . P16/666
B. P29/666 D. P 1/666
Dep#eciation + Ta/es
1
. Prime onsulting/ 7nc. operates consulting offices in Manila/ >longapo/ and ebu. The firm is
presently considering an investment in a ne! mainframe computer and communication
soft!are. The computer !ould cost P. million and have an e'pected life of 9 years. Cor ta'
purposes/ the computer can be depreciated using either straight-line method or "um-of-the-
<ears&-Digits @"<DA method over five years. 4o salvage value is recogni%ed in computing
depreciation e'pense and no salvage value is e'pected at the end of the life of the e0uipment.
The company&s cost of capital is )6 percent and its ta' rate is 16 percent.
The present value of annuity of ) for * periods is #.8$) and for 9 periods is *.##*. The present
values of ) end of each period are+
) 6.$6$) * 6..26$
2 6.92.1 . 6.*.1*
# 6..*)# 8 6.*)#2
1 6..9#6 9 6.1..*
The present value of the net advantage of using "<D method of depreciation !ith a five-year
life instead of straight-line method of depreciating the e0uipment is+
A. P 9./221 . P2)*/*.6
B. P))*/).9 D. P298/9$#
*
. Cor P1*6/666/ Maleen orporation purchased a ne! machine !ith an estimated useful life of
five years !ith no salvage value. The machine is e'pected to produce cash flo! from
operations/ net of 16 percent income ta'es/ as follo!s+
Cirst year P).6/666
"econd year )16/666
Third year )96/666
Courth year )26/666
Cifth year )66/666
Maleen !ill use the sum-of-the-years-digits& method to depreciate the ne! machine as follo!s+
Cirst year P)*6/666
"econd year )26/666
Third year $6/666
Courth year .6/666
Cifth year #6/666
The present value of ) for * periods at )2 percent is #..6189. The present values of ) at )2
percent at end of each period are+
5nd of+
Period ) 6.9$296
Period 2 6.8$8)$
Period # 6.8))89
Period 1 6..#**2
Period * 6.*.81#
2ad Maleen used straight-line method of depreciation instead of declining method/ !hat is the
difference in net present value provided by the machine at a discount rate of )2 percent3
A. 7ncrease of P $/8*6 . Decrease of P21/#8.
B. Decrease of P $/8*6 D. 7ncrease of P21/#8.
Accontin" #ate o' #et#n
Based on initial investment
.
. A piece of labor saving e0uipment that Marubeni 5lectronics ompany could use to reduce
costs in one of its plants in Angeles ity has (ust come onto the market. ,elevant data relating
to the e0uipment follo!+
Purchase cost of the e0uipment P1#2/666
Annual cost savings that !ill be provided by the e0uipment $6/666
Bife of the e0uipment )2 years
:hat is the simple rate of return to be provided by the e0uipment3
A. Bet!een )*F and )9F. . 26.9#F.
B. 2*.66F. D. )2.*6F.
Based on average investment
8
. The B7B> ompany has made an investment in video and recording e0uipment that costs
P)6./866. The e0uipment is e'pected to generate cash inflo!s of P26/666 per year. 2o!
many years !ill the e0uipment have to be used to provide the company !ith a )6 percent
234
Capital Budgeting
average accounting rate of return on its investment3
A. 8.29 years . $.6* years
B. *.** years D. 1.8* years
9
. "ho! ompany is negotiating to purchase an e0uipment that !ould cost P266/666/ !ith the
e'pectation that P16/666 per year could be saved in after-ta' cash operating costs if the
e0uipment !ere ac0uired. The e0uipment&s estimated useful life is )6 years/ !ith no salvage
value/ and !ould be depreciated by the straight-line method. "ho! ompany&s minimum
desired rate of return is )2 percent. The present value of an annuity of ) at )2 percent for )6
periods is *..*. The present value of ) due in )6 periods/ at )2 percent/ is 6.#22.
The average accrual accounting rate of return @A,,A during the first year of asset&s use is+
A. 26.6 percent . )6.6 percent
B. )6.* percent D. 16.6 percent
$
. An asset !as purchased for P../666. The asset is e'pected to last for . years and !ill have a
salvage value of P)./666. The company e'pects the income before ta' to be P8/266 and the
ta' rate applicable to the company is #6F. :hat is the average return on investment
@accounting rate of returnA3
A. )8..F . )6.$F
B. 8..F D. )2.#F
4et 7nvestment
)6
. The Makabayan ompany is planning to purchase a ne! machine !hich it !ill depreciate/ for
book purposes/ on a straight-line basis over a ten-year period !ith no salvage value and a full
year&s depreciation taken in the year of ac0uisition. The ne! machine is e'pected to produce
cash flo!s from operations/ net of income ta'es/ of P../666 a year in each of the ne't ten
years. The accounting @book valueA rate of return on the initial investment is e'pected to be )2
percent. 2o! much !ill the ne! machine cost3
A. P#66/666 . P**6/666
B. P..6/666 D. P8$2/666
))
. The Cields ompany is planning to purchase a ne! machine !hich it !ill depreciate/ for book
purposes/ on a straight-line basis over a ten-year period !ith no salvage value and a full year&s
depreciation taken in the year of ac0uisition. The ne! machine is e'pected to produce cash
flo! from operations/ net of income ta'es/ of P../666 a year in each of the ne't ten years.
The accounting @book valueA rate of return on the initial investment is e'pected to be )2F.
2o! much !ill the ne! machine cost3
A. P#66/666 . P..6/666
B. P**6/666 D. P8$2/666
CAT
)2
. The 2ills ompany/ a calendar company/ purchased a ne! machine for P296/666 on Ganuary
). Depreciation for ta' purposes !ill be P#*/666 annually for eight years. The accounting
@book valueA rate of return @A,,A is e'pected to be )*F on the initial increase in re0uired
investment. >n the assumption of a uniform cash inflo!/ this investment is e'pected to
provide annual cash flo! from operations/ net of income ta'es/ of
A. P#*/666 . P12/666
B. P16/2*6 D. P88/666
Pa,bac2 Pe#io!
)#
. 7f an asset costs P#*/666 and is e'pected to have a P*/666 salvage value at the end of its ten-
year life/ and generates annual net cash inflo!s of P*/666 each year/ the cash payback period
is
A. 9 years . . years
B. 8 years D. * years
)1
. onsider a pro(ect that re0uires cash outflo! of P*6/666 !ith a life of eight years and a
salvage value of P*/666. Annual before-ta' cash inflo! amounts to P)6/666 assuming a ta'
rate of #6F and a re0uired rate of return of 9F. "alvage value is ignored in computing
depreciation. The pro(ect has a payback period of
A. *.6 years . ..6 years
B. *.. years D. ... years
)*
. The follo!ing incomplete information is provided for an investment decision.
<ear ash Clo!
Discount
Cactor @)6FA
Discounted
ash Clo!s
umulative ash
Clo!s
6 P@1*6/666A ).666 P@1*6/666A P@1*6/666A
) 296/666 .$6$ 2*1/*26
2 2)6/666 .92.
# )16/666 .8*)
Dsing break-even time @B5TA analysis/ !hen !ill the investment be recovered3
A. 7n 2.8# years . At the end of year 2
B. Bonger than three years D. 7n 2.2) years
).
. >rlando orporation is considering an investment in a ne! cheese-cutting machine to replace
its e'isting cheese cutter. 7nformation on the e'isting machine and the replacement machine
235
Capital Budgeting
follo!+
ost of the ne! machine P166/666
4et annual savings in operating costs $6/666
"alvage value no! of the old machine .6/666
"alvage value of the old machine in 9 years 6
"alvage value of the ne! machine in 9 years *6/666
5stimated life of the ne! machine 9 years
:hat is the e'pected payback period for the ne! machine3
A. 1.11 years . 2..8 years
B. 9.*6 years D. #.89 years
)8
. Cor P1/*66/666/ "iniloan orporation purchased a ne! machine !ith an estimated useful life
of five years !ith no salvage value at its retirement. The machine is e'pected to produce cash
flo! from operations/ net of income ta'es/ as follo!s+
Cirst year P $66/666
"econd year )/266/666
Third year )/*66/666
Courth year $66/666
Cifth year 966/666
"iniloan !ill use the sum-of-the-years-digits& method to depreciate the ne! machine as
follo!s+
Cirst year P)/*66/666
"econd year )/266/666
Third year $66/666
Courth year .66/666
Cifth year #66/666
:hat is the payback period for the machine3
A. # years . * years
B. 1 years D. 2 years
)9
. Pa% 7nsurance ompany&s management is considering an advertising program that !ould
re0uire an initial e'penditure of P).*/*66 and bring in additional sales over the ne't five years.
The cost of advertising is immediately recogni%ed as e'pense. The pro(ected additional sales
revenue in <ear ) is P8*/666/ !ith associated e'penses of P2*/666. The additional sales
revenue and e'penses from the advertising program are pro(ected to increase by )6 percent
each year. Pa% 7nsurance ompany&s ta' rate is 16 percent.
The payback period for the advertising program is
A. 1.. years . #.6 years
B. ).$ years D. 2.* years
)$
. The Beisure ompany is considering the purchase of electronic pinball machines to place in
amusement houses. The machines !ould cost a total of P#66/666/ have an eight-year useful
life/ and have a total salvage value of P26/666. Based on e'perience !ith other e0uipment/
the company estimates that annual revenues and e'penses associated !ith the machines
!ould be as follo!s+
,evenues form use P266/666
Bess operating e'penses
ommissions to amusement houses P)66/666
7nsurance 8/666
Depreciation #*/666
Maintenance )9/666 ).6/666
4et income P 16/666
7gnoring the effect of income ta'es/ the payback period for the pinball machines !ould be
A. #.8# years . 1.6 years
B. #.2# years D. 8.* years
Net P#esent )ale
26
. 7t is the start of the year and Agudelo ompany plans to replace its old grinding e0uipment.
The follo!ing information are made available by the management+
>ld 4e!
50uipment cost P86/666 P)26/666
urrent salvage value )1/666 -
"alvage value/ end of useful life */666 )./666
Annual operating costs 11/666 #2/666
Accumulated depreciation **/#66 -
5stimated useful life )6 years )6 years
The company is not sub(ect to ta' and its cost of capital is )2F. :hat is the present value of
all the relevant cash flo!s at time %ero3
A. @P *1/666A . @P)6./666A
B. @P)26/666A D. @P)21/866A
2)
. onsider a pro(ect that re0uires an initial cash outflo! of P*66/666 !ith a life of eight years
and a salvage value of P26/666 upon its retirement. Annual cash inflo! before ta' amounts to
P)66/666 and a ta' rate of #6 percent !ill be applicable. The re0uired minimum rate of return
for this type of investment is 9 percent. The present value of ) and the annuity of )/
discounted at 9 percent for 9 periods are 6.*1 and *.818/ respectively. "alvage value is
236
Capital Budgeting
ignored in computing depreciation. The net present value amounts to
A. P 8/*.6 . P )8/.6.
B. P )6/6*6 D. P 26/6*6
22
. =ap Manufacturing has an investment opportunity to embark on a pro(ect !here yearly
revenues for five years are to be P166/666 and operating costs of P)61/966. The e0uipment
costs P) million/ and straight-line depreciation !ill be used for book and ta' purposes. 4o
salvage value is e'pected at the end of the pro(ect&s life. The company has a 16 percent
marginal ta' rate and a )6 percent cost of capital. The e0uipment manufacturer has offered a
delayed payment plan of P*.6/*66 per year at the end of the first and second years. There !ill
be no changes in !orking capital.
The present value of annuity of ) for * periods is #.8$69 at )6 percent.
The present values of ) end of each period at )6 percent are+
Period ) 6.$6$)
Period 2 6.92.1
Period # 6.8*)#
Period 1 6..9#6
Period * 6..26$
The net present value if the e0uipment !ere purchased is
A. P @98/$88A . P )/$22
B. P @2*/#)6A D. P @.)/6$1A
2#
. Pa% 7nsurance ompany&s management is considering an advertising program that !ould
re0uire an initial e'penditure of P).*/*66 and bring in additional sales over the ne't five years.
The cost of advertising is immediately recogni%ed as e'pense. The pro(ected additional sales
revenue in <ear ) is P8*/666/ !ith associated e'penses of P2*/666. The additional sales
revenue and e'penses from the advertising program are pro(ected to increase by )6 percent
each year. Pa% 7nsurance ompany&s ta' rate is 16 percent.
The present value of ) at )6 percent/ end of each period+
Period Present value of )
). 6.$6$6$
2. 6.92.1*
#. 6.8*)#)
1. 6..9#6)
*. 6..26$2
The net present value of the advertising program !ould be
A. P #8/6.1 . P 2$/)#.
B. P@#8/6.1A D. P@2$/)#.A
21
. Mario 2ernande% plans to buy a haymaker. 7t costs P)8*/666 and is e'pected to last for five
years. 2e presently hires . !orkers at P)6/666 per month for each of the three harvesting
months each year. The e0uipment !ould eliminate the need for t!o !orkers. 2ernande% uses
straight-line depreciation and pro(ects a salvage value of P2*/666. 2is ta' rate is 2*F and
opportunity cost of funds is )2.6F. The present value of )discounted at )2 percent at the end
of * periods is 6.*.81# and the present value of an annuity of ) for * periods is #..6189.
:hich of the follo!ing is true3
A. The present value of cash flo!s in year * is P22/8)6
B. 4P? is P29/1#.
. 4P? is P)*/2*6
D. 4P? is P)1/)9.
2*
. Tabucol Aggregates/ 7nc. plans to replace one of its machines !ith a ne! efficient one. The
old machine has a net book value of P)26/666 !ith remaining economic life of 1 years. This
old machine can be sold for P96/666. 7f the ne! machine !ere ac0uired/ the cash operating
e'penses !ill be reduced from P216/666 to P).6/666 for each of the four years/ the e'pected
economic life of the ne! machine. The ne! machine !ill cost Tabucol a cash payment to the
dealer of P#66/666. The company is sub(ect to #2 percent ta' and for this kind of investment/
a marginal cost of capital of $ percent. The present value of annuity of ) and the present value
of ) for 1 periods using $ percent are #.2#$82 and 6.8691#/ respectively.
The net present value to be provided by the replacement of the old machine is
A. P29/1$# . P1./8$1
B. P)*/.$# D. P*$/*$1
2.
. =ambales Mines/ 7nc. is contemplating the purchase of e0uipment to e'ploit a mineral deposit
that is located on land to !hich the company has mineral rights. An engineering and cost
analysis has been made/ and it is e'pected that the follo!ing cash flo!s !ould be associated
!ith opening and operating a mine in the area.
ost of ne! e0uipment and timbers 2/8*6/666
:orking capital re0uired )/666/666
4et annual cash receiptsH )/266/666
ost to construct ne! road in three years 166/666
"alvage value of e0uipment in 1 years .*6/666
H,eceipts from sales of ore/ less out-of-pocket costs for salaries/ utilities/ insurance/ etc.
7t is estimated that the mineral deposit !ould be e'hausted after four years of mining. At that
point/ the !orking capital !ould be released for reinvestment else!here. The company&s
discount rate is 26F.
237
Capital Budgeting
The net present value for the pro(ect is+
A. P 1*1/.26. . P@*.)/**#A
B. P @8$/#6#A. D. P@261/.99A.
:ith inflation
28
. By the end of December #)/ 266*/ Alay Coundation is considering the purchase of a copying
machine for P96/666. The e'pected annual cash savings are e'pected to be P#2/666 in the
ne't four years. At the end of the four years/ the machine !ill be discarded !ithout any
salvage value. All the cash savings are stated in number of pesos at December #)/ 266.. The
company e'pected that the inflation rate is constantly * percent each year. 2ence/ the first
year&s cash inflo! !as ad(usted for * percent inflation. Cor simplicity/ all cash inflo!s are
assumed to be at year-end.
The present value at )1 F of ) for 1 periods is 2.$)#8). The present value of ) at end of
each period are+
Period ) 6.988)$
Period 2 6.8.$18
Period # 6..81$8
Period 1 6.*$269
Dsing the nominal rate of return of )1 percent/ the net present value for this machine is
A. P)2/2#$ . P)#/1)$
B. P)$/.86 D. P28/$#.
29
. Perpetual Coundation/ 7nc./ a nonprofit organi%ation/ has one of its activities/ the production of
cookies for its snack food store. "everal years ago/ Perpetual Coundation/ 7nc. purchased a
special cookie-cutting machine. As of December #)/ 266./ this machine !ill have been used
for three years. Management is considering the purchase of a ne!er/ more efficient machine.
7f purchased/ the ne! machine !ould be ac0uired on December #)/ 266.. Management
e'pects to sell #66/666 do%en cookies in each of the ne't si' years. The selling price of the
cookies is e'pected to average P).)* per do%en.
Perpetual Coundation/ 7nc. has t!o options+ continue to operate the old machine/ or sell the
old machine and purchase the ne! machine. 4o trade-in !as offered by the seller of the ne!
machine. The follo!ing information has been assembled to help management decide !hich
option is more desirable.
>ld Machine 4e! Machine
>riginal cost of machine at ac0uisition P96/666 P)26/666
,emaining useful life as of )2I#)I6. . years . years
5'pected annual cash operating e'penses+
?ariable cost per do%en P6.#9 P6.2$
Total fi'ed costs P2)/666 P ))/666
5stimated cash value of machines+
December #)/ 266. P16/666 P)26/666
December #)/ 26)2 P 8/666 P 26/666
Assume all operating revenues and e'penses occur at the end of the year.
The net advantage in present value of the better alternative is+
A. ,etain >ld Machine/ P.)/.8*.
B. Buy 4e! Machine/ P.)/.8*.
. ,etain >ld Machine/ P)./#1*.
D. Buy 4e! Machine/ P)./#1*.
P#o'itabilit, in!e/
2$
. The Pambansang Jamao orporation has to replace its completely damaged boiler machine
!ith a ne! one. The old machine has a net book value of P)66/666 !ith %ero market valueK
therefore it !ill give a ta' shield/ based on #*F ta' rate if replaced/ by P#*/666. The company
has a )6 percent cost of capital. Dnderstandably/ the ne! machine/ through a uniform
decrease in cash operating costs/ !ill give a positive net present value/ because this machine
!ill provide an internal rate of return of )2 percent.
The present values at )6F and )2F/ respectively/ are+
)6F )2F
Annuity of )/ . periods 1.#**2. 1.)))1)
) end of . periods 6.*.118 6.*6..#
7f the machine !ere to be depreciated using straight-line method for . years !ithout any
salvage value/ the estimated profitability inde' is+
A. ).26
B. ).6.
. ).68
D. annot be determined from the information
#6
. The Me(icano ompany is planning to purchase a piece of e0uipment that !ill reduce annual
cash e'penses over its *-year useful life by e0ual amounts. The company !ill depreciate the
e0uipment using straight-line method of depreciation based on estimated life of * years
!ithout any salvage value. The company is sub(ect to 16 percent ta'. The marginal cost of
capital for this ac0uisition is )).6** percent. The management accountant calculated that the
internal rate of return based on the estimated after-ta' cash flo!s is )2.#9. percent and a net
present value of P)6/666. The president/ ho!ever/ !ants to kno! the profitability inde' before
he finally decides.
:hat is the profitability inde' for this investment3
238
Capital Budgeting
A. ).6)) . ).622
B. ).6#1 D. ).611
Inte#nal Rate o' Ret#n
#)
. Diamond ompany is planning to buy a coin-operated machine costing P166/666. Cor book
and ta' purposes/ this machine !ill be depreciated P96/666 each year for five years.
Diamond estimates that this machine !ill yield an annual inflo!/ net of depreciation and
income ta'es/ of P)26/666. Diamond&s desired rate of return on its investments is )2F. At the
follo!ing discount rates/ the 4P?s of the investment in this machine are+
Discount ,ate 4P?
)2F LP#/2*9
)1F L )/)$8
).F - 869
)9F - 2/181
Diamond&s e'pected 7,, on its investment in this machine is
A. #.2*F . )..66F
B. )2.66F D. )*.#6F
,e0uired investment
#2
. Jipling ompany has invested in a pro(ect that has an eight-year life. 7t is e'pected that the
annual cash inflo! from the pro(ect !ill be P26/666. Assuming that the pro(ect has a internal
rate of return of )2F/ ho! much !as the initial investment in the pro(ect if the present value
of annuity of ) for 9 periods is 1.$.9 and the present value of ) is 6.1613
A. P).6/666 . P 96/966
B. P $$/#.6 D. P .1/.16
##
. Jatol ompany invested in a machine !ith a useful life of si' years and no salvage value. The
machine !as depreciated using the straight-line method. 7t !as e'pected to produce annual
cash inflo! from operations/ net of income ta'es/ of P./666. The present value of an ordinary
annuity of P) for si' periods at )6F is 1.#**. The present value of P) for si' periods at )6F is
6.*.1. Assuming that Jatol used a time- ad(usted rate of return of )6F/ !hat !as the amount
of the original investment3
A. P)6/.16 . P22/8*6
B. P2$/*)6 D. P2./)#6
#1
. The Corest ompany is planning to invest in a machine !ith a useful life of five years and no
salvage value. The machine is e'pected to produce cash flo! from operations/ net of income
ta'es/ of P26/666 in each of the five years. Corest&s e'pected rate of return is )6F.
7nformation on present value and future amount factors is as follo!s+
P 5 , 7 > D
) 2 # 1 *
Present value of P) at )6F .$6$ .92. .8*) ..9# ..2)
Present value of an annuity of P) at )6F .$6$ ).8#. 2.198 #.)86 #.8$)
Cuture amount of P) at )6F ).)66 ).2)6 ).##) ).1.1 )..))
Cuture amount of an annuity of P) at
)6F
).66 2.)66 #.#)6 1..1) ..)6*
How much will the machine cost?
A. P #2/226 . P 8*/926
B. P .2/)66 D. P)22/)66
,e0uired unit sales
#*
. Paper Products ompany is considering a ne! product that !ill sell for P)66 and has a
variable cost of P.6. 5'pected volume is 26/666 units. 4e! e0uipment costing P)/*66/666
and having a five-year useful life and no salvage value is needed/ and !ill be depreciated
using the straight-line method. The machine has fi'ed cash operating costs of P266/666 per
year. The firm is in the 16 percent ta' bracket and has cost of capital of )2 percent. The
present value of )/ end of five periods is 6.*.81#K present value of annuity of ) for * periods is
#..6189.
2o! many units per year the firm must sell for the investment to earn )2 percent internal rate
of return3
A. )8/##9 . $/9#9
B. 29/9$8 D. )2/##9
,e0uired selling price
#.
. Bugha! Products ompany is considering a ne! product that !ill sell for P)66 and has a
variable cost of P.6. 5'pected sales volume is 26/666 units. 4e! e0uipment costing
P)/*66/666 !ith a five-year useful life and no terminal salvage value is needed. The machine
!ill be depreciated using the straight-line method. The machine has cash operating costs of
P266/666 per year. The firm is in the 16 percent ta' bracket and has cost of capital of )2
percent. The present value of )/ end of five periods is 6.*.81#K present value of annuity of )
for * periods is #..6189.
"uppose the 26/666 estimated sales volume is sound/ but the price is in doubt/ !hat is the
selling price @rounded to nearest pesoA needed to earn a )2 percent internal rate of return3
A. P9).66 . P86.66
B. P$*.66 D. P$6.66
239
Capital Budgeting
,e0uired CBT
#8
. Aloha o. is considering the purchase of a ne! ocean-going vessel that could potentially
reduce labor costs of its operation by a considerable margin. The ne! ship !ould cost
P*66/666 and !ould be fully depreciated by the straight-line method over )6 years. At the end
of )6 years/ the ship !ill have no value and !ill be sunk in some already polluted harbor. The
Aloha o.&s cost of capital is )2 percent/ and its marginal ta' rate is 16 percent. 7f the ship
produces e0ual annual labor cost savings over its )6-year life/ ho! much do the annual
savings in labor costs need to be to generate a net present value of P6 on the pro(ect3
Dse the follo!ing P?+ annuity of )/ )6 periods at )2F - *..*62K end of )6th period M 6.#2)$8.
A. P .9/1$2 . P))1/)*1
B. P)18/198 D. P 99/1$2
,e0uired CAT
#9
. Prudu ompany has decided to invest in some ne! e0uipment. The e0uipment !ill have a
three-year life and !ill produce a uniform series of cash savings. The net present value of the
e0uipment is P)/8*6/ using a discount rate of 9 percent. The internal rate of return is )2
percent.
Present values at 9F and )2F respectively+
9F+ Annuity M 2.*88)K end of # periods/ 6.8$#9
)2F+ Annuity M 2/16)9K end of # periods/ 6.8))9
:hat is the amount of annual cash inflo!3
A. P $/$96 . P2#/216
B. P2)/#12 D. P)2/#*)
#$
. An asset is purchased for P)26/666. 7t is e'pected to provide an additional P29/666 of annual
net cash inflo!s. The asset has a )6-year life and an e'pected salvage value of P)2/666. The
hurdle rate is )6F. The present value of an annuity factor of )6F for )6 years is ..)11./ and
the present value of P)/ discounted for )6 years at )6F is 6.#9**.
Niven the data provided/ the minimum amount of annual cash inflo!s that !ould provide the
)6F time-ad(usted return is appro'imately
A. P)9/88. . P21/166
B. P2./.66 D. P22/*#*
,e0uired 7ncrease in CAT
16
. The follo!ing data pertain to Gulian orp. !hose management is planning to purchase a unit of
e0uipment.
). 5conomic life of e0uipment M 9 years.
2. Disposal value after 9 years M =ero.
#. 5stimated net annual cash inflo!s for each of the 9 years M P9)/666.
1. Time-ad(usted internal rate of return M )1F
*. ost of capital of Bayan Muna M ).F
.. The table of present values of P) received annually for 9 years has these factors+ at
)1F E 1..#$/ at ).F E 1.#11
8. Depreciation is appro'imately P1./$86 annually.
Cind the re0uired increase in annual cash inflo!s in order to have the time-ad(usted rate of
return appro'imately e0ual the cost of capital.
A. P./*6) . P1/#11
B. P*/*6) D. P*/98)
,e0uired CAT for a certain year
1)
. A company is considering putting up P*6/666 in a three-year pro(ect. The company&s
e'pected rate of return is )2F. The present value of P).66 at )2F for one year is 6.9$#/ for
t!o years is 6.8$8/ and for three years is 6.8)2. The cash flo!/ net of income ta'es !ill be
P)9/666 @present value of P)./681A for the first year and P22/666 @present value of P)8/*#1A
for the second year. Assuming that the rate of return is e'actly )2F/ the cash flo!/ net of
income ta'es/ for the third year !ould be
A. P2#/622 . P)6/666
B. P 8/)26 D. P)./#$2
,e0uired salvage value
12
. The aravan ompany is contemplating to purchase a machine that costs P966/666. The
machine is e'pected to last for * years !ith a salvage value of P*6/666 at the end of the fifth
year. 7f the machine !ere purchased/ before-ta' annual cash savings on operating e'penses
!ill be reali%ed. aravan ompany !ill depreciate the machine using straight-line depreciation
for * years/ !ith the salvage value considered in the computation.
The company has a )2 percent cost of capital and is sub(ect to 16 percent ta' rate.
The present values using )2 percent are+
Annuity of ) for * periods #..6189
Present value of )/ end of * periods 6.*.81#
The initial analysis indicated a net present value of P8/66#. <ou believe the estimated before-
ta' cash savings are fairly determined but you are in doubt of the e'pected salvage value of
the machine.
2o! much is the estimated salvage value re0uired if the investment has to yield an 7,, of )2
percent3
A. P1)/966 . P2*/)66
B. P21/$66 D. P11/.66
240
Capital Budgeting
,e0uired value of intangible benefits
1#
. "olidum ompany is investigating the purchase of a piece of automated e0uipment that !ill
save P)66/666 each year in direct labor and inventory carrying costs. This e0uipment costs
P8*6/666 and is e'pected to have a )6-year useful life !ith no salvage value. The company
re0uires a minimum )*F return on all e0uipment purchases. Management anticipates that this
e0uipment !ill provide intangible benefits such as greater fle'ibility and higher 0uality output.
The P? of annuity of )/ )*F for )6 periods *.6)988
The P? of )/ end )6 period 6.218)9
:hat peso value per year !ould these intangible benefits have to have in order to make the
e0uipment an acceptable investment3
A. P219/)2# . P .)/##)
B. P 1$/116 D. P **/666
11
. Altas/ 7nc./ is considering investing in automated e0uipment !ith a ten-year useful life.
Managers at Altas have estimated the cash flo!s associated !ith the tangible costs and
benefits of automation/ but have been unable to estimate the cash flo!s associated !ith the
intangible benefits. Dsing the company&s )6F discount rate/ the net present value of the
cash flo!s associated !ith (ust the tangible costs and benefits is a negative P)91/#*6. The
present value of annuity of ) at )6 percent for ten years is ..)1* !hile the present value of )
is 6.#9.. 2o! large !ould the annual net cash inflo!s from the intangible benefits have to
be to make this a financially acceptable investment3
A. P)9/1#*. . P#*/666.
B. P#6/666. D. P#8/2#..
In!i''e#ence Point
1*
. Moon ompany uses a )6F discount rate and the total cost approach to capital budgeting
analysis. Both alternatives are Akda 7nvestments !hich has a marginal cost of capital of )2
percent is evaluating t!o mutually e'clusive pro(ects @; and <A/ !hich have the follo!ing
pro(ections+
P,>G5T ; P,>G5T <
7nvestment P19/666 P9#/22*
After-ta' cash inflo! )2/666 )*/266
Asset life . years )6 years
The indifference point for the t!o pro(ects is
A. )2..1F . )2.66F
B. )..6)F D. )$.##F
1.
. "ilky Products is considering t!o pieces of machinery. The first machine costs P*6/666 more
than the second machine. During the t!o-year life of these t!o alternatives/ the first machine
has a P)**/666 more cash flo! in year one and a P))6/666 less cash flo! in year t!o than
the seconds machine. All cash flo!s occur at year-end. The present value of ) at )* percent
end of ) period and 2 periods are 6.9.$*8 and/ 6.8*.)1/ respectively. The present value of )
at 9 percent end of period ) is 6.$2*$#/ and Period 2 is 6.9*8#1.
At !hat discount rate !ould Machine ) be e0ually acceptable as machine 2&s3
A. $F . ))F
B. )6F D. )2F
Decision Rle - In!epen!ent P#o.ects
18
. "ylvia Products is considering t!o types of machinery. The first machine costs P*6/666 more
than the second machine. During the t!o-year life of these t!o alternatives/ the first machine
has a P)**/666 more cash flo! in year one and a P))6/666 less cash flo! in year t!o than
the seconds machine. All cash flo!s occur at year-end. The present value of ) at )* percent
end of ) period and 2 periods are 6.9.$*8 and/ 6.8*.)1/ respectively. The present value of )
at 9 percent end of period ) is 6.$2*$#/ and Period 2 is 6.9*8#1.
:hich machine should be purchased if the relevant discount rates are )* percent and 9
percent/ respectively3
)*F Discount 9F Discount
A. Machine ) Machine )
B. Machine 2 Machine 2
. Machine ) Machine 2
D. Machine 2 Machine )
Co%p#e&ensi$e
Payback/ 4P?/ A,,
Ouestion 4os. 8) through 8# are based on the follo!ing+
ayco Medical enter is considering purchasing an ultrasound machine for P$*6/666. The
machine has a )6 M year life and an estimated salvage value of P**/666. 7nstallation costs and
freight charges !ill be P21/266 and P966/ respectively. 4e!man uses straight-line depreciation.
The medical center estimates that the machine !ill be used five times a !eek !ith the average
charges to the patient for ultrasound of P966. There are P)6 in medical supplies and P16 of
technician costs for each procedure performed using the machine. The present value of an annuity
of ) for )6 years at $F is ..1)9 !hile the present value of ) for )6 years at $F is 6.1221)
241
Capital Budgeting
19
. The cash payback period is+
A. #.6 years . *.6 years
B. 1.* years D. ..6 years
1$
. The pro(ect is e'pected to generate net present value of+
A. P28./*)6 . P##)/*)6
B. P2$$/81# D. P2*#/288
*6
. :hat is the accounting rate of return provided by the pro(ect3
A. 26.6 percent . )).2 percent
B. )6.. percent D. #9.6 percent
4P?/ CAT/ Ma'imum lost unit sales
Ouestion 4os. 8* through 88 are based on the follo!ing+
Jabalikat ompany has the opportunity to introduce a ne! product. Jabalikat e'pects the product
to sell for P8* !ith variable cost per unit of P*6. The annual fi'ed costs/ e'cluding the amount of
depreciation is P1/*66/666. The company e'pects to sell #66/666 units. To produce the ne!
product line/ the company needs to purchase a ne! machine that costs P./666/666. The ne!
machine is e'pected to last for four years !ith a very negligible salvage value. The company has a
policy of depreciating its machine for both book and ta' purposes for four years. The company has
a marginal cost of capital of )#.8* percent and is sub(ect to ta' rate of 16 percent.
*)
. The amount of annual after-ta' cash flo!s is+
A. P2/166/666 . P $66/666
B. P#/666/666 D. P)/*66/666
*2
. The machine&s net present value is+
A. P2/89./)66 . P)/629/$66
B. P $29/*66 D. P )*6/286
*#
. Assuming that some of the #66/666 units that are e'pected as sales !ould be to group of
customers !ho currently buy J-=/ another product of Jabalikat ompany. This Product J-=
sells for P#* !ith variable cost of P26. 2o! many units of J-= can Jabalikat afford to lose
before the purchase of the ne! machine becomes unattractive3
A. #$/666 units . )./8)1 units
B. 2#/166 units D. )6/62$ units
A,,/ 4P?/ P7/ Payback
Ouestions ) through 1 !ill be based on the follo!ing data+
The management of Arleen orporation is considering the purchase of a ne! machine costing
P166/666. The company&s desired rate of return is )6F. The present value of P) at compound
interest of )6F for ) through * years are 6.$6$/ 6.92./ 6.8*)/ 6..9#/ and 6..2)/ respectively/ and
the present value of annuity of ) for * periods at )6 percent is #.8$. 7n addition to the foregoing
information/ use the follo!ing data in determining the acceptability in this situation+
<ear 7ncome from >perations 4et ash Clo!
) P)66/666 P)96/666
2 16/666 )26/666
# 26/666 )66/666
1 )6/666 $6/666
* )6/666 $6/666
*1
. The average rate of return for this investment is+
A. )9 percent . *9 percent
B. . percent D. )6 percent
**
. The net present value for this investment is+
A. Positive P #./166 . 4egative P $$/.66
B. Positive P **/266 D. 4egative P)2./966
*.
. The present value inde' for this investment is+
A. 6.99 . ).)1
B. ).1* D. 6.86
*8
. The cash payback period for this investment is+
A. 1 years . 26 years
B. * years D. # years
Payback/ 4P?/ A,,/ 7,,
Dse the follo!ing information for 0uestions .8 - 86
Pillo ompany is considering t!o capital investment proposals.
5stimates regarding each pro(ect are provided belo!+
Pro(ect MA Pro(ect PA
242
Capital Budgeting
7nitial investment P2666/666 P#66/666
Annual net income )6/666 2)/666
4et annual cash inflo! *6/666 8)/666
5stimated useful life * years . years
"alvage value -6- -6-
The company re0uires a )6F rate of return on all ne! investments.
Present ?alue of an Annuity of )
Period $F )6F ))F )2F
* #.9$6 #.8$) #..$. #..6*
. 1.19. 1.#** 1.2#) 1.)))
*9
. The cash payback period for Pro(ect MA is
A. 26 years . * years
B. )6 years D. 1 years
*$
. The net present value for Pro(ect PA is
A. P#6$/261 . P *6/666
B. P $)/1*. D. P $/26*
.6
. The annual rate of return for Pro(ect MA is
A. *F . 2*F
B. )6F D. *6F
.)
. The internal rate of return for Pro(ect PA is closest to
A. )6F . )2F
B. ))F D. none of these
Depreciation ta' shield/ CAT/ Payback/ 4P?/ 7,,
Ouestion 4os. 9. through $6 are based on the follo!ing+
onsider a pro(ect that re0uires cash outflo! of P*6/666 !ith a life of eight years and a salvage
value of P2/666. Annual cash inflo! amounts to P)6/666 assuming a ta' rate of #6F and a
re0uired rate of return of 9F. "alvage value is ignored in computing depreciation.
.2
. Annual depreciation ta' shield amounts to
A. P)/98* . P9/98*
B. P8/666 D. P)6/666
.#
. Annual cash flo! after ta' amounts to
A. P )/98* . P 9/98*
B. P 8/666 D. P)6/666
.1
. Payback amounts to
A. *.6 years . ..6 years
B. *.. years D. ... years
.*
. 4et present value amounts to
A. P 8*. . P)/8*.
B. P)/66* D. P2/66*
..
. 7nternal rate of return on this pro(ect is appro'imatel
A. 9.6F . $.6F
B. 9.*F D. $.*F
CAT/ 4P?/ 7,,
Ouestions 1. rough *) are based on the follo!ing+
2ome&s Pi%%a&s/ 7nc./ operates pi%%a shops in several cities. >ne of the company&s most profitable
shops is located ad(acent to the large PA revie! center in Manila. A small bakery ne't to the shop
has (ust gone out of business/ and 2ome&s Pi%%as has an opportunity to lease the vacated space
for P)9/666 per year under a )*-year lease. 2ome&s management is considering t!o !ays in !hich
the available space might be used.
Alte#nati$e 3. The pi%%a shop in this location is currently selling 16/666 pi%%as per year.
Management is confident that sales could be increased by 8*F by taking out the !all bet!een the
pi%%a shop and the vacant space and e'panding the pi%%a outlet. osts for remodeling and for ne!
e0uipment !ould be P**6/666. Management estimates that 26F of the ne! sales !ould be small
pi%%as/ *6F !ould be medium pi%%as/ and #6F !ould be large pi%%as. "elling prices and costs for
ingredients for the three si%es of pi%%as follo! @per pi%%aA+
"elling Price ost of 7ngredients
"mall P ..86 P).#6
Medium 9.$6 2.16
Barge )).66 #.)6
243
Capital Budgeting
An additional P8/*66 of !orking capital !ould be needed to carry the larger volume of business.
This !orking capital !ould be released at the end of the lease term. The e0uipment !ould have a
salvage value of P#6/666 in )* years/ !hen the lease ends.
Alte#nati$e 4. 2ome&s sales manager feels that the company needs to diversify its operations. 2e
has suggested that an opening be cut in the !all bet!een the pi%%a shop and the vacant space
and that video games be placed in the space/ along !ith a small snack bar. osts for remodeling
and for the snack bar facilities !ould be P2$6/666. The games !ould be leased from a large
distributor of such e0uipment. The distributor has stated that based on the use of game centers
else!here/ 2ome&s could e'pect about 2./666 people to use the center each year and to spend an
average of P* each on the machines. 7n addition/ it is estimated that the snack bar !ould provide a
net cash inflo! of P)*/666 per year. An investment of P1/666 in !orking capital !ould be needed.
This !orking capital investment !ould be released at the end of the lease term. The snack bar
e0uipment !ould have a salvage value of about P)2/666 in )* years.
2ome&s management is unsure !hich alternative to select and has asked you to help in making the
decision. <ou have gathered the follo!ing information relating to added costs that !ould be
incurred each year under the t!o alternatives+
5'pand the Pi%%a "hop 7nstall the Name enter
,ent- building space P)9/666 P)9/666
,ent- video games --- #6/666
"alaries *1/666 )8/666
Dtilities )#/266 */166
7nsurance and other 8/966 $/.66
The company is currently using a ). percent minimum acceptable rate of return for its capital
investment. The present value of annuity of ) at ). percent for )* periods is *.*8* and end of )*
periods is 6.)69. The company is not liable to pay income ta'es.
.8
. The incremental e'pected annual cash inflo!s from Alternative ) is+
A. P $6/666 . P)66/266
B. P)69/666 D. P26)/666
.9
. The incremental e'pected annual cash inflo!s from Alternative 2 is+
A. P )8/666 . P *$/.66
B. P .*/666 D. P)1*/666
.$
. The net present value for Alternative ) is+
A. P19/.*6 . P1*/666
B. P18/916 D. P#2/*66.
86
. The net present value for Alternative 2 is+
A. P2)/62) . P.9/#8*
B. P86/)6# D. P)2/968
8)
. Assume that the company decides to accept alternative 2. At the end of the first year/ the
company finds that only 2)/666 people used the game center during the year @each person
spent P* on gamesA. Also/ the snack bar provided a net cash inflo! of only P)#/666. 7n light of
this information/ !hat is the net present value for alternative 23
A. P@96/122A . P@92/)*6A
B. P@8./122A D. P@96/9*1A
82
. The sales manager has suggested that an advertising program be initiated to dra! another
*/666 people into the game center each year. Assuming that another */666 people can be
attracted into the center and that the snack bar receipts increase to the level originally
estimated/ ho! much can be spent on advertising each year and still allo! the game center to
provide a ).F rate of return3
A. P86/)6#.66 . P*9/$*#.66
B. P 1/.8#.*# D. P)2/*81.*#
4et 7ncome/ CBT/ A,,/ Payback Period
Ouestions *2 through *. are based on the follo!ing information+
Pine!ood raft ompany is considering the purchase of t!o different items of e0uipment/ as
described belo!+
Mac&ine A. A compacting machine has (ust come onto the market that !ould permit Pine!ood
raft ompany to compress sa!dust into various shelving products. At present the sa!dust is
disposed of as a !aste product. The follo!ing information is available on the machine+
a. The machine !ould cost P126/666 and !ould have a )6F salvage value at the end of its
)2-year useful life. The company uses straight-line depreciation and considers salvage
value in computing depreciation deductions.
b. The shelving products manufactured from use of the machine !ould generate revenues of
P#66/666 per year. ?ariable manufacturing costs !ould be 26F of sales.
c. Ci'ed e'penses associated !ith the ne! shelving products !ould be @per yearA+
advertising/ P16/666K salaries/ P))6/666K utilities/ P*/266K and insurance/ P966.
244
Capital Budgeting
Mac&ine B. A second machine has come onto the market that !ould allo! Pine!ood raft
ompany to automate a sanding process that is no! done largely by hand. The follo!ing
information is available+
a. The ne! sanding machine !ould cost P2#1/666 and !ould have no salvage value at the
end of its )#-year useful life. The company !ould use straight-line depreciation on the
ne! machine.
b. "everal old pieces of sanding e0uipment that are fully depreciated !ould be disposed of
at a scrap value of P$/666.
c. The ne! sanding machine !ould provide substantial annual savings in cash operating
costs. 7t !ould re0uire an operator at an annual salary of P)./#*6 and P*/166 in annual
maintenance costs. The current/ hand-operated sanding procedure costs the company
P89/666 per year in total.
Pine!ood raft ompany re0uires a simple rate of return of )*F on all e0uipment purchases.
Also/ the company !ill not purchase e0uipment unless the e0uipment has a payback period of 1.6
years or less.
@7n all the follo!ing 0uestions/ please ignore income ta' effectA
8#
. The e'pected income each year from the ne! shelving products @Machine AA is+
A. P *2/*66 . P 91/666
B. P216/666 D. P $2/*66
81
. The annual savings in cost if Machine B is purchased is
A. P*./2*6 . P#9/2*6
B. P1#/2*6 D. P2)/8*6
8*
. The simple rate @FA of return for Machine A is+
A. )2.* percent . 2*.6 percent
B. 26.6 percent D. )9.6 percent
8.
. The simple rate of return for Machine B is+
A. )..# percent . 2*.6 percent
B. )8.6 percent D. #1.6 percent
88
. The payback period for Machine A is+
A. #.6 years . *.6 years
B. 1.* years D. 8.* years
89
. The payback period for Machine B is+
A. 1.6 years. . ..) years.
B. 1.2 years. D. *.$ years.
4et 7nvestment/ CBT/ Ta' Benefits/ 4P?/ Depreciation Ta' "hield/
Ouestion 4os. *9 through .# are based on the follo!ing+
Turkey ompany&s average production of valve stems over the past three years has been 96/666
units each year. 5'pectations are that this volume !ill remain constant over the ne't four years.
ost records indicate that unit product costs for the valve stem over the last several years have
been as follo!s+
Direct materials P #..6
Direct labor #.$6
?ariable manufacturing overhead ).*6
Ci'ed manufacturing overheadH $.66
Dnit product cost P)9.66
HDepreciation of tools @that must no! be replacedA accounts for one-third of the fi'ed overhead.
The balance is for other fi'ed overhead costs of the factor that re0uire cash e'penditures.
7f the speciali%ed tools are purchased/ they !ill cost P2/*66/666 and !ill have a disposal value of
P)66/666 at the end of their four-year useful life. Turkey ompany has a #6F ta' rate/ and
management re0uires a )2F after-ta' return on investment. "traight-line depreciation !ould be
used for financial reporting purposes/ but for the ta' purposes/ the follo!ing variable depreciation
each year !ill be used.
<ear ) P 9#2/*66
<ear 2 )/))2/*66
<ear # #86/666
<ear 1 )9*/666
The sales representative for the manufacturer of the speciali%ed tools has stated/ PThe ne! tools
!ill allo! direct labor and variable overhead to be reduced by P)..6 per unit.Q Data from another
company using identical tools and e'periencing similar operating conditions/ e'cept that annual
production generally averages )66/666 units/ confirms the direct labor and variable overhead cost
245
Capital Budgeting
savings. 2o!ever/ the other company indicates that it e'perienced an increase in ra! material
cost due to the higher 0uality of material that had to be used !ith the ne! tools. The other
company indicates that its unit product costs have been as follo!s+
Direct materials P 1.*6
Direct labor #.66
?ariable manufacturing overhead 6.96
Ci'ed manufacturing overhead )6.96
Dnit product cost P)$.)6
,eferring to the figures above/ the production manager stated/ PThese numbers look great until you
consider the difference in volume. 5ven !ith the reduction in labor and variable overhead cost/ 7&ll
bet our total unit cost figure !ould increase to over P26 !ith the ne! tools.Q
Although the old tools being used by Turkey ompany are no! fully depreciated/ they have a
salvage value of P1*/666. These tools !ill be sold if the ne! tools are purchasedK ho!ever if the
ne! tools are not purchased/ then the old tools !ill be retained as standby e0uipment. Turkey
ompany&s accounting department has confirmed that total fi'ed manufacturing overhead costs/
other than depreciation/ !ill not change regardless of the decision made concerning the valve
stems. 2o!ever/ the accounting department has estimated that !orking capital needs !ill increase
by P.6/666 if the ne! tools are purchased due to the higher 0uality of material re0uired in the
manufacture of the valve stems.
The present values of ) at the end of each period using )2 percent are+
Period ) 6.9$29.
Period 2 6.8$8)$
Period # 6.8))89
Period 1 6..#**2
P? of annuity of )/ 1 periods #.6#8#*
8$
. The net investment in ne! tools amounted to+
A. P)/98#/#66. . P2/*29/*66.
B. P2/*)*/666. D. P2/*1..*66.
96
. 2o! much annual cost savings !ill be generated if the Turkey ompany purchases the ne!
tools3
A. P )29/666 . P $#./666
B. P 2)./666 D. P)/669/666
9)
. The present value of ta' benefits e'pected from the use of the ne! machine tools is+
A. P .6#/### . P)/168/888
B. P 961/111 D. P2/6))/)))
92
. The present value of the salvage value of the ne! tools to be received at the end of fourth
year is
A. P .#/**2. . P 11/19..
B. P )$/6.*. D. P2)2/.)*.
9#
. Dsing the minimum acceptable rate of return of )2 percent/ the net present value of the
investment in ne! tools is
A. P)69/$)#. . P)18/68#.
B. P)28/$8$. D. P)../)#$.
91
. The net advantage of the use of declining method of depreciation instead of straight-line
method is
A. P ##/9#6. . P))2/8.8.
B. P *./.)6. D. P)18/8#).
4et 7nvestment/ CAT/ Depreciation ta' shield/ 4P?
Ouestion 4os. 88 through 92 are based on the follo!ing+
Cran%en ompany manufactures three different models of paper shredders including the !aste
container/ !hich serves as the base. :hile the shredder heads are different for all three models/
the !aste container is the same. The number of !aste containers that Cran%en !ill need during
the ne't five years is estimated as follo!s+
2668 *6/666
2669 *6/666
266$ *2/666
26)6 **/666
26)) **/666
The e0uipment used to manufacture the !aste container must be replaced because it is broken
and cannot be repaired. The ne! e0uipment !ould have a purchase price of P$1*/666 !ith terms
2I)6/ nI#6K the company&s policy is to take all purchase discounts. The freight on the e0uipment
!ould be P))/666/ and installation costs !ould total P22/$66. The e0uipment !ould be purchased
in December 266. and placed into service on Ganuary )/ 2668. 7t !ould have a five-year economic
life and !ould have the follo!ing depreciation. The e0uipment is e'pected to have a salvage value
246
Capital Budgeting
of P)2/666 at the end of its economic life in 26)). The ne! e0uipment !ould be more efficient
than the old e0uipment/ resulting in a 2* percent reduction in both direct material and variable
overhead. The savings in direct material !ould result in an additional one-time decrease in
!orking capital re0uirements of P2/*66/ resulting from a reduction in direct material inventories.
This !orking capital reduction !ould be recogni%ed at the time of e0uipment ac0uisition.
The old e0uipment is fully depreciated and is not included in the fi'ed overhead. The old
e0uipment from the plant can be sold for a salvage amount of P)/*66. ,ather than replace the
e0uipment/ one of Cran%en&s production managers has suggested that the !aste containers be
purchased. >ne supplier has 0uoted a price of P28 per container. This price is P9 less than
Cran%en&s current manufacturing cost/ !hich is presented belo!.
Direct materials P)6
Direct labor 9
?ariable overhead .
Ci'ed overhead+
"upervision P2
Cacilities *
Neneral 1 ))
Total unit cost P#*
Cran%en uses a plant!ide fi'ed overhead rate in its operations. 7f the !aste containers are
purchase outside/ the salary and benfits of one supervisor/ included in fi'ed overhead of P1*/666
!ould be eliminated. There !ould be no other changes in the other cash and noncash items
included in fi'ed overhead e'cept depreciation on the ne! e0uipment.
The ne! e0uipment !ill be depreciated according to the follo!ing declining amounts+
<ear Depreciation
2668 P#)$/$.9
2669 12./826
266$ )12/)8.
26)6 8)/)#.
26)) 6
Cran%en is sub(ect to a 16 percent ta' rate. Management assumes that all cash flo!s occur at the
end of the year and uses a )2 percent after-ta' discount rate.
9*
. The initial net cash outflo!s if the company decides to continue making the !aste containers
is+
A. P $*./.66 . P $89/$66
B. P $8*/*66 D. P)/1**/.)#
9.
. The total after-ta' cash outflo!s/ e'cluding the initial cash outflo!s/ if the ne! e0uipment is
purchased are+
A. P $*./.66 . P2/$)9/#66
B. P2/998/966 @defectiveA D. P#/28$/666
98
. The present value of the total depreciation shield is+
A. P#69/$26 . P#68/92.
B. P#)#/*66 D. P#2)/#6#
99
. The total relevant after-ta' costs to buy the !aste containers are+
A. P2/92$/216 . P1/21#/*66 @defective
B. P#/6#$/..2 D. P8/681/666
9$
. :hat is the net present value of the purchase alternative3
A. P#/6#$/..2 @defectiveA . P2/69#/6.2
B. P2/8#6/812 D. P2/8)9/#*$
$6
. :hat is the net present value of the make alternative3
A. P2/6#./.6# . P2/$$./.6#
B. P#/6#$/..2 D. P2/$$#/26# @defectiveA
ANS5ER E6PLANATIONS
247
1
. Ans!er+ B
7nitial amount of investment ).6/666
Bess ash inflo! @decrease in outflo!A at period 6+
M? of old e0uipment 96/666
Ta' benefits on loss on sales @26/666 ' .1A 9/666 99/666
4et investment 82/666
2
. Ans!er+ D
ATC E 4et investment R Payback period
ATC @916/666 R #.#2.A 2*2/***
4et income @2*2/*** M )16/666A ))2/***
Before-ta' income @))2/*** R 6..6A )98/*$2
Before-ta' savings @)98/*$2 L )16/666A #28.*$2
The computation of after-ta' cash flo!s/ given the amount of investment and internal rate of return or P? of annuity of )
discounted at 7,, is the reverse of the computation of payback period. ,emember that the payback method/ though a
nondiscounted techni0ue/ is closely related to internal rate of return because the payback period is e'actly the present
value of annuity of ) if they are discounted using the internal rate of return.
3
. Ans!er+ A
Annual savings on e'penses P*6/666
Bess+ Additional depreciation @16/666 M 2*/666A )*/666
Additional ta'able income #*/666
Additional ta' @#*/666 ' 16FA P)1/666
Additional depreciation can be easily calculated by subtracting the book value of the old machine from the cost of ne!
machine and then the difference divided by the useful life @).6/666 M )66/666A R 1 E )*/666.
4
)6. Ans!er+ B
<ear"<D"traight BineDifferencePresent ?alue)2/666/666)/266/666966/666
828/2962)/.66/666)/266/666166/666##6/*.6#)/266/666)/266/666 -61 966/666)/266/666@166/666A @28#/266A*
166/666)/266/666@966/666A @1$./826ATotal present value of difference in depreciation298/$26Ta' ,ate16FPresent value
of net advantage))*/).9
5
. Ans!er+ B
"<D"BDifferencePresent ?alue) )*6/666$6/666.6/666*#/*.92 )26/666$6/666#6/6662#/$).#
$6/666$6/666-61 .6/666$6/666@#6/666A@)$/6..A* #6/666$6/666@.6/666A@#1/61.ATotal of present values of
depreciation21/#82Ta' rate16FPresent value of net advantage $/81$"<D method provides a higher present value on
ta' benefits because of less amount of ta' during year ) - 2. 7n year 1 and */ the use of "<D re0uires higher ta'es but
their e0uivalent present values are lo!er already.
6
. Ans!er+ D
Annual cost savings $6/666
Bess depreciation @1#2/666 R )2A #./666
Annual income *1/666
"imple ,ate of ,eturn+ *1/666 R 1#2/666 )2.* F
7
. Ans!er+ A
The useful life of the pro(ect can be calculated by using the computational pattern for Accounting ,ate of ,eturn+
4et investment )6./866
Divide by Depreciation e'pense
CAT 26/666
Bess+ 4et income @)6./866 ' *FA )1/..* */##*
Average life @in yearsA 8.29
H )6F A,, based on average investment E *F A,, based on initial investment
8
. Ans!er+ B
A,, E Average annual net income R Average 7nvestment
Annual after-ta' cash flo! 16/666
Bess Depreciation 26/666
4et 7ncome 26/666
Divide by Average 7nvestment @266/666 L )96/666AI2 )$6/666
A,,+ )6.*F
The problem asked for the average accounting rate of return for the first year of asset&s life.
9
. Ans!er+ D
The average @accountingA rate of return is determined by dividing the annual after-ta' net income by the average cost of
the investment/ @beginning book value L ending book valueAI2.
After ta' income @P8/266 - @P8/266 ' #6FAA P */616
Average investment+ @P../666 L )./666A R 2 P1)/666
Accounting rate of return+ P*/616IP1)/666A )2.#F
10
. Ans!er+ A
@ATC M DepreciationA R 7nitial investment E Accounting ,ate of ,eturn
Bet ; E 7nitial investment
@../666 M 6.)6;A R ; E 6.)2
../666 - .)6; E .)2;
.22; E ../666
; E #66/666
11
. Ans!er+ A
4et 7ncome+ E ../666 - .)6;
AA, E 47I 7nvestment
.)2 E @../666 - .)6;A I ;
.)2; E ../666 - .)6;
.22 ; E ../666
; E #66/666
12
. Ans!er+ D
4et 7ncome @296/666 ' )*FA 12/666
Add back depreciation #*/666
ATC 88/666
13
. Ans!er+ B
Payback period E 7nitial amount of investment R Annual after-ta' cash flo!s
P#*/666 R P*/666 E 8 years
14
. Ans!er+ B
4et investment *6/666
Divide by CAT @)6/666 ' 6.8A R @*6/666 R 9 ' 6.#A 9/98*
Payback period *.. years
15
. Ans!er+ D
umulative cash flo!s end of <ear ) @1*6/666A M 2*1/*26 @)$*/196A
Discounted cash flo! for <ear 2 )8#/1.6
umulative cash flo!s/ end of <ear 2 @ 22/626A
Break-even time 2 L @22/626 R )6*/)16A 2.2) years
16
. Ans!er+ D
ost of the ne! machine 166/666
"alvage value of old machine at period %ero .6/666
4et investment @>utflo!sA #16/666
Divide by cash flo! after ta' $6/666
Payback period #.89 years
17
. Ans!er+ B
ash 7nflo!Dnrecovered >utflo!>utflo!s@1/*66/666ACirst year$66/666@#/.66/666A"econd year)/266/666@2/166/666AThird
year)/*66/666@ $66/666ACourth year $66/6666
Payback Period+ At the end of 1 periods/ the initial outflo!s are fully recovered.
4ote to the PA andidates+ A modified 0uestion for this problem is to compute the Present ?alue of the net advantage
of using sum-of-the-years& digits of depreciation instead of straight-line method.
18
. Ans!er+
ash inflo!s7nvestmentPeriod 6@$$/#66APeriod ) @8*/666 M 2*/666A ' .. #6/666@.$/#66APeriod 2 @ #6/666 ' ).)6A
##/666@#./#66APeriod # @##/666 ' ).)6A #./#66 -6-At the end of the third year/ investment is fully recovered.
The net investment of $$/#66 is net of ta' benefit/ @).*/*66 ' ..A
19
. Ans!er+
Before-ta' cash flo! E 16/666 L #*/666 8*/666
Payback period+ #66/666 R 8*/666 1 years
20
. Ans!er+
There are t!o cash flo!s at time %ero+ P)26/666 outflo! and P)1/666 inflo!.
4et cash outflo! @)26/666 M )1/666A E )6./666
21
. Ans!er+
omputation of ash Clo! After-ta'
CBT )66/666 ' 6.8 86/666
Depreciation ta' shield .2/*66 ' 6.# )9/8*6
CAT 99/8*6
omputation of 4et Present ?alue+
P? of ATC+ 99/8*6 ' *.818 *)6/61.
P? of After-ta' "alvage ?alue+ 26/666 ' 6.86 ' 6.*1 8/*.6
Total *)8/.6.
7nvestment *66/666
4et Present ?alue )8/.6.
The problem assumed that the salvage value is ignored in the computation of annual depreciation so that the annual
cash flo!s !ill be greater. The problem did not include among the choices the assumption that salvage value !ill be
deducted from the cost in computing the amount of annual depreciation.
22
. Ans!er+ B
Annual revenues 166/666
Bess cash operating costs )61/966
ash flo! before ta' 2$*/266
Bess Depreciation @)M R *A 266/666
7ncome before ta' $*/266
Bess income ta' @16FA 29/696
4et income *8/)26
Add back depreciation 266/666
ATC 2*8/)26
P? of ATC/ nE*K kE)6F 2*8/)26 ' #.8$69 $81/.$6
7nvestment )/666/666
4egative 4et Present ?alue @ 2*/#)6A
The manner of financing the pro(ect is not considered in the analysis of capital investment. 7nvestment must be
separate from financing. 7t is a normally committed error in the application of capital budgeting techni0ues !here
financing strategy is considered. The e'plicit or implicit cost of financing the pro(ect is taken care of the discounting
process.
23
. Ans!er+ A
Present value of cash returns+ @#6/666 ' 6.$6$6$A ' * periods )#./#.1
4et investment $$/#66
4et present value #8/6.1
4ote+ Because the constant gro!th rate and the discount rate are both )6F/ the present value for each period is
constant.
24
. Ans!er+ B
"avings @2 !orkers/ each P)6/666 for # monthsA 2 ' P)6/666 ' # P.6/666
Depreciation @)8*/666 M 2*/666A R * years P#6/666
After-ta' cash savings+ @.6/666 ' 6.8*A L @#6/666 ' 6.2*A P*2/*66
Present value of after-ta' cash savings @*2/*66 ' #..6189A P)9$/2*6
Present value of "alvage ?alue @2*/666 ' 6.*.81#A )1/)9.
Total 26#/1#.
7nvestment )8*/666
4et Present ?alue P 29/1#.
25
. Ans!er+ B
omputation of net investment+
ash purchase price #66/666
Bess+ M? of old machine 96/666
Ta' shield on loss on sale @16/666 ' 6.#2A )2/966 $2/966
4et investment 268/266
Annual cash savings before ta' @216/666 M ).6/666A 96/666
Additional depreciation @#66/666 M )26/666A R 1 1*/666
Additional ta'able income #*/666
Bess Additional ta' @#*/666 ' 6.#2A ))/266
4et income 2#/966
Add back depreciation 1*/666
After-ta' cash flo! .9/966
Alternative computation for ATC+
@96/666 ' 6..9A L @1*/666 ' 6.#2A .9/966
Present value of ATC @.9/966 ' #.2#$82A 222/9$#
7nvestment 268/266
4et Present ?alue )*/.$#
26
. Ans!er+ B
P? of annual cash receipts )/266/666 ' 2.*9982 #/)6./1.#
P? of salvage value .*6/666 ' 6.1922* #)#/1.2
P? of return of !orking capital )/666/666 ' 6.1922* 192/2*6
ost of ne! e0uipment and timbers @2/8*6/666A
:orking capital @)/666/666A
P? of cost of construction of road 166/666 ' .*898 @ 2#)/196A
4egative net present value @8$/#6#A
27
. Ans!er+ B
Period4ominal ash "avingsP? CactorPresent ?alue)#2/666 6.988$629/686.692#2/666 ' ).6*##/.66
6.8.$182*/9*1.)$##2/666 ' ).6*2#*/296 6..81$82#/9)2.$11#2/666 ' ).6*##8/611
6.*$2692)/$##.6)Total$$/.86.227nvestment96/666.664P?)$/.86.224ote that all the annual cash inflo!s are ad(usted
by one period.
28
. Ans!er+ B
The solution used total analysis approach in computing present value.
,etain the >ld Machine+
Present value of annual cash outlay
CAT @#66/666 ' P6.#9A L P2)/666 E P)#*/666
P?CAT @)#*/666 ' #..918A P1$8/1#*
Present value of salvage value @8/666 ' 6.1)611A @ 2/98#A
Total P1$1/*.2
Buy 4e! machine+
Present ?alue of Annual cash outlay
CAT @#66/666 ' P6.2$A L P))/666 E P$9/666
P?CAT P$9/666 ' #..918A P#.)/)66
"alvage value of ne! machine/ end of . years@P26/666 ' 6.1)611A @ 9/26$A
7nvestment in ne! machine @)26/666 M 16/666A 96/666
Total P1#2/9$)
29
. Ans!er+ B
The purpose of profitability inde' is to compare t!o pro(ects& profitability by reducing the present value per ) peso of
investment. Therefore/ the ratio of 1.#**2. S )6F to 1.)))1) S )2F indicated the profitability inde'.
Profitability inde'+ 1.#**2.I1.)))1) E ).6.
30
. Ans!er+ B
P? of annuity of ) at 7,, T@) R ).)2#9.A* #.*86*8
P? of annuity of ) at M T@) R ).))6**A* #..$68$
After-ta' cash flo!s )6/666 R @#..$68$ M #.*86*8A 9#/)96.91
7nvestment+ 9#/)96.91 ' #.*86*8 2$8/666
Profitability inde' @2$8/666 L )6/666A R 2$8/666 ).6#1
A shorter calculation of the Profitability 7nde' can be made by+
#..$68$ R #.*86*8 E ).6#1
31
. Ans!er+ D
7n discounting the annual cash inflo! by the 7,,/ the 4P? E P6
The net present value of =5,> is )1F and ).F. Cor better time management/ the candidate is e'pected not to do
detailed calculation of finding out the e'act rate.
The use of interpolation indicated that the 7,, is )*.#F+
Discount ,ate4et Present ?alue6.)1)/)$87,,66.).-869
@6.)1 M 7,,A R @6.)1 M 6.).A E )/)$8 R @ )/)$8 L 869A
@6.)1 M 7,,A R -.62 E )/)$8 R )$6*
@6.)1 M 7,,A R - .62 E 6..29
@6.)1 M 7,,A E 6..29 ' -6.62
6.)1 M 7,, E 6. 6)#
7,, E 6.)*# or )*.#6F
4ote+ "ince at the 7,,/ 4P? is %ero/ the ans!er can only be bet!een )1F - ).F/ since only one of the choices/ satisfy
the criteria/ the ans!er is @DA.
32
. Ans!er+ B
The payback period that corresponds to the pro(ect&s internal rate of return of )2 percent is 1.$.9. Therefore/ the
amount of investment must e0ual the product of the payback period and the net cash flo!s+
7nvestment+ @1.$.9 ' 26/666A E P$$/#.6
33
. Ans!er+ D
The amount of investment+ the P? of annuity at 7,,
1.#** ' ./666 E 2./)#6
34
. Ans!er+
Present value of cash inflo!s e0uals amount of investment at )6F 7,,.
P26/666 ' #.8$) E P8*/926
35
. Ans!er+ A
ATC+ P)/*66/666I#..6182 1)./)2)
Depreciation #66/666
4et income+ 1)./)2) M #66/666 ))./)2)
Before-ta' income+ ))./)2)I6..6 )$#/*#*
Ci'ed costs *66/666
ontribution margin+ )$#/*#* L *66/666 .$#/*#*
Dnit sales .$#/*#* R @)66 - .6A )8/##9
36
. Ans!er+ B
ontribution margin @per 4o. 2#A .$#/*#*
Divide by sales volume R 26/666
ontribution margin per unit P#1..9
Add variable cost per unit .6.66
"elling price per unit P$1..9
Alternative "olution+
ash inflo! before ta' based on present price+ @26/666 ' 16A M 266/666 .66/666
After-ta' cash inflo! @.66/666 ' 6..A L @#66/666 ' 6.1A 196/666
Present value of ATC @196/666 ' #..6189A )/8#6/2$1
7nvestment )/*66/666
4et present value @present priceA 2#6/2$1
Annual e'cess ATC due to e'cess price @2#6/2$1 R #..6189A .#/99*
Before-ta' e'cess cash inflo! @.#/99* R 6..A )6./18*
5'cess selling price+ )6./18* R 26/666 *.#2
,educed selling price to achieve 7,, of )2F @)66 M *.#2A $1..9
37
. Ans!er+
Annual after-ta' cash flo! *66/666I*..*62 99/1$2
Depreciation *66/666I)6 *6/666
4et income #9/1$2
7ncome before ta' #9/1$2I6.. .1/)*1
Depreciation *6/666
ash savings before ta'+ .1/)*1 L *6/666 ))1/)*1
38
. Ans!er+ A
The amount of annual cash flo!s can be solved by e0uation+
4P? E P? of annual C M 7nvestment
)/8*6 E 2.188)C M 2.16)9C
)/8*6 E 6.)8*#C
C E $/$96
39
. Ans!er+ A
7nvestment )26/666
Bess Present value of salvage value @)2/666 ' 6.#9**A 1/.2.
Present value of Annual ash 7nflo!s ))*/#81
Minimum Annual ash Clo!s @))*/#81 R ..)11.A )9/88.
40
. Ans!er+ B
Present value of annual cash flo!s at 7,, @9)/666 ' 1..#$A #8*/8*$
7nvestment 9)/666 ' 1.#11 #*)/9.1
Difference 2#/9$*
Annual increase in cash flo!s 2#/9$*I1.#11 */*6)
41
. Ans!er+ A
7nvestment @Total of present value S 7,, of )2FA *6/666
Bess P?/ year ) - 2 @)./681 L )8/*#1A ##/.69
P? of the #rd cash flo! )./#$2
After-ta' cash flo!/ third year )./#$2I6.8)2 2#/622
42
. Ans!er+ B
The net present value E P? of e'cess salvage value less P? of decrease in after-ta' cash flo!
Bet ; E the e'cess salvage value
8/66# E 6.*.81#; M U#..6189 ' @6.2; H 6.1A
8/66# E 6.*.81#; M 6.299#921;
8/66# E 6.28$618.;
; E 2*/6$.
,e0uired salvage value+ *6/666 M 2*/6$. E 21/$61
43
. Ans!er+ B
ost of e0uipment 8*6/666
Bess P? of tangible benefits )66/666 ' *.6)988 *6)/988
P? of annual intangible benefits 219/)2#
Amount of annual intangible benefits 219/)2#I*.6)988 1$/116
44
. Ans!er+ B
To be acceptable/ the pro(ect should yield a net present value of %ero. The negative net present value must be offset by
the present value of annual intangible benefits.
Present value of intangible benefits P)91/#*6
P? of annuity of ) at )6F for )6 years R ..)1*
Annual net intangible benefits P#6/666
45
. Ans!er+ A
The indifference rate @crossover or fisher rateA refers to the rate at !hich the net present values of the 2 alternatives are
indifferent or e0ual.
The easier test of the rate is to look for 7,, @using trial and error techni0ueA of the investment difference.
Difference 96/666 M 19/666 #*/22*
P? inflo!s T@#/266 R ).)2.1A. @)2/$22A
P? inflo!s T@)*/266 R ).)2.1A)6-. @22/#6#A
Difference 47B
Alternative "olution+
Pro(ect ;Pro(ect <P? of after-ta' cash flo!s
T@)2/666 R ).)2.1A.
19/1** T@)*/266 R ).)2.1A)69#/.967nvestment19/6669#/22*4et Present ?alue 1** 1**
46
. Ans!er+ B
The determination of the indifference point/ !hich is )6F/ for the t!o pro(ects can be made through the use of trial and
error estimation.
Machine )Machine 2P? of Difference in ATC <ear ) )**/666 R ).)6 )16/$6$.)6@)16/$6$.)6A <ear 2 @))6/666 R
).)6A2@ $6/$6$.)6A $6/$6$.)64et difference *6/666.66@ *6/666.66ADifference in investment@ *6/666.66A
*6/666.664P? 47B 47B
47
. Ans!er+
)*F Discount ,ate
Machine )Machine 2P? of Difference in ATC <ear ) )**/666 ' 6.9.$*8 )#1/89#.#*@)#1/89#.#*A <ear 2 ))6/666 '
6.8*.)1@ 9#/)8*.16A 9#/)8*.164et difference *)/.68.$*@ *)/.68.$*ADifference in investment@ *6/666.66A
*6/666.664P? )/.68.$*@ )/.68.$*A
At )* percent discount rate/ Machine ) is more acceptable.
9F Discount ,ate
Machine )Machine 2P? of Difference in ATC <ear ) )**/666 ' 6.$2*$# )1#/*)$.)*@)1#/*)$.)*A <ear 2 ))6/666 '
6.9*8#1@ $1/#68.16A $1/#68.164et difference 1$/2)).8*@ 1$/2)).8*ADifference in investment@ *6/666.66A
*6/666.664P? @ 899.2*A 899.2*
At 9 percent discount rate/ Machine 2 is more acceptable.
48
. Ans!er+
ost of 7nvestment+
7nvoice price $*6/666
7nstallation cost 21/266
Creight charge 966
Total investment $8*/666
Annual ash Clo!+
4umber of procedures+ @*2 ' *A 2.6
ontribution margin per procedures+ @P966 M P)6 M P16A P8*6
Total annual cash flo!+ @2.6 ' P8*6A P)$*/666
ash payback period+ @$8*/666 R )$*/666A * years
49
. Ans!er+ B
Present value of cash flo! @)$*/666 ' ..1)9A P)/2*)/*)6
Present value of salvage value @**/666 ' 6.1221)A 2#/2##
Total P)/281/81#
apital investment $8*/666
4et present value P 2$$/81#
50
. Ans!er+ A
Average investment+ @$8*/666 L **/666A R 2 *)*/666
Annual depreciation+ @$8*/666 M **/666A R )6 $2/666
Annual net income+ )$*/666 M $2/666 )6#/666
Average annual ,ate of ,eturn+ P)6#/666 P*)*/666 26F
51
. Ans!er+ A
ontribution margin+ #66/666 ' @8* M *6A 8/*66/666
Bess Ci'ed costs 1/*66/666
ash flo! before ta' #/666/666
Bess+ Depreciation @./666/666 R 1A )/*66/666
7ncome before ta' )/*66/666
Bess+ 7ncome ta' @)/*66/666 ' 6.1A .66/666
4et income $66/666
Add back+ Depreciation )/*66/666
After-ta' ash Clo! 2/166/666
52
. Ans!er+
P? of After-ta' ash Clo!s @2/166/666 ' 2.$298A 8/629/$66
ost of investment ./666/666
4et Present ?alue )/629/$66
53
. Ans!er+ A
Annual e'cess present value @)/629/666 R 2.$298A P#*)/666
5'cess cash before ta' @#*)/666 R 6..A P*9*/666
Ma'imum number of units as decrease @*9*/666 R )*A #$/666
54
. Ans!er+ A
Average Annual net income+
@)66/666 L 16/666 L 26/666 L )6/666 L )6/666A R * E #./666
Divide by average investment @166/666 R 2A 266/666
Accounting rate of return )9F
Accounting rate of return or unad(usted rate of return computes the profitability of the pro(ect in term of accrual profit.
4et profit under accrual method considers depreciation/ a substantial amount that understates the average profit. This
understatement of amount that is used in the computation necessarily re0uires that preferably/ average investment
should be used/ instead of the initial investment/ in the determination of accounting rate of return.
55
. Ans!er+ B
ash Clo!P? CactorP? of annual net cash flo!s+)96/6666.$6$).#/.26)26/6666.92. $$/)26)66/6666.8*)
8*/)66$6/6666..9# .)/186$6/6666..2) **/9$6Total1**/266Amount of investment166/6664et Present ?alue **/266
56
. Ans!er+
Present ?alue 7nde' @Profitability 7nde'A
Present ?alue of ATC R 4et 7nvestment @1**/266 R 166/666A E ).)1
The present value inde' computes net present value in terms of P) investment. Therefore/ the inde' of ).)1 means the
net present value per P) of investment is P6.)1. This concept makes the present value inde' better than the net
present value techni0ue because the inde' indicates !hich one is the most profitable on a per P) investment.
57
. Ans!er+ D
ash 7nflo!Dnrecovered 7nvestmentPeriod 6 >utflo!s@166/666APeriod ))96/666@226/666APeriod 2)26/666@)66/666APeriod
#)66/666=ero
The total outflo!s are fully recovered by the end of period #.
The analyst should be careful in computing the payback period !hen the pro(ect has uneven cash inflo!s. The common
error in handling uneven cash flo!s is using the average cash flo!s instead of reducing the unrecovered outflo!s.
58
. Ans!er+ D
Payback period+ 7nvestment R 4et Annual ash 7nflo!
P266/666 R P*6/666 E 1 years
59
. Ans!er+ D
Present value of 4et ash 7nflo! @8)/666 ; 1.#**A #6$/26*
7nvestment #66/666
4et Present value $.26*
60
. Ans!er+ B
Average 7nvestment+ @266/666 R 2A E )66/666
Accounting ,ate of ,eturn E 4et 7ncome R Average 7nvestment
@)6/666 R )66/666A E )6 percent
61
. Ans!er+ B
The payback for PA is 1.22*. This is closest to the present value of annuity of ) discounted at )) percent for . periods
!hich is 1.2#).
62
. Ans!er+ A
Annual depreciation+ @P*6/666 R 9A P./2*6
Annual ta' shield+ @P./2*6 ' 6.#A P)/98*
63
. Ans!er+
Before-ta' cash inflo! P)6/666
Bess depreciation ./2*6
7ncome before ta' #/8*6
Bess income ta' @#/8*6 ' 6.#A )/)2*
4et income 2/.2*
Add back depreciation ./2*6
After-ta' cash inflo! P 9/98*
A 0uicker calculation of after ta' cash flo! can be made by adding the ta' shield to after-ta' cash inflo! !ithout any ta'
benefit on depreciation.
@P)6/666 V .86A L P)/98* E P9/98*
64
. Ans!er+ B
Payback period+ @P*6/666 R P9/98*A E *.. years
65
. Ans!er+
Present value of annual ATC @P9/98* ' *.818A P*)/666
Present value of after-ta' salvage value @P)/166 ' 6.*1A 8*.
Total *)/8*.
7nvestment *6/666
4et present value P )/8*.
66
. Ans!er+
At the discount rate of 9 percent/ there is a net present value of P)/8*.. Therefore/ the 7,, is higher than 9 percent.
Dsing trial and error approach/ the first try should use $ percent. 7f the present value of the inflo!s e'ceeds P*6/666/
then the 7,, is lo!er than $ percent/ other!ise it should be $.* percent.
Dsing $.6 percent in discounting the inflo!s/ there is a net present value of P@)81AK therefore the 7,, is slightly lo!er
than but very close to $.6 percent.
@P9/98* ' *.*#*A L @P)/166 ' 6.*6)$A M P*6/666 E P@)81A
67
. Ans!er+ B
Additional contribution margin+
"mall ./666 ' *.16 #2/166
Medium )*/666 ' ..*6 $8/*66
Barge $/666 ' 8.$6 8)/)66
Total 26)/666
Bess ash Ci'ed 5'penses+
,ent )9/666
"alaries *1/666
Dtilities )#/266
7nsurance/ etc. 8/966 $#/666
Annual ash 7nflo!s )69/666
68
. Ans!er+ B
Additional rental income )#6/666
Additional cash flo!/ snack bar )*/666
Total )1*/666
Bess ash Ci'ed 5'penses+
,ent 19/666
"alaries )8/666
Dtilities */166
7nsurance/ etc. $/.66 96/666
Annual ash 7nflo! .*/666
69
. Ans!er+ A
P? of annual cash inflo! @)69/666 ' *.*8*A .62/)66
P? of salvage value @86/666 ' 6.)69A #/216
P? of !orking capital return @8/*66 ' 6.)69A 9)6
Total .6./)*6
7nvestment+
,emodeling cost **6/666
:orking capital 8/*66 **8/*66
4et Present ?alue 19/.*6
70
. Ans!er+ B
P? of annual cash inflo! @.*/666 ' *.*8*A #.2/#8*
P? of salvage value )/2$.
P? of !orking capital return 1#2
Total #.1/)6#
7nvestment+
,emodeling cost 2$6/666
:orking capital 1/666 2$1/666
4et Present ?alue 86/)6#
71
. Ans!er+ A
,ental income 2)/666 ' * )6*/666
Additional cash inflo!/ snack bar )#/666
Total ))9/666
Bess fi'ed e'penses 96/666
Annual cash inflo! #9/666
P? of annual cash inflo! @#9/666 ' */*8*A 2))/9*6
P? of salvage value )/2$.
P? of !orking capital return 1#2
Total 2)#/*89
7nvestment 2$1/666
4egative 4et Present ?alue @ 96/122A
72
. Ans!er+ D
The annual cost of advertising can be easily calculated by dividing the net present value of alternative 2/ at ).F by the
present value of annuity of ).
86/)6# R */*8* E )2/*81.*#
73
. Ans!er+ A
Annual revenues #66/666
?ariable e'penses .6/666
ontribution margin 216/666
Ci'ed e'penses
Advertising 16/666
"alaries ))6/666
Dtilities */266
7nsurance 966 )*./666
Annual cash income 91/666
Bess Depreciation 126/666 ' 6.$6 R )2 #)/*66
Annual 7ncome *2/*66
74
. Ans!er+ A
urrent operating costs M old machine 89/666
Deduct >perating costs M Machine B
Annual salary of operator )./#*6
Annual maintenance cost */166 2)/8*6
Annual cash savings *./2*6
75
. Ans!er+ A
"imple ,ate of ,eturn E 4et 7ncome R 7nitial 7nvestment
*2/*66 R 126/666 E )2.*6 F
76
. Ans!er+ B
"avings *./2*6
Bess Depreciation 2#1666 R )# years )9/666
Annual income #9/2*6
"imple Annual ,eturn #9/2*6 R 22*/666 )8 F
77
. Ans!er+
Payback period E 7nitial 7nvestment R Annual ash 7nflo!
126/666 R 91/666 E * years
78
. Ans!er+ A
22*/666 R *./2*6 E 1 years
79
. Ans!er+
Purchase price of ne! tools 2/*66/666
Add increase in !orking capital .6/666
Total 2/*.6/666
Deduct "alvage value of the old tools 1*/666
4et investment 2/*29/*66
80
. Ans!er+
Purchase price of valve stem 96/666 ' 26 )/.66/666
ost to make+
Direct materials 96/666 ' 1.*6 #.6/666
Direct labor 96/666 ' #.$6 #)2/666
?ariable overhead 96/666 ' ).*6 )26/666
Decrease in directs labor and variable costs 96/666 ' )..6 @)29/666A ..1/666
ost savings $#./666
81
. Ans!er+ A
P? of annual depreciation
PeriodDepreciationP? CactorPresent ?alue<ear ) 9#2/*666.9$29.81#/#6*.$* 2 ))2/*666.8$8)$99./98#.99 #
#86/6666.8))892.#/#*9..6 1 )9*/6666..#**2))8/*8).26Total2/6))/)6$..#Ta' rate6.#6P? of ta' benefits from
depreciation.6#/##2.9$
82
. Ans!er+
After ta' salvage value )66/666 ' .8 86/666
P? of ) end of 1 periods 6..#**2
P? of after M ta' salvage value 11/19..1
83
. Ans!er+
P? of after cash savings $#./666 ' .8 ' #.6#8#* )$$6682
P? of ta' benefits from depreciation .6#/###
P? of after ta' salvage value 11/19.
P? of !orking capital return .6/666 ' 6..#**2 #9/)#)
7nvestment @2*29/*66A
4et present value )18/*22
84
. Ans!er+ A
P? of ta' benefits/ declining - balance .6#/###
P? of ta' benefits/ straight-line method 2/*66/666 1 ' .# ' #.6#8#* *.$/*6#
4et advantage ##/9#6
85
. Ans!er+ A
7nvoice price of ne! e0uipment @$1*/666 ' 6.$9A P$2./)66
Creight ))/666
7nstallation cost 22/$66
Total $.6/666
Bess+ "alvage value of old e0uipment @6.. ' )/*66A $66
,eduction in !orking capital 2/*66 #/166
4et initial outflo!s P$*./.66
86
. Ans!er+ B
Total variable costs @2.2/666 units ' P26HA P*/216/666
Avoidable fi'ed costs @P1*/666 ' * yearsA 22*/666
Total */1.*/666
After-ta' ash outflo!s
>perating e'penses @*/1.*/666 ' 6..A P#/28$/666
Depreciation @$.6/666 ' 6.1A @ #91/666A
After-ta' salvage value of ne! e0uipment @)2/666 ' 6..6A @ 8/266A
4et outflo!s P2/998/966
H?ariable cost per unit
Direct material @)6.66 ' 6.8*A P 8.*6
Direct labor 9.66
?ariable overhead @..66 ' 6.8*A 1.*6
Total P26.66
87
. Ans!er+ A
The present value of the ta' shield based on declining-depreciation is+
<earDepreciationTa' "hield @16FAP? CactorP? of Ta' "hield2668P#)$/$.9P)28/$986.9$#P))1/2$22669 12./826
)86/.996.8$8 )#./6#9266$ )12/)8. *./9866.8)2 16/1$226)6 8)/)#. 29/1**6..#. )9/6$9TotalP#69/$26
88
. Ans!er+
Purchase ost
<ear ATC2668*6/666 ' 28 ' 6.. 9)6/6662669*6/666 ' 28 ' 6.. 9)6/666266$*2/666 ' 28 ' 6..
912/16626)6**/666 ' 28 ' 6.. 9$)/66626))**/666 ' 28 ' 6.. 9$)/666266.@)/*66 ' 6..A @ $66A Total
1/21#/*66
89
. Ans!er+ A
Present value of after-ta' cash flo!s
2668 @9)6/666 ' 6.9$#A P 82#/##6
2669 @9)6/666 ' 6.8$8A .1*/*86
266$ @912/166 ' 6.8)2@ *$$/89$
26)6 @9$)/666 ' 6..#.A *../.8.
26)) @9$)/666 ' 6.*.8A *6*/)$8
"alvage value of old e0uipment @)/*66 ' 6..6A @$66A
4et present value P#/6#$/..2
90
. Ans!er+ D
CBTCATP? CactorP?CAT266.7nitial outflo!@P$*./.66A2668@*6/666 ' 26A L 1*/666
@)/61*/666 ' 6..A - @#)$/$.9 ' 6.1A)/61*/666
1$$/6)#
6.9$#
11*/.)$2669@)/61*/666 ' 6..A M @12./826 ' 6.1A1*./#)26.8$8#.#/.9)266$@*2/666 ' 26A L 1*/666
@)/69*/666 ' 6..A M @)12/)8. ' 6.1A)/69*/666
*$1.)#6
6.8)2
12#/62)26)6@**/666 ' 26A L 1*/666
@)/)1*/666 ' 6..A M @8)/)#.A)/)1*/666
.*9/*1.
6..#.
1)9/9#*26))@**/666 ' 26A L 1*/666
@)/)1*/666 ' 6..A)/)1*/666
.98/666
6.*.8
#9*/118"alvage value @)2/666 ' 6..A8/266P2/$$#/26#