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MODULE 9 C. higher the cost of capital is.

CAPITAL BUDGETING D. higher the discount rate is.


9. Cost of capital is the
THEORIES: A. amount the company must pay for its plant assets.
Basic Concepts B. dividends a company must pay on its equity securities.
Decision Making Process C. cost the company must incur to obtain its capital resources.
2. The first step in the decision-making process is to D. cost the company is charged by investment bankers who handle the
A. determine and evaluate possible courses of action. issuance of equity or long-term debt securities.
B. identify the problem and assign responsibility. 14. How should the following projects be listed in order of increasing risk?
C. make a decision. A. New venture, replacement, expansion.
D. review results of the decision. B. Replacement, new venture, expansion.
Strategic planning C. Replacement, expansion, new venture.
39. Strategic planning is the process of deciding on an organization D. Expansion, replacement, new venture.
A. minor programs and the approximate resources to be devoted to them 41. Problems associated with justifying investments in high-tech projects
B. major programs and the approximate resources to be devoted to them often include discount rates that are too
C. minor programs prior to consideration of resources that might be needed A. low and time horizons that are too long
D. major programs prior to consideration of resources that might be needed B. high and time horizons that are too long
Capital budgeting defined C. high and time horizons that are too short
1. The long-term planning process for making and financing investments that D. low and time horizons that are too short
affect a companys financial results over a number of years is referred to as 60. In evaluating high-tech projects,
A. capital budgeting C. master budgeting A. only tangible benefits should be considered.
B. strategic planning D. long-range planning B. only intangible benefits should be considered.
3. Capital budgeting is the process C. both tangible and intangible benefits should be considered.
A. used in sell or process further decisions. D. neither tangible nor intangible benefits should be considered.
B. of determining how much capital stock to issue Types of capital projects
C. of making capital expenditure decisions 4. A project that when accepted or rejected will not affect the cash flows of
D. of eliminating unprofitable product line another project.
5. A capital investment decision is essentially a decision to: A. Independent projects C. Mutually exclusive projects
A. exchange current assets for current liabilities. B. Dependent projects D. Both b and c
B. exchange current cash outflows for the receiving future cash inflows. Capital budgeting process
C. exchange current cash flow from operating activities for future cash 7. The normal methods of analyzing investments
inflows from investing activities. A. cannot be used by not-for-profit entities.
D. exchange current cash inflows for future cash outflows. B. do not apply if the project will not produce revenues.
Risk & return C. cannot be used if the company plans to finance the project with funds
6. The higher the risk element in a project, the already available internally.
A. more attractive the investment is. D. require forecasts of cash flows expected from the project.
B. higher the net present value is. Investments
Sale of old asset B. Decrease the cost of the investment and decrease cash flows at the end
38. When disposing of an old asset and replacing it with a new one, tax of the projects life.
effect on C. Decrease the cost of the investment.
A. gain on sale of the old asset reduces the basis of the new asset D. Decrease the cost of the investment and increase the cash flow at the
B. gain on sale of the old asset increases the basis of the new asset end of the projects life.
C. loss on sale of the old asset reduces the basis of the new asset Relevant cash flows
D. b and c 72. Which of the following represents the biggest challenge in the decision to
Working capital purchase new equipment?
18. A major difference between an investment in working capital and one in A. Estimating employee training for the new project.
depreciable assets is that B. Estimating cash flows for the future.
A. an investment in working capital is never returned, while most depreciable C. Estimating transportation costs of the new equipment.
assets have some residual value. D. Estimating maintenance costs for the new equipment.
B. an investment in working capital is returned in full at the end of a projects 51. When a firm has the opportunity to add a project that will utilize factory
life, while an investment in depreciable assets has no residual value. capacity that is currently not being used, which costs should be used to
C. an investment in working capital is not tax-deductible when made, nor determine if the added project should be undertaken?
taxable when returned, while an investment in depreciable assets does allow A. Opportunity costs C. Net present costs
tax deductions. B. Historical costs D. Incremental costs
D. because an investment in working capital is usually returned in full at the 11. The only future costs that are relevant to deciding whether to accept an
end of the projects life, it is ignored in computing the amount of the investment are those that will
investment required for the project. A. be different if the project is accepted rather than rejected.
30. The proper treatment of an investment in receivables and inventory is to B. be saved if the project is accepted rather than rejected.
A. ignore it C. be deductible for tax purposes.
B. add it to the required investment in fixed assets D. affect net income in the period that they are incurred.
C. add it to the required investment in fixed assets and subtract it from the Cash inflow
annual cash flows 66. Which of the following is not a typical cash inflow in capital investment
D. add it to the investment in fixed assets and add the present value of the decisions?
recovery to the present value of the annual cash flows A. Incremental revenues C. Salvage value
31. In connection with a capital budgeting project, an investment in working B. Cost reductions D. Additional working capital
capital is normally recovered Out-of-pocket costs
A. at the end of the projects life 45. Which of the following is a cost that requires a future outlay of cash that
B. in the first year of the projects life is which relevant for future decision-making?
C. evenly through the projects life A. Opportunity cost C. Sunk costs
D. when the company goes out of businessA B. Out-of-pocket cost D. Relevant benefits
32. XYZ Co. is adopting just-in-time principles. When evaluating an Depreciation & Tax
investment project that would reduce inventory, how should XYZ treat the 22. If there were no income taxes,
reduction? A. depreciation would be ignored in capital budgeting.
A. Ignore it. B. the NPV method would not work.
C. income would be discounted instead of cash flow. B. show the loan as an increase in the investment.
D. all potential investments would be desirable. C. show the loan as a cash outflow in the second year of the projects life.
21. Relevant cash flows for net present value (NPV) models include all of D. ignore the loan
the following except Sunk cost
A. outflows to purchase new equipment 29. In deciding whether to replace a machine, which of the following is NOT
B. depreciation expense on the newly acquired piece of equipment a sunk cost?
C. reductions in operating cash flows as a result of using the new A. The expected resale price of the existing machine.
equipment. B. The book value of the existing machine.
D. cash outflows related to purchasing additional inventories for another C. The original cost of the existing machine.
retail store. D. The depreciated cost of the existing machine.
55. When evaluating depreciation methods, managers who are concerned Accounting rate of return
about capital investment decisions will: 54. The primary advantages of the average rate of return method are its
A. choose straight line depreciation so there is minimum impact on the ease of computation and the fact that:
decision. A. It is especially useful to managers whose primary concern is liquidity
B. use units of production so more depreciation expense will be allocated to B. There is less possibility of loss from changes in economic conditions and
the later years. obsolescence when the commitment is short-term
C. use accelerated methods to have as much depreciation in the early years C. It emphasizes the amount of income earned over the life of the proposal
of an assets life. D. Rankings of proposals are necessary
D. choice of depreciation method has no impact on the capital investment Nondiscounted cash flow method
decision. Payback method
70. The tax consequences should be considered under which circumstances 36. There are several capital budgeting decision models that do not use
when making capital investment decisions? discounted cash flows. What is the name of the simple technique that
A. Positive net income C. Depreciation calculates the total time it will take to recover, using cash inflows from
B. Disposal of an asset D. All of the above operations, the amount of cash invested in a project?
Irrelevant cash flows A. Recovery period C. External rate of return
Loan financing B. Payback model D. Accounting rate of return
43. In addition to incremental revenues, cash inflows from capital 34. The technique most concerned with liquidity is
investments can be generated from all of the following sources except: A. Payback method.
A. debt financing B. Net present value technique.
B. cost savings C. Internal rate of return.
C. salvage value D. book rate of return.
D. reduction in the amount of working capital 73. Which of the following is a potential use of the payback method?
10. If Helena Company expects to get a one-year bank loan to help cover A. Help managers control the risks of estimating cash flows
the initial financing of one of its capital projects, the analysis of the project B. Help minimize the impact of the investment on liquidity
should C. Help control the risk of obsolescence
A. offset the loan against any investment in inventory or receivables required D. All of the answers are correct
by the project. 47. The cash payback technique:
A. should be used as a final screening tool. on cash flows for each option and then converts these total cash flows to
B. can be the only basis for the capital budgeting decision. their present values is called the
C. is relatively easy to compute and understand. A. differential approach C. contribution approach
D. considers the expected profitability of a project. B. incremental approach. D. total project approach.
33. Which of the following is NOT a defect of the payback method? 40. The discount rate commonly used in present value calculations is the
A. It ignores cash flows because it uses net income. A. treasury bill rate
B. It ignores profitability. B. weighted average return on assets adjusted for risk
C. It ignores the present values of cash flows. C. risk free rate plus inflation rate
D. It ignores the pattern of cash flows beyond the payback period. D. shareholders expected return on equity
48. The payback method, as a capital budgeting technique, assumes that all 44. Which is true of the net present value method of determining the
intermediate cash inflows are reinvested to yield a return equal to: acceptability of an investment?
A. Zero C. The Discount Rate A. The initial cost of the investment is subtracted from the present value of
B. The Time-Adjusted-Rate-of-Return D. The Cost-of-Capital net cash flows
52. Which of the following capital budgeting methods is the least B. The net cash flows are not adjusted to present value
theoretically correct? C. A negative net present value indicates the investment should be
A. payback method C. internal rate of return undertaken
B. net present value D. none of the above D. The net present value method requires no subjective judgments
Discounted cash flow method Profitability index
49. Which of the following methods of evaluating capital investment projects 35. The profitability index
incorporates the time value of money? A. does not take into account the discounted cash flows.
A. Payback period, accounting rate of return, and internal rate of return B. Is calculated by dividing total cash flows by the initial investment.
B. Accounting rate of return, net present value, and internal rate of return C. allows comparison of the relative desirability of projects that require
C. Payback period and accounting rate of return differing initial investments.
D. Net present value and internal rate of return D. will never be greater than 1.0.
Net present value Internal rate of return
69. Discounted cash flow analysis is used in which of the following 56. According to the reinvestment rate assumption, which method of capital
techniques? budgeting assumes cash flows are reinvested at the projects rate of return?
A. Net present value C. Cost of capital A. payback period C. internal rate of return
B. Payback period D. All of the above B. net present value D. none of the above
8. The primary capital budgeting method that uses discounted cash flow 62. The rate of interest that produces a zero net present value when a
techniques is the projects discounted cash operating advantage is netted against its
A. net present value method. discounted net investment is the:
B. cash payback technique. A. Cost of capital C. Cutoff rate
C. annual rate of return method. B. Discount rate D. Internal rate of return
D. profitability index method. 57. A weakness of the internal rate of return method for screening
20. The net present value (NPV) model can be used to evaluate and rank investment projects is that it:
two or more proposed projects. The approach that computes the total impact A. Does not consider the time value of money
B. Implicitly assumes that the company is able to reinvest cash flows from Sensitivity analysis
the project at the companys discount rate 13. In capital budgeting, sensitivity analysis is used
C. Implicitly assumes that the company is able to reinvest cash flows from A. to determine whether an investment is profitable.
the project at the internal rate of return B. to see how a decision would be affected by changes in variables.
D. Fails to consider the timing of cash flows C. to test the relationship of the IRR and NPV.
Comprehensive D. to evaluate mutually exclusive investments.
50. Which of the following methods of evaluating capital investment projects 15. An approach that uses a number of outcome estimates to get a sense of
do not use a percentage as a measurement unit? the variability among potential returns is
A. Payback period and net present value A. the discounted cash flow technique.
B. Accounting rate of return and payback period B. the net present value method.
C. Net present value and internal rate of return C. risk analysis.
D. Internal rate of return and payback period D. sensitivity analysis.
Relationships among NPV, PI & IRR 42. Sensitivity analysis is the study of how the outcome of a decision making
24. If a companys required rate of return is 12 percent and in using the process
profitability index method, a projects index is greater than 1.0, this indicates A. changes as one or more of the assumptions change
that the projects rate of return is B. remains the same even though one or more of the assumptions change
A. equal to 12 percent. C. less than 12 percent. C. changes even though one or more of the assumptions do not change
B. greater than 12 percent. D. dependent on the size of the investment. D. does not change as the assumptions do not change either
25. If the present value of the future cash flows for an investment 64. Sensitivity analysis is:
equals the required investment, the IRR is A. An appropriate response to uncertainty in cash flow projections
A. equal to the cutoff rate. B. Useful in measuring the variance of the Fisher rate
B. equal to the cost of borrowed capital. C. Typically conducted in the post investment audit
C. equal to zero. D. Useful to compare projects requiring vastly different levels of initial
D. lower than the companys cutoff rate return. investment
27. The relationship between payback period and IRR is that IRR = 0
A. a payback period of less than one-half the life of a project will yield an 58. if the internal rate of return on an investment is zero:
IRR lower than the target rate. A. its NPV is positive.
B. the payback period is the present value factor for the IRR. B. its annual cash flows equal its required investment.
C. a project whose payback period does not meet the companys cutoff rate C. it is generally a wise investment.
for payback will not meet the companys criterion for IRR. D. its cash flows decrease over its life.
D. none of the above. Change in NPV
67. When comparing NPV and IRR, which is not true? 59. Which of the following would decrease the net present value of a
A. With NPV, the discount rate can be adjusted to take into account project?
increased risk and the uncertainty of cash flows A. A decrease in the income tax rate
B. With IRR, cash flows can be adjusted to account for risk B. A decrease in the initial investment
C. NPV can be used to compare investments of various size or magnitude C. An increase in the useful life of the project
D. Both NPV and IRR can be used for screening decisions D. An increase in the discount rate
Effect of change in cost of capital D. The proposal is undesirable and the rate of return expected from the
26. All other things being equal, as cost of capital increases proposal exceeds the minimum rate used for the analysis
A. more capital projects will probably be acceptable. 63. NPV indicates a project is deemed desirable, when the NPV is
B. fewer capital projects will probably be acceptable. A. greater than or equal to zero
C. the number of capital projects that are acceptable will change, but the B. less than zero
direction of the change is not determinable just by knowing the direction of C. greater than or equal to the risk-adjusted cost of capital
the change in cost of capital. D. less than or equal to the risk-adjusted cost of capital
D. the company will probably want to borrow money rather than issue stock. Internal rate of return
Effect of change in residual value 12. If Arbitrary Company wants to use IRR to evaluate long-term decisions
23. Assuming that a project has already been evaluated using the following and to establish a cutoff rate of return, it must be sure that the cutoff rate is
techniques, the evaluation under which technique is least likely to be A. at least equal to its cost of capital.
affected by an increase in the estimated residual value of the project? B. at least equal to the rate used by similar companies.
A. Payback Period. C. Net Present Value. C. greater than the IRR on projects accepted in the past.
B. Internal Rate of Return. D. Profitability Index. D. greater than the current book rate of return.
Decision rules independent projects NPV & IRR
68. What type of decision involves deciding if an investment meets a 19. The NPV and IRR methods give
predetermined standard? A. the same decision (accept or reject) for any single investment.
A. Investment decisions C. Management decisions B. the same choice from among mutually exclusive investments.
B. Screening decisions D. Preference decisions C. different rankings of projects with unequal lives.
Payback period D. the same rankings of projects with different required investments.
46. If a payback period for a project is greater than its expected useful life, Decision rule mutually exclusive projects
A. project will always be profitable. 71. Mutually exclusive projects are those that:
B. entire initial investment will not be recovered. A. if accepted, preclude the acceptance of competing projects.
C. project would only be acceptable if the companys cost of capital was low. B. if accepted, can have a negative effect on the companys profit.
D. projects return will always exceed the companys cost of capital. C. if accepted, can also lead to the acceptance of a competing project.
Net present value D. require all managers to consider.
61. An analysis of a proposal by the net present value method indicated that 28. In choosing from among mutually exclusive investments the manager
the present value of future cash inflows exceeded the amount to be should normally select the one with the highest
invested. Which of the following statements best describes the results of A. Net present value. C. Profitability index.
this analysis? B. Internal rate return. D. Book rate of return.
A. The proposal is desirable and the rate of return expected from the 53. Why do the NPV method and the IRR method sometimes produce
proposal exceeds the minimum rate used for the analysis different rankings of mutually exclusive investment projects?
B. The proposal is desirable and the rate of return expected from the A. The NPV method does not assume reinvestment of cash flows while the
proposal is less than the minimum rate used for the analysis IRR method assumes the cash flows will be reinvested at the IRR.
C. The proposal is undesirable and the rate of return expected from the B. The NPV method assumes a reinvestment rate equal to the discount rate
proposal is less than the minimum rate used for the analysis while the IRR method assumes a reinvestment rate equal to the IRR.
C. The IRR method does not assume reinvestment of the cash flows while useful life with P25,000 depreciation each year. The old equipment can be
the NPV assumes the reinvestment rate is equal to the discount rate. sold at P80,000. The new equipment costs P160,000, have a 4-year life.
D. The NPV method assumes a reinvestment rate equal to the bank loan Cash savings on operating expenses before 40% taxes amount to P50,000
interest rate while the IRR method assumes a reinvestment rate equal to the per year. What is the amount of investment in the new equipment?
discount rate. A. P160,000 C. P 80,000
Post-audit B. P 72,000 D. P 68,000
16. Post-audit of capital projects Operating Cash Flow
A. is usually conclusive. Cash Flow Before tax
B. is done using different evaluation techniques than were used in making 2. Taal Company is considering the purchase of a machine that promises to
the original capital budgeting decision. reduce operating costs by equal amounts every year of its 6-year useful life.
C. provides a formal mechanism by which the company can determine The machine will cost P840,000 and has no salvage value. The machine
whether existing projects should be supported or terminated. has a 20% internal rate of return. Taal Company is subject to 40% income
D. all of the above. tax rate. The present value of 1 for 6 periods at 20% is 3.326, and at the
17. A thorough evaluation of how well a projects actual performance end of 6 periods is 0.3349.
matches the projections made when the project was proposed is called a The approximate annual cash savings before tax is closest to:
A. pre-audit. C. sensitivity analysis. A. P252,555 C. P187,592
B. post-audit. D. risk analysis. B. P112,555 D. P327,592
37. A follow-up evaluation of a capital project is performed to see that Increase in Annual Income Tax
investment expenditures are proceeding on time and on budget, to compare 3. Mayon Company is considering replacing its old machine with a new and
actual cash flows with those originally predicted, and to evaluate more efficient one. The old machine has book value of P100,000, a
continuation of the project. This follow-up is called a remaining useful life of 4 years, and annual straight-line depreciation of
A. post-audit. C. management audit P25,000. The existing machine has a current market value of P80,000. The
B. performance evaluation D. project review replacement machine would cost P160,000, have a 4-year life, and will save
65. Companies use post audits to: P50,000 per year in cash operating costs. If the replacement machine would
A. chastise managers whose project does not exceed projections. be depreciated using the straight-line method and the tax rate is 40%, what
B. prove to managers that they should have accepted projects they should be the increase in annual income taxes?
previously rejected. A. P14,000 C. P40,000
C. have the managers revise poorly performing projects so the projects will B. P28,000 D. P 4,000
have larger return in the future. Depreciation & Taxes
D. provide feedback that enables managers to improve the accuracy 4. Prime Consulting, Inc. operates consulting offices in Manila, Olongapo,
of the projections of future cash flows, thereby maximizing the quality of the and Cebu. The firm is presently considering an investment in a new
firms capital investments. mainframe computer and communication software. The computer would
cost P6 million and have an expected life of 8 years. For tax purposes, the
PROBLEMS: computer can be depreciated using either straight-line method or Sum-of-
Net Investment the-Years-Digits (SYD) method over five years. No salvage value is
1. Bruell Company is considering to replace its old equipment with a new recognized in computing depreciation expense and no salvage value is
one. The old equipment had a net book value of P100,000, 4 remaining expected at the end of the life of the equipment. The companys cost of
capital is 10 percent and its tax rate is 40 percent. The present value of Had Maleen used straight-line method of depreciation instead of declining
annuity of 1 for 5 periods is 3.791 and for 8 periods is 5.335. The present method, what is the difference in net present value provided by the machine
values of 1 end of each period are: at a discount rate of 12 percent?
1 0.9091 5 0.6209 A. Increase of P 9,750 C. Decrease of P24,376
2 0.8264 6 0.5645 B. Decrease of P 9,750 D. Increase of P24,376
3 0.6513 7 0.5132 Accounting rate of return
4 0.6830 8 0.4665 Based on initial investment
The present value of the net advantage of using SYD method of 6. A piece of labor saving equipment that Marubeni Electronics Company
depreciation with a five-year life instead of straight-line method of could use to reduce costs in one of its plants in Angeles City has just come
depreciating the equipment is: onto the market. Relevant data relating to the equipment follow:
A. P 86,224 C. P215,560 Purchase cost of the equipment P432,000
B. P115,168 D. P287,893 Annual cost savings that will be provided by the equipment 90,000
5. For P450,000, Maleen Corporation purchased a new machine with an Life of the equipment 12 years
estimated useful life of five years with no salvage value. The machine is What is the simple rate of return to be provided by the equipment?
expected to produce cash flow from operations, net of 40 percent income A. Between 15% and 18%. C. 20.83%.
taxes, as follows: B. 25.00%. D. 12.50%.
First year P160,000 Based on average investment
Second year 140,000 7. The BIBO Company has made an investment in video and recording
Third year 180,000 equipment that costs P106,700. The equipment is expected to generate
Fourth year 120,000 cash inflows of P20,000 per year. How many years will the equipment have
Fifth year 100,000 to be used to provide the company with a 10 percent average accounting
Maleen will use the sum-of-the-years-digits method to depreciate the new rate of return on its investment?
machine as follows: A. 7.28 years C. 9.05 years
First year P150,000 B. 5.55 years D. 4.75 years
Second year 120,000 8. Show Company is negotiating to purchase an equipment that would cost
Third year 90,000 P200,000, with the expectation that P40,000 per year could be saved in
Fourth year 60,000 after-tax cash operating costs if the equipment were acquired. The
Fifth year 30,000 equipments estimated useful life is 10 years, with no salvage value, and
The present value of 1 for 5 periods at 12 percent is 3.60478. The present would be depreciated by the straight-line method. Show Companys
values of 1 at 12 percent at end of each period are: minimum desired rate of return is 12 percent. The present value of an
End of: annuity of 1 at 12 percent for 10 periods is 5.65. The present value of 1 due
Period 1 0.89280 in 10 periods, at 12 percent, is 0.322. The average accrual accounting rate
Period 2 0.79719 of return (ARR) during the first year of assets use is:
Period 3 0.71178 A. 20.0 percent C. 10.0 percent
Period 4 0.63552 B. 10.5 percent D. 40.0 percent
Period 5 0.56743 9. An asset was purchased for P66,000. The asset is expected to last for 6
years and will have a salvage value of P16,000. The company expects the
income before tax to be P7,200 and the tax rate applicable to the company A. 8 years C. 6 years
is 30%. What is the average return on investment (accounting rate of B. 7 years D. 5 years
return)? 14. Consider a project that requires cash outflow of P50,000 with a life of
A. 17.6% C. 10.9% eight years and a salvage value of P5,000. Annual before-tax cash inflow
B. 7.6% D. 12.3% amounts to P10,000 assuming a tax rate of 30% and a required rate of
Net Investment return of 8%. Salvage value is ignored in computing depreciation. The
10. The Makabayan Company is planning to purchase a new machine which project has a payback period of
it will depreciate, for book purposes, on a straight-line basis over a ten-year A. 5.0 years C. 6.0 years
period with no salvage value and a full years depreciation taken in the year B. 5.6 years D. 6.6 years
of acquisition. The new machine is expected to produce cash flows from 15. The following incomplete information is provided for an investment
operations, net of income taxes, of P66,000 a year in each of the next ten decision.
years. The accounting (book value) rate of return on the initial investment is Discount Discounted Cumulative Cash
expected to be 12 percent. How much will the new machine cost? Year Cash Flow Factor (10%) Cash Flows Flows
A. P300,000 C. P550,000 0 P(450,000) 1.000 P(450,000) P(450,000)
B. P660,000 D. P792,000 1 280,000 .909 254,520
11. The Fields Company is planning to purchase a new machine which it will 2 210,000 .826
depreciate, for book purposes, on a straight-line basis over a ten-year period 3 140,000 .751
with no salvage value and a full years depreciation taken in the year of Using break-even time (BET) analysis, when will the investment be
acquisition. The new machine is expected to produce cash flow from recovered?
operations, net of income taxes, of P66,000 a year in each of the next ten A. In 2.73 years C. At the end of year 2
years. The accounting (book value) rate of return on the initial investment is B. Longer than three years D. In 2.21 years
expected to be 12%. How much will the new machine cost? 16. Orlando Corporation is considering an investment in a new cheese-
A. P300,000 C. P660,000 cutting machine to replace its existing cheese cutter. Information on the
B. P550,000 D. P792,000 existing machine and the replacement machine follow:
CFAT Cost of the new machine P400,000
12. The Hills Company, a calendar company, purchased a new machine for Net annual savings in operating costs 90,000
P280,000 on January 1. Depreciation for tax purposes will be P35,000 Salvage value now of the old machine 60,000
annually for eight years. The accounting (book value) rate of return (ARR) is Salvage value of the old machine in 8 years 0
expected to be 15% on the initial increase in required investment. On the Salvage value of the new machine in 8 years 50,000
assumption of a uniform cash inflow, this investment is expected to provide Estimated life of the new machine 8 years
annual cash flow from operations, net of income taxes, of What is the expected payback period for the new machine?
A. P35,000 C. P42,000 A. 4.44 years C. 2.67 years
B. P40,250 D. P77,000 B. 8.50 years D. 3.78 years
Payback Period 17. For P4,500,000, Siniloan Corporation purchased a new machine with an
13. If an asset costs P35,000 and is expected to have a P5,000 salvage estimated useful life of five years with no salvage value at its retirement. The
value at the end of its ten-year life, and generates annual net cash inflows of
P5,000 each year, the cash payback period is
machine is expected to produce cash flow from operations, net of income Depreciation 35,000
taxes, as follows: Maintenance 18,000 160,000
First year P 900,000 Net income P 40,000
Second year 1,200,000 Ignoring the effect of income taxes, the payback period for the pinball
Third year 1,500,000 machines would be
Fourth year 900,000 A. 3.73 years C. 4.0 years
Fifth year 800,000 B. 3.23 years D. 7.5 years
Siniloan will use the sum-of-the-years-digits method to depreciate the new Net Present Value
machine as follows: 20. It is the start of the year and Agudelo Company plans to replace its old
First year P1,500,000 grinding equipment. The following information are made available by the
Second year 1,200,000 management:
Third year 900,000 Old New
Fourth year 600,000 Equipment cost P70,000 P120,000
Fifth year 300,000 Current salvage value 14,000 -
What is the payback period for the machine? Salvage value, end of useful life 5,000 16,000
A. 3 years C. 5 years Annual operating costs 44,000 32,000
B. 4 years D. 2 years Accumulated depreciation 55,300 -
18. Paz Insurance Companys management is considering an advertising Estimated useful life 10 years 10 years
program that would require an initial expenditure of P165,500 and bring in The company is not subject to tax and its cost of capital is 12%. What is the
additional sales over the next five years. The cost of advertising is present value of all the relevant cash flows at time zero?
immediately recognized as expense. The projected additional sales revenue A. (P 54,000) C. (P106,000)
in Year 1 is P75,000, with associated expenses of P25,000. The additional B. (P120,000) D. (P124,700)
sales revenue and expenses from the advertising program are projected to 21. Consider a project that requires an initial cash outflow of P500,000 with
increase by 10 percent each year. Paz Insurance Companys tax rate is 40 a life of eight years and a salvage value of P20,000 upon its retirement.
percent. The payback period for the advertising program is Annual cash inflow before tax amounts to P100,000 and a tax rate of 30
A. 4.6 years C. 3.0 years percent will be applicable. The required minimum rate of return for this type
B. 1.9 years D. 2.5 years of investment is 8 percent. The present value of 1 and the annuity of 1,
19. The Leisure Company is considering the purchase of electronic pinball discounted at 8 percent for 8 periods are 0.54 and 5.747, respectively.
machines to place in amusement houses. The machines would cost a total Salvage value is ignored in computing depreciation. The net present value
of P300,000, have an eight-year useful life, and have a total salvage value of amounts to
P20,000. Based on experience with other equipment, the company A. P 7,560 C. P 17,606
estimates that annual revenues and expenses associated with the machines B. P 10,050 D. P 20,050
would be as follows: 22. Zap Manufacturing has an investment opportunity to embark on a project
Revenues form use P200,000 where yearly revenues for five years are to be P400,000 and operating costs
Less operating expenses of P104,800. The equipment costs P1 million, and straight-line depreciation
Commissions to amusement houses P100,000 will be used for book and tax purposes. No salvage value is expected at the
Insurance 7,000
end of the projects life. The company has a 40 percent marginal tax rate 12 percent at the end of 5 periods is 0.56743 and the present value of an
and a 10 percent cost of capital. The equipment manufacturer has offered a annuity of 1 for 5 periods is 3.60478. Which of the following is true?
delayed payment plan of P560,500 per year at the end of the first and A. The present value of cash flows in year 5 is P22,710
second years. There will be no changes in working capital. B. NPV is P28,436
The present value of annuity of 1 for 5 periods is 3.7908 at 10 percent. C. NPV is P15,250
The present values of 1 end of each period at 10 percent are: D. NPV is P14,186
Period 1 0.9091 25. Tabucol Aggregates, Inc. plans to replace one of its machines with a
Period 2 0.8264 new efficient one. The old machine has a net book value of P120,000 with
Period 3 0.7513 remaining economic life of 4 years. This old machine can be sold for
Period 4 0.6830 P80,000. If the new machine were acquired, the cash operating expenses
Period 5 0.6209 will be reduced from P240,000 to P160,000 for each of the four years, the
The net present value if the equipment were purchased is expected economic life of the new machine. The new machine will cost
A. P (87,977) C. P 1,922 Tabucol a cash payment to the dealer of P300,000. The company is subject
B. P (25,310) D. P (61,094) to 32 percent tax and for this kind of investment, a marginal cost of capital of
23. Paz Insurance Companys management is considering an advertising 9 percent. The present value of annuity of 1 and the present value of 1 for 4
program that would require an initial expenditure of P165,500 and bring in periods using 9 percent are 3.23972 and 0.70843, respectively.The net
additional sales over the next five years. The cost of advertising is present value to be provided by the replacement of the old machine is
immediately recognized as expense. The projected additional sales revenue A. P28,493 C. P46,794
in Year 1 is P75,000, with associated expenses of P25,000. The additional B. P15,693 D. P59,594
sales revenue and expenses from the advertising program are projected to 26. Zambales Mines, Inc. is contemplating the purchase of equipment to
increase by 10 percent each year. Paz Insurance Companys tax rate is 40 exploit a mineral deposit that is located on land to which the company has
percent.The present value of 1 at 10 percent, end of each period: mineral rights. An engineering and cost analysis has been made, and it is
Period Present value of 1 expected that the following cash flows would be associated with opening
1 0.90909 and operating a mine in the area.
2 0.82645 Cost of new equipment and timbers 2,750,000
3 0.75131 Working capital required 1,000,000
4 0.68301 Net annual cash receipts* 1,200,000
5 0.62092 Cost to construct new road in three years 400,000
The net present value of the advertising program would be Salvage value of equipment in 4 years 650,000
A. P 37,064 C. P 29,136 *Receipts from sales of ore, less out-of-pocket costs for salaries, utilities,
B. P(37,064) D. P(29,136) insurance, etc.It is estimated that the mineral deposit would be exhausted
24. Mario Hernandez plans to buy a haymaker. It costs P175,000 and is after four years of mining. At that point, the working capital would be
expected to last for five years. He presently hires 6 workers at P10,000 per released for reinvestment elsewhere. The companys discount rate is 20%.
month for each of the three harvesting months each year. The equipment The net present value for the project is:
would eliminate the need for two workers. Hernandez uses straight-line A. P 454,620. C. P(561,553)
depreciation and projects a salvage value of P25,000. His tax rate is 25% B. P (79,303). D. P(204,688).
and opportunity cost of funds is 12.0%. The present value of 1discounted at With inflation
27. By the end of December 31, 2005, Alay Foundation is considering the expenses:
purchase of a copying machine for P80,000. The expected annual cash Variable cost per dozen P0.38 P0.29
savings are expected to be P32,000 in the next four years. At the end of the Total fixed costs P21,000 P 11,000
four years, the machine will be discarded without any salvage value. All the Estimated cash value of machines:
cash savings are stated in number of pesos at December 31, 2006. The December 31, 2006 P40,000 P120,000
company expected that the inflation rate is constantly 5 percent each year. December 31, 2012 P 7,000 P 20,000
Hence, the first years cash inflow was adjusted for 5 percent inflation. For Assume all operating revenues and expenses occur at the end of the year.
simplicity, all cash inflows are assumed to be at year-end. The net advantage in present value of the better alternative is:
The present value at 14 % of 1 for 4 periods is 2.91371. The present value A. Retain Old Machine, P61,675.
of 1 at end of each period are: B. Buy New Machine, P61,675.
Period 1 0.87719 C. Retain Old Machine, P16,345.
Period 2 0.76947 D. Buy New Machine, P16,345.
Period 3 0.67497 Profitability index
Period 4 0.59208 29. The Pambansang Kamao Corporation has to replace its completely
Using the nominal rate of return of 14 percent, the net present value for this damaged boiler machine with a new one. The old machine has a net book
machine is value of P100,000 with zero market value; therefore it will give a tax shield,
A. P12,239 C. P13,419 based on 35% tax rate if replaced, by P35,000. The company has a 10
B. P19,670 D. P27,936 percent cost of capital. Understandably, the new machine, through a
28. Perpetual Foundation, Inc., a nonprofit organization, has one of its uniform decrease in cash operating costs, will give a positive net present
activities, the production of cookies for its snack food store. Several years value, because this machine will provide an internal rate of return of 12%.
ago, Perpetual Foundation, Inc. purchased a special cookie-cutting machine. The present values at 10% and 12%, respectively, are:
As of December 31, 2006, this machine will have been used for three years. 10% 12%
Management is considering the purchase of a newer, more efficient Annuity of 1, 6 periods 4.35526 4.11141
machine. If purchased, the new machine would be acquired on December 1 end of 6 periods 0.56447 0.50663
31, 2006. Management expects to sell 300,000 dozen cookies in each of If the machine were to be depreciated using straight-line method for 6 years
the next six years. The selling price of the cookies is expected to average without any salvage value, the estimated profitability index is:
P1.15 per dozen. A. 1.20
Perpetual Foundation, Inc. has two options: continue to operate the old B. 1.06
machine, or sell the old machine and purchase the new machine. No trade- C. 1.07
in was offered by the seller of the new machine. The following information D. Cannot be determined from the information
has been assembled to help management decide which option is more 30. The Mejicano Company is planning to purchase a piece of equipment
desirable. that will reduce annual cash expenses over its 5-year useful life by equal
Old Machine New Machine amounts. The company will depreciate the equipment using straight-line
Original cost of machine at acquisition P80,000 P120,000 method of depreciation based on estimated life of 5 years without any
Remaining useful life as of 12/31/06 6 years 6 years salvage value. The company is subject to 40 percent tax. The marginal
Expected annual cash operating cost of capital for this acquisition is 11.055 percent. The management
accountant calculated that the internal rate of return based on the estimated A. P10,640 C. P22,750
after-tax cash flows is 12.386 percent and a net present value of P10,000. B. P29,510 D. P26,130
The president, however, wants to know the profitability index before he 34. The Forest Company is planning to invest in a machine with a useful life
finally decides. of five years and no salvage value. The machine is expected to produce
What is the profitability index for this investment? cash flow from operations, net of income taxes, of P20,000 in each of the
A. 1.011 C. 1.022 five years. Forests expected rate of return is 10%. Information on present
B. 1.034 D. 1.044 value and future amount factors is as follows:
Internal Rate of Return PERIOD
31. Diamond Company is planning to buy a coin-operated machine costing 1 2 3 4 5
P400,000. For book and tax purposes, this machine will be depreciated Present value of P1 at 10% .909 .826 .751 .683 .621
P80,000 each year for five years. Diamond estimates that this machine will Present value of an annuity of P1 at 10% .909 1.736 2.487 3.170 3.791
yield an annual inflow, net of depreciation and income taxes, of P120,000. Future amount of P1 at 10% 1.100 1.210 1.331 1.464 1.611
Diamonds desired rate of return on its investments is 12%. At the following Future amount of an annuity of P1 at 10% 1.00 2.100 3.310 4.641 6.105
discount rates, the NPVs of the investment in this machine are: How much will the machine cost?
Discount Rate NPV A. P 32,220 C. P 75,820
12% +P3,258 B. P 62,100 D. P122,100
14% + 1,197 Required unit sales
16% - 708 35. Paper Products Company is considering a new product that will sell for
18% - 2,474 P100 and has a variable cost of P60. Expected volume is 20,000 units. New
Diamonds expected IRR on its investment in this machine is equipment costing P1,500,000 and having a five-year useful life and no
A. 3.25% C. 16.00% salvage value is needed, and will be depreciated using the straight-line
B. 12.00% D. 15.30% method. The machine has fixed cash operating costs of P200,000 per year.
Required investment The firm is in the 40 percent tax bracket and has cost of capital of 12
32. Kipling Company has invested in a project that has an eight-year life. It is percent. The present value of 1, end of five periods is 0.56743; present
expected that the annual cash inflow from the project will be P20,000. value of annuity of 1 for 5 periods is 3.60478.
Assuming that the project has a internal rate of return of 12%, how much How many units per year the firm must sell for the investment to earn 12
was the initial investment in the project if the present value of annuity of 1 for percent internal rate of return?
8 periods is 4.968 and the present value of 1 is 0.404? A. 17,338 C. 9,838
A. P160,000 C. P 80,800 B. 28,897 D. 12,338
B. P 99,360 D. P 64,640 Required selling price
33. Katol Company invested in a machine with a useful life of six years and 36. Bughaw Products Company is considering a new product that will sell for
no salvage value. The machine was depreciated using the straight-line P100 and has a variable cost of P60. Expected sales volume is 20,000 units.
method. It was expected to produce annual cash inflow from operations, net New equipment costing P1,500,000 with a five-year useful life and no
of income taxes, of P6,000. The present value of an ordinary annuity of P1 terminal salvage value is needed. The machine will be depreciated using the
for six periods at 10% is 4.355. The present value of P1 for six periods at straight-line method. The machine has cash operating costs of P200,000 per
10% is 0.564. Assuming that Katol used a time- adjusted rate of return of year. The firm is in the 40 percent tax bracket and has cost of capital of 12
10%, what was the amount of the original investment?
percent. The present value of 1, end of five periods is 0.56743; present Given the data provided, the minimum amount of annual cash inflows that
value of annuity of 1 for 5 periods is 3.60478. Suppose the 20,000 estimated would provide the 10% time-adjusted return is approximately
sales volume is sound, but the price is in doubt, what is the selling price A. P18,776 C. P24,400
(rounded to nearest peso) needed to earn a 12 % internal rate of return? B. P26,600 D. P22,535
A. P81.00 C. P70.00 Required Increase in CFAT
B. P95.00 D. P90.00 40. The following data pertain to Julian Corp. whose management is
Required CFBT planning to purchase a unit of equipment.
37. Aloha Co. is considering the purchase of a new ocean-going vessel that 1. Economic life of equipment 8 years.
could potentially reduce labor costs of its operation by a considerable 2. Disposal value after 8 years Zero.
margin. The new ship would cost P500,000 and would be fully depreciated 3. Estimated net annual cash inflows for each of the 8 years P81,000.
by the straight-line method over 10 years. At the end of 10 years, the ship 4. Time-adjusted internal rate of return 14%
will have no value and will be sunk in some already polluted harbor. The 5. Cost of capital of Bayan Muna 16%
Aloha Co.s cost of capital is 12 percent, and its marginal tax rate is 40 6. The table of present values of P1 received annually for 8 years has these
percent. If the ship produces equal annual labor cost savings over its 10- factors: at 14% = 4.639, at 16% = 4.344
year life, how much do the annual savings in labor costs need to be to 7. Depreciation is approximately P46,970 annually.
generate a net present value of P0 on the project? Find the required increase in annual cash inflows in order to have the time-
Use the following PV: annuity of 1, 10 periods at 12% - 5.6502; end of 10th adjusted rate of return approximately equal the cost of capital.
period 0.32197. A. P6,501 C. P4,344
A. P 68,492 C. P114,154 B. P5,501 D. P5,871
B. P147,487 D. P 88,492 Required CFAT for a certain year
Required CFAT 41. A company is considering putting up P50,000 in a three-year project.
38. Prudu Company has decided to invest in some new equipment. The The companys expected rate of return is 12%. The present value of P1.00
equipment will have a three-year life and will produce a uniform series of at 12% for one year is 0.893, for two years is 0.797, and for three years is
cash savings. The net present value of the equipment is P1,750, using a 0.712. The cash flow, net of income taxes will be P18,000 (present value of
discount rate of 8 percent. The internal rate of return is 12 percent. P16,074) for the first year and P22,000 (present value of P17,534) for the
Present values at 8% and 12% respectively: second year. Assuming that the rate of return is exactly 12%, the cash flow,
8%: Annuity 2.5771; end of 3 periods, 0.7938 net of income taxes, for the third year would be
12%: Annuity 2,4018; end of 3 periods, 0.7118 A. P23,022 C. P10,000
What is the amount of annual cash inflow? B. P 7,120 D. P16,392
A. P 9,980 C. P23,240 Required salvage value
B. P21,342 D. P12,351 42. The Caravan Company is contemplating to purchase a machine that
39. An asset is purchased for P120,000. It is expected to provide an costs P800,000. The machine is expected to last for 5 years with a salvage
additional P28,000 of annual net cash inflows.The asset has a 10-year life value of P50,000 at the end of the fifth year. If the machine were purchased,
and an expected salvage value of P12,000. The hurdle rate is 10%. The before-tax annual cash savings on operating expenses will be realized.
present value of an annuity factor of 10% for 10 years is 6.1446, and the Caravan Company will depreciate the machine using straight-line
present value of P1, discounted for 10 years at 10% is 0.3855. depreciation for 5yrs., with the salvage value considered in the computation.
The company has a 12 % cost of capital and is subject to 40%t tax rate.
The present values using 12 percent are: 45. Moon Company uses a 10% discount rate and the total cost approach to
Annuity of 1 for 5 periods 3.60478 capital budgeting analysis. Both alternatives are Akda Investments which
Present value of 1, end of 5 periods 0.56743 has a marginal cost of capital of 12 percent is evaluating two mutually
The initial analysis indicated a net present value of P7,003. You believe the exclusive projects (X and Y), which have the following projections:
estimated before-tax cash savings are fairly determined but you are in doubt PROJECT X PROJECT Y
of the expected salvage value of the machine. How much is the estimated Investment P48,000 P83,225
salvage value required if the investment has to yield an IRR of 12 percent? After-tax cash inflow 12,000 15,200
A. P41,800 C. P25,100 Asset life 6 years 10 years
B. P24,900 D. P44,600 The indifference point for the two projects is
Required value of intangible benefits A. 12.64% C. 12.00%
43. Solidum Company is investigating the purchase of a piece of automated B. 16.01% D. 19.33%
equipment that will save P100,000 each year in direct labor and inventory 46. Silky Products is considering two pieces of machinery. The first machine
carrying costs. This equipment costs P750,000 and is expected to have a costs P50,000 more than the second machine. During the two-year life of
10-year useful life with no salvage value. The company requires a minimum these two alternatives, the first machine has a P155,000 more cash flow in
15% return on all equipment purchases. Management anticipates that this year one and a P110,000 less cash flow in year two than the seconds
equipment will provide intangible benefits such as greater flexibility and machine. All cash flows occur at year-end. The present value of 1 at 15
higher quality output. percent end of 1 period and 2 periods are 0.86957 and, 0.75614,
The PV of annuity of 1, 15% for 10 periods 5.01877 respectively. The present value of 1 at 8 percent end of period 1 is 0.92593,
The PV of 1, end 10 period 0.24718 and Period 2 is 0.85734. At what discount rate would Machine 1 be equally
What peso value per year would these intangible benefits have to have in acceptable as machine 2s?
order to make the equipment an acceptable investment? A. 9% C. 11%
A. P248,123 C. P 61,331 B. 10% D. 12%
B. P 49,440 D. P 55,000 Decision Rule Independent Projects
44. Altas, Inc., is considering investing in automated equipment with a ten- 47. Sylvia Products is considering two types of machinery. The first machine
year useful life. Managers at Altas have estimated the cash flows associated costs P50,000 more than the second machine. During the two-year life of
with the tangible costs and benefits of automation, but have been unable to these two alternatives, the first machine has a P155,000 more cash flow in
estimate the cash flows associated with the intangible benefits. Using the year one and a P110,000 less cash flow in year two than the seconds
companys 10% discount rate, the net present value of the cash flows machine. All cash flows occur at year-end. The present value of 1 at 15
associated with just the tangible costs and benefits is a negative P184,350. percent end of 1 period and 2 periods are 0.86957 and, 0.75614,
The present value of annuity of 1 at 10 percent for ten years is 6.145 while respectively. The present value of 1 at 8 percent end of period 1 is 0.92593,
the present value of 1 is 0.386. How large would the annual net cash and Period 2 is 0.85734.Which machine should be purchased if the relevant
inflows from the intangible benefits have to be to make this a financially discount rates are 15 percent and 8 percent, respectively?
acceptable investment? 15% Discount 8% Discount
A. P18,435. C. P35,000. A. Machine 1 Machine 1
B. P30,000. D. P37,236. B. Machine 2 Machine 2
Indifference Point C. Machine 1 Machine 2
D. Machine 2 Machine 1 A. P2,786,100 C. P1,028,900
Comprehensive B. P 928,500 D. P 150,270
Payback, NPV, ARR 53. Assuming that some of the 300,000 units that are expected as sales
Question Nos.48 through 50 are based on the following: would be to group of customers who currently buy K-Z, another product of
Cayco Medical Center is considering purchasing an ultrasound machine for Kabalikat Company. This Product K-Z sells for P35 with variable cost of
P950,000. The machine has a 10 year life and an estimated salvage value P20. How many units of K-Z can Kabalikat afford to lose before the
of P55,000. Installation costs and freight charges will be P24,200 and P800, purchase of the new machine becomes unattractive?
respectively. Newman uses straight-line depreciation. The medical center A. 39,000 units C. 16,714 units
estimates that the machine will be used five times a week with the average B. 23,400 units D. 10,029 units
charges to the patient for ultrasound of P800. There are P10 in medical ARR, NPV, PI, Payback
supplies and P40 of technician costs for each procedure performed using Questions 54 through 57 will be based on the following data:
the machine. The present value of an annuity of 1 for 10 years at 9% is The management of Arleen Corporation is considering the purchase of a
6.418 while the present value of 1 for 10 years at 9% is 0.42241 new machine costing P400,000. The companys desired rate of return is
48. The cash payback period is: 10%. The present value of P1 at compound interest of 10% for 1 through 5
A. 3.0 years C. 5.0 years years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively, and the
B. 4.5 years D. 6.0 years present value of annuity of 1 for 5 periods at 10 percent is 3.79. In addition
49. The project is expected to generate net present value of: to the foregoing information, use the following data in determining the
A. P276,510 C. P331,510 acceptability in this situation:
B. P299,743 D. P253,277 Year Income from Operations Net Cash Flow
50. What is the accounting rate of return provided by the project? 1 P100,000 P180,000
A. 20.0 percent C. 11.2 percent 2 40,000 120,000
B. 10.6 percent D. 38.0 percent 3 20,000 100,000
NPV, CFAT, Maximum lost unit sales 4 10,000 90,000
Question Nos. 51 through 53 are based on the following: 5 10,000 90,000
Kabalikat Company has the opportunity to introduce a new product. 54. The average rate of return for this investment is:
Kabalikat expects the product to sell for P75 with variable cost per unit of A. 18 percent C. 58 percent
P50. The annual fixed costs, excluding the amount of depreciation is B. 6 percent D. 10 percent
P4,500,000. The company expects to sell 300,000 units. To produce the 55. The net present value for this investment is:
new product line, the company needs to purchase a new machine that costs A. Positive P 36,400 C. Negative P 99,600
P6,000,000. The new machine is expected to last for four years with a very B. Positive P 55,200 D. Negative P126,800
negligible salvage value. The company has a policy of depreciating its 56. The present value index for this investment is:
machine for both book and tax purposes for four years. The company has a A. 0.88 C. 1.14
marginal cost of capital of 13.75 percent and is subject to tax rate of 40%. B. 1.45 D. 0.70
51. The amount of annual after-tax cash flows is: 56 The cash payback period for this investment is:
A. P2,400,000 C. P 900,000 A. 4 years B. 5 years C. 20 years D. 3 years
B. P3,000,000 D. P1,500,00 Payback, NPV, ARR, IRR
52. The machines net present value is:
Use the following information for questions 57 - 70 A. P 1,875 C. P 8,875
Pillo Company is considering two capital investment proposals. B. P 7,000 D. P10,000
Estimates regarding each project are provided below: 62. Payback amounts to
Project MA Project PA A. 5.0 years C. 6.0 years
Initial investment P2000,000 P300,000 B. 5.6 years D. 6.6 years
Annual net income 10,000 21,000 63. Net present value amounts to
Net annual cash inflow 50,000 71,000 A. P 756 C. P1,756
Estimated useful life 5 years 6 years B. P1,005 D. P2,005
Salvage value -0- -0- 64. Internal rate of return on this project is approximatel
The company requires a 10% rate of return on all new investments. A. 8.0% C. 9.0%
Present Value of an Annuity of 1 B. 8.5% D. 9.5%
Period 9% 10% 11% 12% CFAT, NPV, IRR
5 3.890 3.791 3.696 3.605 Questions 65 through 69 are based on the following:
6 4.486 4.355 4.231 4.111 Homes Pizzas, Inc., operates pizza shops in several cities. One of the
57. The cash payback period for Project MA is companys most profitable shops is located adjacent to the large CPA review
A. 20 years C. 5 years center in Manila. A small bakery next to the shop has just gone out of
B. 10 years D. 4 years business, and Homes Pizzas has an opportunity to lease the vacated space
58. The net present value for Project PA is for P18,000 per year under a 15-year lease. Homes management is
A. P309,204 C. P 50,000 considering two ways in which the available space might be used.
B. P 91,456 D. P 9,205
Alternative 1. The pizza shop in this location is currently selling 40,000
59. The annual rate of return for Project MA is
pizzas per year. Management is confident that sales could be increased by
A. 5% C. 25%
75% by taking out the wall between the pizza shop and the vacant space
B. 10% D. 50%
and expanding the pizza outlet. Costs for remodeling and for new equipment
60. The internal rate of return for Project PA is closest to
A. 10% C. 12% would be P550,000. Management estimates that 20% of the new sales
B. 11% D. none of these would be small pizzas, 50% would be medium pizzas, and 30% would be
Depreciation tax shield, CCFAT, Payback, NPV, IRR large pizzas. Selling prices and costs for ingredients for the three sizes of
pizzas follow (per pizza):
Question Nos. 60 through 64 are based on the following:
Selling Price Cost of Ingredients
Consider a project that requires cash outflow of P50,000 with a life of eight
Small P 6.70 P1.30
years and a salvage value of P2,000. Annual cash inflow amounts to
P10,000 assuming a tax rate of 30% and a required rate of return of 8%. Medium 8.90 2.40
Salvage value is ignored in computing depreciation. Large 11.00 3.10
60. Annual depreciation tax shield amounts to An additional P7,500 of working capital would be needed to carry the larger
volume of business. This working capital would be released at the end of the
A. P1,875 C. P8,875
B. P7,000 D. P10,000 lease term. The equipment would have a salvage value of P30,000 in 15
61. Annual cash flow after tax amounts to years, when the lease ends.
Alternative 2. Homes sales manager feels that the company needs to A. P48,650 C. P45,000
diversify its operations. He has suggested that an opening be cut in the wall B. P47,840 D. P32,500.
between the pizza shop and the vacant space and that video games be 67. The net present value for Alternative 2 is:
placed in the space, along with a small snack bar. Costs for remodeling and A. P21,021 C. P68,375
for the snack bar facilities would be P290,000. The games would be leased B. P70,103 D. P12,807
from a large distributor of such equipment. The distributor has stated that 68. Assume that the company decides to accept alternative 2. At the end of
based on the use of game centers elsewhere, Homes could expect about the first year, the company finds that only 21,000 people used the game
26,000 people to use the center each year and to spend an average of P5 center during the year (each person spent P5 on games). Also, the snack
each on the machines. In addition, it is estimated that the snack bar would bar provided a net cash inflow of only P13,000. In light of this information,
provide a net cash inflow of P15,000 per year. An investment of P4,000 in what is the net present value for alternative 2?
working capital would be needed. This working capital investment would be A. P(80,422) C. P(82,150)
released at the end of the lease term. The snack bar equipment would have B. P(76,422) D. P(80,854)
a salvage value of about P12,000 in 15 years. 69. The sales manager has suggested that an advertising program be
initiated to draw another 5,000 people into the game center each year.
Homes management is unsure which alternative to select and has asked Assuming that another 5,000 people can be attracted into the center and
you to help in making the decision. You have gathered the following that the snack bar receipts increase to the level originally estimated, how
information relating to added costs that would be incurred each year under much can be spent on advertising each year and still allow the game center
the two alternatives: to provide a 16% rate of return?
A. P70,103.00 C. P58,953.00
Expand the Pizza Shop Install the Game Center B. P 4,673.53 D. P12,574.53
Rent- building space P18,000 P18,000 Net Income, CFBT, ARR, Payback Period
Rent- video games --- 30,000 Questions 70 through 75 are based on the following information:
Salaries 54,000 17,000 Pinewood Craft Company is considering the purchase of two different items
Utilities 13,200 5,400 of equipment, as described below:
Insurance and other 7,800 9,600 Machine A. A compacting machine has just come onto the market that
would permit Pinewood Craft Company to compress sawdust into various
The company is currently using a 16 percent minimum acceptable rate of shelving products. At present the sawdust is disposed of as a waste
return for its capital investment. The present value of annuity of 1 at 16 product. The following information is available on the machine:
percent for 15 periods is 5.575 and end of 15 periods is 0.108. The a. The machine would cost P420,000 and would have a 10% salvage value
company is not liable to pay income taxes. at the end of its 12-year useful life. The company uses straight-line
64. The incremental expected annual cash inflows from Alternative 1 is: depreciation and considers salvage value in computing depreciation
A. P 90,000 C. P100,200 deductions.
B. P108,000 D. P201,000 b. The shelving products manufactured from use of the machine would
65. The incremental expected annual cash inflows from Alternative 2 is: generate revenues of P300,000 per year. Variable manufacturing costs
A. P 17,000 C. P 59,600 would be 20% of sales
B. P 65,000 D. P145,000
66. The net present value for Alternative 1 is:
c. Fixed expenses associated with the new shelving products would be (per A. 4.0 years. C. 6.1 years.
year): advertising, P40,000; salaries, P110,000; utilities, P5,200; and B. 4.2 years. D. 5.9 years.
insurance, P800. Net Investment, CFBT, Tax Benefits, NPV, Depreciation Tax Shield,
Machine B. A second machine has come onto the market that would allow Question Nos. 76 through 81 are based on the following:
Pinewood Craft Company to automate a sanding process that is now done Turkey Companys average production of valve stems over the past three
largely by hand. The following information is available: years has been 80,000 units each year. Expectations are that this volume
a. The new sanding machine would cost P234,000 and would have no will remain constant over the next four years. Cost records indicate that unit
salvage value at the end of its 13-year useful life. The company would use product costs for the valve stem over the last several years have been as
straight-line depreciation on the new machine. follows:
b. Several old pieces of sanding equipment that are fully depreciated would Direct materials P 3.60
be disposed of at a scrap value of P9,000. Direct labor 3.90
c. The new sanding machine would provide substantial annual savings in Variable manufacturing overhead 1.50
cash operating costs. It would require an operator at an annual salary of Fixed manufacturing overhead* 9.00
P16,350 and P5,400 in annual maintenance costs. The current, hand- Unit product cost P18.00
operated sanding procedure costs the company P78,000 per year in total. *Depreciation of tools (that must now be replaced) accounts for one-third of
Pinewood Craft Company requires a simple rate of return of 15% on all the fixed overhead. The balance is for other fixed overhead costs of the
equipment purchases. Also, the company will not purchase equipment factor that require cash expenditures.
unless the equipment has a payback period of 4.0 years or less. If the specialized tools are purchased, they will cost P2,500,000 and will
(In all the following questions, please ignore income tax effect) have a disposal value of P100,000 at the end of their four-year useful life.
Turkey Company has a 30% tax rate, and management requires a 12%
70. The expected income each year from the new shelving products after-tax return on investment. Straight-line depreciation would be used for
(Machine A) is: financial reporting purposes, but for the tax purposes, the following variable
A. P 52,500 C. P 84,000 depreciation each year will be used.
B. P240,000 D. P 92,500 Year 1 P 832,500
71. The annual savings in cost if Machine B is purchased is Year 2 1,112,500
A. P56,250 C. P38,250 Year 3 370,000
B. P43,250 D. P21,750 Year 4 185,000
72. The simple rate (%) of return for Machine A is: The sales representative for the manufacturer of the specialized tools has
A. 12.5 percent C. 25.0 percent stated, The new tools will allow direct labor and variable overhead to be
B. 20.0 percent D. 18.0 percent reduced by P1.60 per unit. Data from another company using identical
73. The simple rate of return for Machine B is: tools and experiencing similar operating conditions, except that annual
A. 16.3 percent C. 25.0 percent production generally averages 100,000 units, confirms the direct labor and
B. 17.0 percent D. 34.0 percent variable overhead cost savings. However, the other company indicates that
74. The payback period for Machine A is: it experienced an increase in raw material cost due to the higher quality of
A. 3.0 years C. 5.0 years material that had to be used with the new tools. The other company
B. 4.5 years D. 7.5 years indicates that its unit product costs have been as follows:
75. The payback period for Machine B is:
Direct materials P 4.50 79. The present value of the salvage value of the new tools to be received at
Direct labor 3.00 the end of fourth year is
Variable manufacturing overhead 0.80 A. P 63,552. C. P 44,486.
Fixed manufacturing overhead 10.80 B. P 19,065. D. P212,615.
Unit product cost P19.10 80. Using the minimum acceptable rate of return of 12 percent, the net
Referring to the figures above, the production manager stated, These present value of the investment in new tools is
numbers look great until you consider the difference in volume. Even with A. P108,913. C. P147,073.
the reduction in labor and variable overhead cost, Ill bet our total unit cost B. P127,979. D. P166,139.
figure would increase to over P20 with the new tools. 81. The net advantage of the use of declining method of depreciation
Although the old tools being used by Turkey Company are now fully instead of straight-line method is
depreciated, they have a salvage value of P45,000. These tools will be sold A. P 33,830. C. P112,767.
if the new tools are purchased; however if the new tools are not purchased, B. P 56,610. D. P147,731.
then the old tools will be retained as standby equipment. Turkey Companys Net Investment, CFAT, Depreciation tax shield, NPV
accounting department has confirmed that total fixed manufacturing Question Nos. 82 through 82 are based on the following:
overhead costs, other than depreciation, will not change regardless of the Franzen Company manufactures three different models of paper shredders
decision made concerning the valve stems. However, the accounting including the waste container, which serves as the base. While the shredder
department has estimated that working capital needs will increase by heads are different for all three models, the waste container is the same.
P60,000 if the new tools are purchased due to the higher quality of material The number of waste containers that Franzen will need during the next five
required in the manufacture of the valve stems. years is estimated as follows:
The present values of 1 at the end of each period using 12 percent are:
Period 1 0.89286 2007 50,000
Period 2 0.79719 2008 50,000
Period 3 0.71178 2009 52,000
Period 4 0.63552 2010 55,000
PV of annuity of 1, 4 periods 3.03735 2011 55,000
76. The net investment in new tools amounted to:
A. P1,873,300. C. P2,528,500. The equipment used to manufacture the waste container must be replaced
B. P2,515,000. D. P2,546.500. because it is broken and cannot be repaired. The new equipment would
77. How much annual cost savings will be generated if the Turkey Company have a purchase price of P945,000 with terms 2/10, n/30; the companys
purchases the new tools? policy is to take all purchase discounts. The freight on the equipment would
A. P 128,000 C. P 936,000 be P11,000, and installation costs would total P22,900. The equipment
B. P 216,000 D. P1,008,000 would be purchased in December 2006 and placed into service on January
78. The present value of tax benefits expected from the use of the new 1, 2007. It would have a five-year economic life and would have the
machine tools is: following depreciation. The equipment is expected to have a salvage value
A. P 603,333 C. P1,407,777 of P12,000 at the end of its economic life in 2011. The new equipment
B. P 804,444 D. P2,011,111 would be more efficient than the old equipment, resulting in a 25 percent
reduction in both direct material and variable overhead. The savings in
direct material would result in an additional one-time decrease in working Year Depreciation
capital requirements of P2,500, resulting from a reduction in direct material 2007 P319,968
inventories. This working capital reduction would be recognized at the time 2008 426,720
of equipment acquisition. 2009 142,176
2010 71,136
The old equipment is fully depreciated and is not included in the fixed 2011 0
overhead. The old equipment from the plant can be sold for a salvage
amount of P1,500. Rather than replace the equipment, one of Franzens Franzen is subject to a 40 percent tax rate. Management assumes that all
production managers has suggested that the waste containers be cash flows occur at the end of the year and uses a 12 percent after-tax
purchased. One supplier has quoted a price of P27 per container. This discount rate.
price is P8 less than Franzens current manufacturing cost, which is 82. The initial net cash outflows if the company decides to continue making
presented below. the waste containers is:
A. P 956,600 C. P 978,900
Direct materials 10 B. P 975,500 D. P1,455,613
Direct labor 8 83. The total after-tax cash outflows, excluding the initial cash outflows, if the
Variable overhead 6 new equipment is purchased are:
Fixed overhead: A. P 956,600 C. P2,918,300
Supervision P2 B. P2,887,800 (defective) D. P3,279,000
Facilities 5 84. The present value of the total depreciation shield is:
General 4 11 A. P308,920 C. P307,826
Total unit cost P35 B. P313,500 D. P321,303
84. The total relevant after-tax costs to buy the waste containers are:
Franzen uses a plantwide fixed overhead rate in its operations. If the waste A. P2,829,240 C. P4,243,500 (defective)
containers are purchase outside, the salary and benfits of one supervisor, B. P3,039,662 D. P7,074,000
included in fixed overhead of P45,000 would be eliminated. There would be 85. What is the net present value of the purchase alternative?
no other changes in the other cash and noncash items included in fixed A. P3,039,662 (defective) C. P2,083,062
overhead except depreciation on the new equipment. B. P2,730,742 D. P2,718,359
The new equipment will be depreciated according to the following declining 86. What is the net present value of the make alternative?
amounts: A. P2,036,603 C. P2,996,603
B. P3,039,662 D. P2,993,203 (defective)