01_CAPITAL BUDGETING

QUIZZER 1

1. SAN JOSE Company can acquire a P700,000 machine now that will benefit the firm over the
next 5 years. A newly hired staff assistant correctly computed the net present value to be
P134,020 by using a 10% hurdle rate. On the basis of this information, the machine was expected
to produce annual cash operating savings of approximately:
a. P166,804 c. P268,605
b. P220,000 d. P834,020

2. COPENHAGEN Company is considering an investment in a machine that would reduce

annual labor costs by P30,000. The machine has an expected life of 10 years with no salvage
value. The machine would be depreciated according to the straight-line method over its useful
life. The company’s marginal tax rate is 30 percent.

Assume that the company will invest in the machine if it generates an internal rate of return of 16
percent. What is the maximum amount the company can pay for the machine and still meet the
internal rate of return criterion?
a. P118,700 c. P187,500
b. P210,000 d. P144,990

3. BONIFACIO GLOBAL CITY is about to replace an old fire truck with a new vehicle in an
effort to save maintenance and other operating costs. Which of the following items, all related to
the transaction, would not be considered in the decision?
a. Purchase price of the old vehicle.
b. Savings in operating costs as a result of the new vehicle.
c. Proceeds from disposal of the old vehicle.
d. Future depreciation on the new vehicle.

4. BERLIN Company is considering a P600,000 investment in new equipment that is

anticipated to produce the following data over a five-year life:

Year Cash Inflows Cash Outflows Depreciation

1 P350,000 P130,000 P120,000
2 450,000 190,000 120,000
3 450,000 170,000 120,000
4 340,000 150,000 120,000
5 300,000 130,000 120,000

Ignoring income taxes and assuming that cash flows occur evenly throughout a year, the
equipment approximate payback period is:
a. 1 year, 7 months. c. 2 years, 5 months.
b. 2 years, 1 month. d. over 5 years.
5. ATHENS Corporation will evaluate a potential investment in an advanced manufacturing
system by use of the net-present-value (NPV) method. Which of the following system
benefits is least likely to be omitted from the NPV analysis?
a. Savings in operating costs.
b. Greater flexibility in the production process.
c. Improved product quality.
d. Shorter manufacturing cycle time.

Hendz Inc. has purchased a new fleet of trucks to deliver its merchandise. The trucks have a
useful life of 8 years and cost a total of P500,000. Hendz expects its net Increase in after-tax cash
flow to be P150,000 in Year 1, P175,000 in Year 2, P125,000 in Year 3, and P100,000 in each of
the remaining years.

6. Ignoring the time value of money, how long will it take Hendz to recover the amount of
investment?
a. 3.5 years.
b. 4.0 years,
c. 4.2 years.
d. 5 years

7. Assume the net cash flow to be P130,000 a year. What is the payback time for the fleet of
trucks?
a. 3 years.
b. 3.15 years.
c. 3.85 years.
d. 4 years

8. Which one of the following statements about the payback method of investment analysis is
correct? The payback method
a. Does not consider the time value of money.
b. Considers cash flows after the payback has been reached.
c. Uses discounted cash flow techniques.
d. Generally leads to the same decision as other methods for long-term projects.

9. When evaluating projects, breakeven time is best described as

a. Annual fixed coats - monthly contribution margin.
b. Project investment — annual net cash inflows.
c. The point where cumulative cash inflows on a project equal total cash outflows.
d. The point at which discounted cumulative cash inflows on a project equal discounted
total cash outflows.

In order to increase production capacity, Gio Industries is considering replacing an existing

production machine with a new technologically improved machine effective January 1. The
following information is being considered by Gio Industries:
  The new machine would be purchased for P160,000 in cash. Shipping, installation, and
testing would cost an additional P30,000.
 The new machine is expected to increase annual sales by 20,000 units at a sales price of
P40 per unit.
 Incremental operating costs include P30 per unit in variable costs and total fixed costs of
P40,000 per year.
 The investment in the new machine will require an immediate increase in working capital
of P35,000. This cash outflow will be recovered at the end of year 5.
 Gio uses straight-line depreciation for financial reporting and tax reporting purposes. The
new machine has an estimated useful life of 5 years and zero salvage value.
 Gio is subject to a 40% corporate income tax rate. Its discount rate is 10%.

10. Gio Industries' net cash outflow in a capital budgeting decision is

a. 190,000
b. 195,000
c. 204,525
d. 225,000

11. Gio Industries' discounted annual depredation tax shield is

a. 57,623
b.56,762
c. 55,833
d.54,486

12. The overall discounted cash flow impact of Gio Industries' working capital investment for the
new production machine would be
a. (7,959)
b. (10,080)
c. (13,265)
d. (35,000)

13. The net present value (NPV) method of investment project analysis assumes that the project's
cash flows are reinvested at the

a. Computed internal rate of return.

b. Risk-free Interest rate.
c. Discount rate used in the NPV calculation.
d. Firm's accounting rate of return.

14. Garf Inc. is considering a 10-year capital investment project with forecasted revenues of
P40,000 per year and forecasted cash operating expenses of P29,000 per year. The initial cost of
the equipment for the project is P23,000 and Garf expects to sell the equipment for P9,000 at the
end of the tenth year. The equipment will be depreciated over 7 years. The project requires a
working capital investment of P7,000 at its inception and another P5,000 at the end of year 5.
Assuming a 40% marginal tax rate, the expected net cash flow from the project in the tenth year
is
 a. 32,000
b. 24,000
c. 20,000
d. 11,000

15. The rankings of mutually exclusive investments determined using the internal rate of return
method (IRR) and the net present value method (NPV) may be different when
a. The lives of the multiple projects are equal and the size of the required investments are
equal.
b. The required rate of return equals the 1RR of each project.
c. The required rate of return is higher than the 1RR of each project.
d. Multiple projects have unequal lives and the size of the investment for each project is
different.

16. The proper discount rate to use to calculating certainty equivalent net present
value is the
a. Risk-adjusted discount rate.
b. Cost of capital.
c. Risk-free rate.
d. Cost of equity capital.

17. Amo Corporation has not yet decided on its hurdle rate for use In the evaluation of capital
budgeting projects. This lack of information will prohibit Amo from calculating a project's
Accounting Net Internal
Rate of Return Present value Rate of Return
A. No No No
B. Yes Yes Yes
C. No Yes Yes
D. No Yes No

18. When determining net present values in an inflationary environment, adjustments should
be made to
a. Increase the discount rate only. .
b. Increase the estimated cash inflows and increase the discount rate.
c. Increase the estimated cash inflows but not the discount rate.
d. Decrease the estimated cash inflows and increase the discount rate.

19. All of the following items are included in discounted cash flow analysis except
a. Future operating cash savings.
b. The current asset disposal price.
c. The future asset depreciation expense.
d. The tax effects of future asset depreciation.

20. The capital budgeting model that is ordinarily considered the best model for long-range
decision making is
 a. Payback model.
b. Accounting rate of return model.
c. Unadjusted rate of return model
d. Discounted cash flow model.

21. The use of an accelerated method instead of the straight-line method of depreciation in
computing the net present value of a project has the effect of
a. Raising the hurdle rate necessary to justify the project.
b. Lowering the net present value of the pro
c. Increasing the present value of the depreciation tax shield.
d. increasing the cash outflows at the initial point of the project

Cape Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis
for four projects for the upcoming year.
Project 1 Project 2 Project 3 Project 4
Initial capital outlay P200,000 P298,000 P248,000 P272,000
Annual net cash inflows
Year 1 65,000 100,000 80,000 95,000
Year 2 70,000 135,000 95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000

Net present value (3,798) 4,276 14,064 14,662

Profitability index 98% 101% 106% 105%
Internal rate of return 11% 13% 14% 15%

22. Which project(s) should Cape Inc. undertake during the upcoming year assuming it has no
budget restrictions?
a. All of the projects.
b. Projects 1, 2, and 3.
c. Projects 2, 3, and 4.
d. Projects 1, 3. and 4.

23. Which project(s) should Cape Inc. undertake during the upcoming year if it has only
P600,000 of funds available?
a. Projects 1 and 3.
b. Projects 2, 3, and 4.
c. Projects 2 and 3.
d. Projects 3 and 4.

24. Which project(s) should Cape Inc. undertake during the upcoming year if it has only
P300,000 of capital funds available?
a. Project 1.
b. Projects 3, and 4.
c. Projects 3 and 4,
 d. Project 3.

25. The NPV of a project has been calculated to be P215,000. Which one of the following
changes in assumptions would decrease the NPV?
a. Decrease the estimated effective income tax rate.
b. Decrease the initial investment amount.
c. Extend the project life and associated cash Inflows.
d. Increase the discount rate,

26. Dawson Inc. is expanding its manufacturing plant, which requires an investment of P4
million in new equipment and plant modifications. Dawson’s sales are expected to increase by
P3 million per year as a result of the expansion. Cash investment in current assets averages
30% of sales; accounts payable and other current liabilities are 10% of sales. What is the
estimated total investment for this expansion?
a. 3.4 million.
b. 4.3 million.
c. 4.6 million.
d. 4.9 million.

27. A disadvantage of the net present value method of capital expenditure evaluation is that it
a. Is calculated using sensitivity analysis.
b. Computes the true interest rate.
c. Does not provide the true rate of return on investment.
d. Is difficult to apply because it uses a trial-and- error approach.

28. Parker Inc. has no capital rationing constraint and Is analyzing many independent
investment alternatives. Packer should accept all investment proposals
a. If debt financing is available for them.
b. That have positive cash flows.
c. That provide returns greater than the before tax cost of debt.
d. That have a positive net present value.

29. Jac Corporation uses net present value techniques in evaluating its capital investment
projects. The company is considering a new equipment acquisition that will cost P100,000,
fully installed, and have a zero salvage value at the end of its five-year productive life. Jac will
depreciate the equipment on a straight-line basis for both financial and tax purposes. Jackson
estimates P70,000 in annual recurring operating cash revenue and P20,000 in annual recurring
operating cash expenses. Jac’s cost of capital is 12% and its effective income tax rate is 40%.
What is the net present value of this investment on an after-tax basis?
a. 28,840
b. 8,150
c. 36,990
d. 80,250
30. Will Inc. has a cost of capital of 15% and is considering the acquisition of a new machine
which costs P400,000 and has a useful life of 5 years. Will projects that earnings and cash flow
will increase as follows:
Net After-Tax
Year Earnings Cash Flow
1 P100,000 P160,000
2 100,000 140,000
3 100,000 100,000
4 100,000 100,000
5 200,000 100,000

The net present value of this investment is

a. Negative, 64,000.
b. Negative, 14,000.
c. Positive, 18,600.
d. Positive, 200,000.

31. A weakness of the internal rate of return (IRR) approach for determining the acceptability
of investments is that it
a. Does not consider the time value of money.
b. Is not a straightforward decision criterion.
c. Implicitly assumes that the firm is able to reinvest project cash flows at the firm’s cost
of capital.
d. Implicitly assumes’ that the firm is able to reinvest project cash flows at the project’s
internal rate of return.

32. The internal rate of return (IRR) is the

a. Hurdle rate.
b. Rate of interest for which the net present value is greater than 1.0.
c. Rate of interest for which the net present value is equal to zero.
d. Rate of return generated from the operational cash flows.

A firm with an 18% cost of capital is considering the following projects ( January 1, year 1):
January 1, Year 1 December 31, Year 5 Project’s
Internal
Cash Outflow Cash inflow Rate of Return
Project A 3,500,000 7,400,000 16%
Project B 4,000,000 9,950,000 ?

33. Using the net-present-value (NPV) method project A's net present value is ,
a. 316,920 c. (265,460)
b. 23,140 d. (316,920)

34. Project B’s internal rate of return is closest to

a. 15% c. 18%
b. 16% d. 20%