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Answer.capital Budgeting

- Capital Budget
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Answer: B

. Answer: D

Net income (252,555 140,000)112,555

Before-tax income (112,555 0.60) 187,592

Before-tax savings (187,592 + 140,000)327.592

The computation of after-tax cash flows, given the amount of investment and internal rate of return or PV of

annuity of 1 discounted at IRR is the reverse of the computation of payback period. Remember that the

payback method, though a nondiscounted technique, is closely related to internal rate of return because the

payback period is exactly the present value of annuity of 1 if they are discounted using the internal rate of

return.

. Answer: A

Less: Additional depreciation (40,000 25,000) 15,000

Additional taxable income 35,000

Additional depreciation can be easily calculated by subtracting the book value of the old machine from the

cost of new machine and then the difference divided by the useful life (160,000 100,000) 4 = 15,000.

10. Answer: B

1 2,000,000 1,200,000 800,000 727,280

2 1,600,000 1,200,000 400,000 330,560

3 1,200,000 1,200,000 - 0

4 800,000 1,200,000 (400,000) (273,200)

5 400,000 1,200,000 (800,000) (496,720)

Total present value of difference in depreciation 287,920

Tax Rate 40%

Present value of net advantage 115,168

. Answer: B

3 90,000 90,000 - 0

SYD method provides a higher present value on tax benefits because of less amount of tax during year 1 & 2.

In year 4 and 5, the use of SYD requires higher taxes but their equivalent present values are lower already.

. Answer: D

. Answer: A

The useful life of the project can be calculated by using the computational pattern for Accounting Rate of

Return:

CFAT 20,000

. Answer: B

Annual after-tax cash flow 40,000

ARR: 10.5%

The problem asked for the average accounting rate of return for the first year of assets life.

. Answer: D

The average (accounting) rate of return is determined by dividing the annual after-tax net income by the

average cost of the investment, (beginning book value + ending book value)/2.

. Answer: A

Let X = Initial investment

(66,000 0.10X) X = 0.12

66,000 - .10X = .12X

.22X = 66,000

X = 300,000

. Answer: A

.22 X = 66,000

X = 300,000

. Answer: D

ATCF 77,000

. Answer: B

. Answer: B

. Answer: D

. Answer: D

Payback period 3.78 years

. Answer: B

Outflows (4,500,000)

First year 900,000 (3,600,000)

Second year 1,200,000 (2,400,000)

Third year 1,500,000 ( 900,000)

Fourth year 900,000 0

Payback Period: At the end of 4 periods, the initial outflows are fully recovered.

Note to the CPA Candidates: A modified question for this problem is to compute the Present Value of the net

advantage of using sum-of-the-years digits of depreciation instead of straight-line method.

. Answer: C

Period 0 (99,300)

The net investment of 99,300 is net of tax benefit, (165,500 x .6)

. Answer: C

. Answer: C

There are two cash flows at time zero: P120,000 outflow and P14,000 inflow.

Net cash outflow (120,000 14,000) = 106,000

. Answer: C

CFAT 88,750

Total 517,606

Investment 500,000

The problem assumed that the salvage value is ignored in the computation of annual depreciation so that the

annual cash flows will be greater. The problem did not include among the choices the assumption that salvage

value will be deducted from the cost in computing the amount of annual depreciation.

. Answer: B

Income before tax 95,200

ATCF 257,120

Investment 1,000,000

The manner of financing the project is not considered in the analysis of capital investment. Investment must

be separate from financing. It is a normally committed error in the application of capital budgeting

techniques where financing strategy is considered. The explicit or implicit cost of financing the project is

taken care of the discounting process.

. Answer: A

Note: Because the constant growth rate and the discount rate are both 10%, the present value for each period

is constant.

. Answer: B

Total 203,436

Investment 175,000

. Answer: B

Additional taxable income 35,000

Investment 207,200

. Answer: B

. Answer: B

1 32,000 0.87790 28,070.08

2 32,000 x 1.05 33,600 0.76947 25,854.19

3 32,000 x 1.052 35,280 0.67497 23,812.94

4 32,000 x 1.053 37,044 0.59208 21,933.01

Total 99,670.22

Investment 80,000.00

NPV 19,670.22

Note that all the annual cash inflows are adjusted by one period.

. Answer: B

Total P494,562

Present Value of Annual cash outlay

CFAT (300,000 x P0.29) + P11,000 = P98,000

Total P432,891

. Answer: B

The purpose of profitability index is to compare two projects profitability by reducing the present value per 1

peso of investment. Therefore, the ratio of 4.35526 @ 10% to 4.11141 @ 12% indicated the profitability index.

. Answer: B

. Answer: D

The net present value of ZERO is 14% and 16%. For better time management, the candidate is expected not

to do detailed calculation of finding out the exact rate.

Discount Rate Net Present Value

0.14 1,197

IRR 0

0.16 -708

(0.14 IRR) -.02 = 1,197 1905

(0.14 IRR) - .02 = 0.628

(0.14 IRR) = 0.628 x -0.02

0.14 IRR = 0. 013

IRR = 0.153 or 15.30%

Note: Since at the IRR, NPV is zero, the answer can only be between 14% & 16%, since only one of the choices,

satisfy the criteria, the answer is (D).

. Answer: B

The payback period that corresponds to the projects internal rate of return of 12 percent is 4.968. Therefore,

the amount of investment must equal the product of the payback period and the net cash flows:

. Answer: D

4.355 x 6,000 = 26,130

. Answer: C

. Answer: A

Depreciation 300,000

. Answer: B

Alternative Solution:

Cash inflow before tax based on present price: (20,000 x 40) 200,000 600,000

Investment 1,500,000

. Answer: C

Depreciation 50,000

. Answer: A

1,750 = 0.1753CF

CF = 9,980

. Answer: A

Investment 120,000

. Answer: B

Difference 23,895

. Answer: A

. Answer: B

The net present value = PV of excess salvage value less PV of decrease in after-tax cash flow

7,003 = 0.2790476X

X = 25,096

. Answer: B

Less PV of tangible benefits 100,000 x 5.01877 501,877

. Answer: B

To be acceptable, the project should yield a net present value of zero. The negative net present value must be

offset by the present value of annual intangible benefits.

. Answer: A

The indifference rate (crossover or fisher rate) refers to the rate at which the net present values of the 2

alternatives are indifferent or equal.

The easier test of the rate is to look for IRR (using trial and error technique) of the investment difference.

Difference NIL

Alternative Solution:

Project X Project Y

PV of after-tax cash flows

(12,000 1.1264)6 48,455

(15,200 1.1264)10 83,680

Investment 48,000 83,225

Net Present Value 455 455

. Answer: B

The determination of the indifference point, which is 10%, for the two projects can be made through the use of

trial and error estimation.

Machine 1 Machine 2

PV of Difference in ATCF

. Answer: C

15% Discount Rate

Machine 1 Machine 2

PV of Difference in ATCF

Net difference 51,607.95 ( 51,607.95)

8% Discount Rate

Machine 1 Machine 2

PV of Difference in ATCF

. Answer: C

Cost of Investment:

. Answer: B

Total P1,274,743

Net present value P 299,743

. Answer: A

. Answer: A

. Answer: C

. Answer: A

Excess cash before tax (351,000 0.6) P585,000

. Answer: A

Accounting rate of return or unadjusted rate of return computes the profitability of the project in term of

accrual profit. Net 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 requires that

preferably, average investment should be used, instead of the initial investment, in the determination of

accounting rate of return.

. Answer: B

Cash Flow PV Factor PV of annual net cash flows:

180,000 0.909 163,620

120,000 0.826 99,120

100,000 0.751 75,100

90,000 0.683 61,470

90,000 0.621 55,890

Total 455,200

Amount of investment 400,000

Net Present Value 55,200

. Answer: C

The present value index computes net present value in terms of P1 investment. Therefore, the index of 1.14

means the net present value per P1 of investment is P0.14. This concept makes the present value index better

than the net present value technique because the index indicates which one is the most profitable on a per P1

investment.

. Answer: D

Period 0 Outflows (400,000)

Period 1 180,000 (220,000)

Period 2 120,000 (100,000)

Period 3 100,000 Zero

The analyst should be careful in computing the payback period when the project has uneven cash inflows. The

common error in handling uneven cash flows is using the average cash flows instead of reducing the

unrecovered outflows.

. Answer: D

. Answer: D

Investment 300,000

. Answer: B

. Answer: B

The payback for PA is 4.225. This is closest to the present value of annuity of 1 discounted at 11 percent for 6

periods which is 4.231.

. Answer: A

. Answer: C

A quicker calculation of after tax cash flow can be made by adding the tax shield to after-tax cash inflow

without any tax benefit on depreciation.

. Answer: B

. Answer: C

Total 51,756

Investment 50,000

. Answer: C

At the discount rate of 8 percent, there is a net present value of P1,756. Therefore, the IRR is higher than 8

percent.

Using trial and error approach, the first try should use 9 percent. If the present value of the inflows exceeds

P50,000, then the IRR is lower than 9 percent, otherwise it should be 9.5 percent.

Using 9.0 percent in discounting the inflows, there is a net present value of P(174); therefore the IRR is slightly

lower than but very close to 9.0 percent.

. Answer: B

Total 201,000

Rent 18,000

Salaries 54,000

Utilities 13,200

. Answer: B

Total 145,000

Rent 48,000

Salaries 17,000

Utilities 5,400

. Answer: A

PV of salvage value (70,000 x 0.108) 3,240

PV of working capital return (7,500 x 0.108) 810

Total 606,150

Investment:

Remodeling cost 550,000

Working capital 7,500 557,500

Net Present Value 48,650

. Answer: B

PV of salvage value 1,296

PV of working capital return 432

Total 364,103

Investment:

Remodeling cost 290,000

Working capital 4,000 294,000

Net Present Value 70,103

. Answer: A

Total 118,000

PV of annual cash inflow (38,000 x 5,575) 211,850

Total 213,578

Investment 294,000

. Answer: D

The annual cost of advertising can be easily calculated by dividing the net present value of alternative 2, at

16% by the present value of annuity of 1.

. Answer: A

Fixed expenses

Advertising 40,000

Salaries 110,000

Utilities 5,200

. Answer: A

. Answer: A

52,500 420,000 = 12.50 %

. Answer: B

Savings 56,250

Less Depreciation 234000 13 years 18,000

Annual income 38,250

Simple Annual Return 38,250 225,000 17 %

. Answer: C

420,000 84,000 = 5 years

. Answer: A

. Answer: C

Total 2,560,000

. Answer: C

Cost to make:

Decrease in directs labor and variable costs 80,000 x 1.60 (128,000) 664,000

. Answer: A

PV of annual depreciation

Year 1 832,500 0.89286 743,305.95

2 112,500 0.79719 886,873.88

3 370,000 0.71178 263,358.60

4 185,000 0.63552 117,571.20

Total 2,011,109.63

Tax rate 0.30

PV of tax benefits from depreciation 603,332.89

. Answer: C

. Answer: C

PV of working capital return 60,000 x 0.63552 38,131

Investment (2528,500)

Net present value 147,522

. Answer: A

. Answer: A

Freight 11,000

Total 960,000

. Answer: B

Total 5,465,000

Total P20.00

. Answer: A

2007 P319,968 P127,987 0.893 P114,292

Total P308,920

. Answer: C

Purchase Cost

Year ATCF

Total 4,243,500

. Answer: A

. Answer: D

2006 Initial outflow (P956,600)

2007 (50,000 x 20) + 45,000 1,045,00

(1,045,000 x 0.6) - (319,968 x 0.4) 0 499,013 0.893 445,619

2008 (1,045,000 x 0.6) (426,720 x 0.4) 456,312 0.797 363,681

2009 (52,000 x 20) + 45,000 1,085,00

(1,085,000 x 0.6) (142,176 x 0.4) 0 594.130 0.712 423,021

(1,145,000 x 0.6) (71,136) 0 658,546 0.636 418,835

2011 (55,000 x 20) + 45,000 1,145,00

(1,145,000 x 0.6) 0 687,000 0.567 385,447

Salvage value (12,000 x 0.6) 7,200

P2,993,203

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