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- Capital Investment Appraisal in Retail Business Management: Sainsbury’s as a Case Study
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CASH FLOWS/ NET PRESENT VALUE/ INTERNAL RATE OF RETURN/ ACCOUNTING RATE OF

RETURN

Problem 1 Cash flows

In 8 years, Karl Garcia will retire. He is exploring the possibility of opening a self-service car wash. The car

wash could be manage In the free time he has available from his regular occupation, and it could be closed

easily when he retires. After careful study, Karl has determined the following:

a. A building in which a car wash could be installed is available under an 8-year lease at a cost of

P2,100 per month. A two- month’s rent is required as deposit to be paid at the beginning of the

contract.

b. Purchase price of the equipment would total P160,000 while installation costs would amount to

P10,000. In 8 years the equipment could be sold for 10% of its original purchase price.

c. An investment of an additional P1,000 would be required to cover working capital needs for

cleaning supplies, changes funds and so forth. After 8 years, this working capital would be released

for investment elsewhere.

d. Both an auto wash and the vacuum service would be offered with a wash priced at P1.60 and the

vacuum price at P0.20 per use.

e. The only variable costs associated with the pertain would be P0.23 per wash for water and P0.1

per use of the vacuum for electricity.

f. In addition to rent, monthly cost of pertain would be: cleaning, P480; insurance, P70; and

maintenance, P520.

g. Gross receipts from the auto wash would be about P1,600 per week. According to the experience

of other self-service car washes, 80% of the customers using the wash would also use the vacuum.

Karl will not open the car wash unless it provides at least an 8% return, since he could earn this rate of

return in high-grade securities.

Required: Compute the initial investment cost, Annual after-tax cash inflow, and the cashflow at disposal

period.

Problem 2

The Chief Financial officer of Pauley Inc. has requested an evaluation of a proposed acquisition of a new

machine at a purchase price of P60,000 and with installation cost of P10,000. A P3,000 increase in working

capital will be required. The company has an old machine that has a book value of P5,000 and can be

sold for P7,000. The new machine will have a useful life of four years after which it can be sold for P10,000

after removal costs amounting to P2,500. The estimated annual incremental operating revenues and cash

operating expenses are P150,000 and P100,000, respectively, for each of the four years. Pauley’s effective

income tax rate is 40% and the cost of capital is 12%. Pauley uses straight-line depreciation for both

financial reporting and income tax purposes however, salvage value will not be considered for income tax

purposes.

Required: Compute the initial investment cost, Annual after-tax cash inflow, and the cash flow at disposal

period.

Problem 3

Tallispan Company has gathered the following data on a proposed investment project:

Cost of the investment P1,200,000

Annual cost inflows 240,000

Estimated salvage value 0

Life of the project 10 years

Discount rate 10%

Problem 4

The Sweetwater Candy Company would like to buy a new Italian-made machine that automatically dips

chocolates. The dipping pertain is currently done by hand. The machine costs P160,000. The machine

would be usable for 12 years but would require the replacement of several key parts at the end of the 6th

year. These parts would cost P8,000, including installation. After 12 years, the machine would be sold for

P7,000. Management estimates that the cost t operate the machine will only P6,500 per year. The present

method of dipping chocolates costs P40,000 per year. In addition to reducing costs, the new machine will

increase production by P5,000 boxes of chocolates per year. The company realizes a contribution margin

of P1.80 per bx. An 18% rate of return is required n all investments.

What is the net present value?

Problem 5

Sta. Ana Corporation recently purchased a P900,000 asset that has three year service life and no salvage

value. The expected pre tax annual cash return is P500,000. The company is subject to a 30% income tax

rate and employs a 20% after tax hurdle rate of return in capital investment decisions. Management is

studying whether to depreciate the asset using the straight-line method or sum-of-the- years’ digit method.

PV factor of an annuity of P1 at 20% 2.106

PV factor of a single payment at 20% Year 1 0.833

Year 2 0.694

Year 3 0.579

1. How much is the net present value if the company uses the straight line method of depreciation?

2. How much is the net present value if the company uses the sum of the years digit method of

depreciation?

3. How much is the total present value of tax shield from depreciation if SYD method is used instead

of a straight line method?

Problem 6

Vigan Corporation invested in a four-year project. The company’s expected rated of return is 10%.

Additional information on the project is as follows:

YEAR AFTER TAX CASH PRESENT

INFLOW FROM VALUE OF P1

OPERATIONS AT 10%

1 40,000 .909

2 44,000 .826

3 48,000 .751

4 52,000 .683

Assuming a positive Net Present Value of P10,000, determine the amount of the original investment.

Gapan Corporation acquired an asset at a cost of P46,000. It had an estimated useful life of 10 years.

Annual after tax benefits are estimated at P10,000 at the end of each year. The following amounts appear

in the interest table for the present value of an annuity of 1 at year end for ten years:

16% - 4.83 18%-4.49 20%-4.19

Determine the internal rate of return.

Problem 8

The following data pertain to an investment in equipment:

Investment Cost P20,000 Pre-tax net annual cash inflow P3,200 Life of the project-8years

5% 6% 7% 8% 9%

PV of 1 (3 digits)

PV of an Ordinary

annuity

The following pertains to Bulacan Corporation’s investment plan

Pretax annual net cash P80,000 Net income P35,000 Useful life 5 years

flow

Equipment P200,000 Salvage Value P50,000 Tax rate 30%

Compute the accounting rate of return of the investment

1. Based on initial investments

Problem 10

Pete Samuels has an opportunity to acquire a franchise from Green Tea Inc., to dispense frozen yogurt

products under the Green tea name Mr. Samuels has assembled the following information relating to the

franchise:

a. A suitable location in a large shopping mall can be rented for P8,750 per month

b. Remodeling and necessary equipment would cost P675,000. The equipment would have a 15 year

life and a P45,000 salvage value would be considered in computing depreciation.

c. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total P750,000 per

year. Ingredients would cost 20% of sales.

d. Operating costs would include P175,000 per year for salaries, P8,750 per year for insurance, and

P67,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to Green

Tea Inc of 12.5% of sales

e. Income tax rate is constant at 40%.

Compute the accounting rate of return of the investment

1. Based on Initial Investments

2. Based on Average Investments

Problem 11

Sharkey’s Fun Center contains a number of electronic games as well as a miniature golf course and

various rides located outside the building. Baby Sharkey, the owner, would like to construct a water slide

on one portion of his property. Baby has gathered the following information about the slide:

a. Water slide equipment could be purchased and installed at a cost of P440,000. The slide would be

usable for 5 years after which it would have no salvage value.

b. Baby would use straight-line depreciation on the slide equipment.

c. To make room for the water slide, several rides would be dismantled and sold. These rides are

fully depreciated, but they could be sold for P20,000 to an amusements park in a nearby city.

d. Baby has concluded that water slides would increase ticket sales by P319,000 per year.

e. Based on experience at other water slide, Baby estimates that incremental operating expenses

each year for the slide would be: salaries, P98,000; Insurance P25,000; Utilities P17,000;

Maintenance P28,000.

Required:

1. Prepare an income statement showing the expected net operating income each year from the water

slide.

2. Compute the simple rate of return expected from the water slide. Based on this computation, would

the water slide be constructed if Paul requires a simple rate of return of at least 14% on all investments?

Problem 12

The following pertains to Bataan Corporation’s Investment plan

Investment Costs P400,000

Annual cash savings 250,000

Required:

1. Compute the payback period of the investment in equipment

2. Compute the payback reciprocal of the investment in equipment

3. What is the payback period of the equipment if instead the annual cash savings of P240,000, the

following are the expected annual cash savings:

Period 1 P 180,000

Period 2 P 140,000

Period 3 P 200,000

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