TUNAY, ROSAN MAY A.

BSA II – B

Finals Module: 4th Assignment

Capital Investment Decisions

CHAPTER 13 CAPITAL INVESTMENT DECISION

Refer to Chapter 13 of your book.
Answer all multiple choice questions.

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1. Basics of Capital Investment

Keira Danes, manager of ABC Laboratory, is investigating the possibility of

acquiring some new test equipment. The equipment requires an initial outlay of
P300,000. To raise the capital, Keira will sell stock valued at P200,000 (the stock
pays dividends of P24,000 per year) and borrow P100,000. The loan for P100,000
would carry an interest rate of 6%. Keira figures that her weighted average cost of
capital is % [(2/3 x 0.12) + (1/3 x 0.06]. This weighted cost of capital is the discount
rate that will be used for capital investment decisions. 
Keira estimates that the new test equipment will produce a cash inflow of
P50,000 per year. Keira expects the equipment to last for 20 years. 

Required:
a. Compute the payback period.
b. Assuming that depreciation is P14,000 per year, compute the ARR (on total
investment)
c. Compute the IRR of the test equipment.
d. Should Keira buy the equipment?

2. Capital Investment with Competing Projects

A hospital is considering the possibility of two new purchases: a new x-ray

equipment and a new biopsy equipment. Each project would require an investment
of P750,000. The expected life for each is 5 years with no expected salvage value.
The new cash inflows associated with the two independent projects are as follows:

Yea X-Ray Equipment Biopsy Equipment

r
1 P375,000 P75,000
2 150,000 75,000
3 300,000 525,000
4 150,000 600,000
5 75,000 675,000

Required:
a. Compute the net present value of each project, assuming a required rate of 12%.
b. Compute the payback period for each project. Assume that the manager of the
hospital accepts only projects with payback period of 3 years or less. Offer some
reasons why this may be a rational strategy even though the NPV computed in
Requirement 1 may indicate otherwise.