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CAPITAL BUDGETING

[Problem 1]

Purchase price

Trade-in allowance

Saving from repairs

Additional tax on savings (P25,000 x 40%)

Net cost of investment for decision analysis

P140,000

( 7,000)

( 25,000)

10,000

P118,000

[Problem 2]

Purchase price

P4,800,000

Freight and installation

45,000

Trade-in allowance

( 200,000)

Salvage value of other assets

12,000

Tax savings – other assets

(

8,000)

Savings from repairs

( 400,000)

Add’l tax on savings from repairs (P400,000 x 40%) 160,000

Additional working capital

350,000

Net cost of investment for decision analysis

P4,759,000

[Problem 3]

Purchase price

Freight charge

Installation costs

Special attachment

Add’l working capital

Proceeds from sale of old assets

Tax savings (P38,000 x 25%)

Savings from repairs

P900,000

25,000

22,000

55,000

110,000

( 22,000)

( 9,500)

( 120,000)

Add’l tax on savings from repairs (P120,000 x 25%)

30,000

Net cost of investment for decision analysis

P990,500

[Problem 4]

Furnishing and equipment

Rental deposits

Accounts receivable (P9M x 1/3 x 2/3)

Inventory

Cash

Net cost of investment for decision analysis

P 500,000

200,000

2,000 000

400,000

120,000

P5,020,000

[Problem 5]

1. Sales

Materials

Labor

Factory overhead

Selling and administrative expenses

Depreciation expense (P1,200,000 ÷ 5 yrs)

Income before income tax

Tax (30%)

Net income

**P6,000,000
**

( 800,000)

( 1,200,000)

( 540,000)

( 700,000)

( 240,000)

2,520,000

( 756,000)

1,764,000

**Add back: Depreciation expense
**

2. Annual net cash flows

240,000

P2,004,000

[Problem 6]

1.

Weighted Average Cost of Capital (WACOC) = ?

Sources of

capital

Market values

Individual Cost of

Capital Mix

Capital

Fraction

Mortgage bonds

(P300,000 x 105%) = P315,000

(10% x 55%) = 5.5%

Preferred equity

(2000 sh x P96)

=

192,000

(P12 / P96) = 12.5

192 / 1.007

Common equity

(50,000 sh x P10)

=

500,000

P1.50 / P10 = 15.0

500 / 1.007

Total

WACOC

315 / 1.007

P1,007,000

1.72%

2.38%

7.45%

11.55%

**Preferred dividends = 12% x P100 = P12 / sh
**

Earnings per share = P75,000 / 50,000 sh = P1.50

2.

Proposed

Investment

A

B

C

ROI

7%

10%

14%

WACOC

11.55%

11.55%

11.55%

Advise

Reject

Reject

Accept

Investments are to be accepted if the WACOC is higher than the ROI.

[Problem 7]

1.

New WACOC = ?

Cost of

Sources of

Money

Long-term

debt

Preferred

equity

Common

equity

Capital

6%

Amount

P10,000,000

11%

14%

Total

2.

Package 1

Package 2

WACOC

Amount

3%

P 2,000 000

**3,000,000 1.65%
**

7,000,000 4.90%

P20,000,000

9.55%

Package 3

WACOC

**11,000 000
**

7,000,

000

Amount

WACOC

0.60% P 6,000,000

1.80%

6.05%

5,000,000

2.75%

4.90%

9,000,000

P20,000,000 11.55% P20,000,000

6.30%

10.85%

Package 1 gives the invest WACOC at 9.55%.

[Problem 8]

Before Bonds Retirement

Amount

Bonds

Preferred

equity

Common

equity

After Bonds Retirement

WACOC

Amount

**P 5,000,000 (8% x 60% x 5/10) = 2.4%
**

1,000,000 (9% x 1/10)

= 0.9%

4,000,000 (12.5% x 4/10)

= 5%

WACOC

**P4,000,000 (8% x 60% x 4/10) = 1.92%
**

1,

000,000 (9% x 1/10)

= 0.90%

4,

000,000 (12.5% x 4/10)

= 5.0%

1,

000,000

Lease

Totals

10% x 60% x 1/10) = 0.60%

P

8.30% 10,000,000

P10,000,000

8.42%

[Problem 9]

a.

WACOC = ?

Funds

Mortgage bonds

Common stock

Ret earnings

Total

Amount

P20,000,000

25,000,000

55,000,000

Individual Cost of

Capital

WACOC

**[(6.5% x 50%) / 95%] 3.42% 0.684%
**

[(P4 x 105%) /P94 + 5%] 9.47 2.3675%

9.47 5.2085%

P100,000,000

8.26%

**b. The weighted average cost of capital is used as a benchmark in evaluating the acceptability or
**

rejection of proposed investment because it measures the point of expected return where the

minimum required return of each class of investor is met by reason of cross-subsidizing from

one class of security to another.

[Problem 10]

a. WACOC under each alternative

Debt

Equity

WACOC

b.

Alternative A

(9% x 50% x 2/6) = 1.5%

{[(P1/P20) + 7%] x 4/6} = 8.0%

9.5%

Alternative B

(12% x 50% x 4/6)

= 4.0%

{[(P0.90/P20) + 12%] x 2/6} = 5.5%

9.5%

**In alternative B, the amount of debt increases thereby increasing the debt equity ratio
**

signalling the firm is highly leveraged and more risky for investment. This tends to increase the

nominal rate of the bonds.

**c. Yes; it is logical for stockholders to expect a higher dividend growth rate under alternative B to
**

compensate the higher rate implied by an increase in the debt exposure of the firm and to

validate the theory that the more debt is used in the financing portfolio, the higher the

profitability rate of the firm, thereby, the higher the growth rate.

[Problem 11]

1.

Marginal Cost of Capital for each fund

2.

WACOC = ?

Capital

Mix

[b]

Sources

Rate

WACOC

Mortgage bonds

15.00%

1.26%

Debentures

25.00%

2.175%

Preferred stock

10.00%

1.36%

Common stock

16.67%

2.11%

(P1.80 / P67.50 + 10%)=12.67%

Retained earnings

33.33%

4.22%

= 12.67%

100.00%

11.125%

3. Maximum point of expansion for retained earnings:

Net income (P4.50 x 15 million shares)

P67,500,000

Common dividends (P67,000,000 x 40%

[a]

Individual COC

(14% x60%)

= 8.4%

(145% x 60%)

= 8.7%

(P13.50/ P99.25) = 13.60%

or P1.80 x 15 million)

( 27,000,000)

Preferred stock dividends

( 6,750,000)

Retained earnings available for expansion P33,750,000

Common equity = 50% of total capitalization

Maximum point of expansion before common stock

shares are issued = P33,750,000 / 50% = P67.5M

4. The WACOC varies among firms in the industry even if the basic business risk is similar for all

firms in the industry. This is true because each firm selects the degree of financial leverage it

desires. This financial leverage affects the capital mix structure of a firm that affects the

determination of the weighted average cost of capital.

[Problem 12]

1.

WACOC before and after bond retirement:

[1] Before Bond Retirement

Capital

Amount

[2] After Bond retirement

WACOC

Amount

Lease

WACOC

P1,000,000 (10% x 60% x 1/10) = 0.6%

8% Debentures

9% Preferred

stock

Common stock

Retained

earnings

P5,000,000 8% x 60% x 5/10) = 2.4%

4,000,000

(8% 60% x 4/10) = 1.92%

1,000,000

(9% x 1/10) = 0.9%

1,000,000

{same} 0.9%

2,000,000

(13% x 2/10) = 2.6%

2,000,000

{same} 2.6%

2,000,000

(13% x 2/10) = 2.4%

2,000,000

{same} 2.4%

8.30% P10,000,000

8.42%

P10,000,000

**2. The component costs and the weighting used to calculate the WACOC in a-1 is different in a-2
**

because P1 M of debentures are replaced by lease which is more expensive (from 8% to 10%

nominal rate). This brings up the WACOC to 8.42%.

3. Market values should be used in calculating the WACOC because COC calculation is used to

estimate the current marginal cost of capital for the company. The use of market values

a. recognizes the current investor attitudes regarding the company’s risk position and will

reflect current rates for capital.

b. recognizes better the capital proportions the company must consider in the capital sources

decision; and

c.

ignores the influence of past values which are not relevant to future decision.

[Problem 13]

1. The board member’s agreement is incorrect because the facts seem to indicate that Kia

Corporation’s capitalization is not in optimum mix (i.e., equilibrium). The issuance of new debt will

increase the financial leverage of the firm, increases the risk, increases the note’s nominal rate,

and decreases the earnings multiple. While the marginal cost of capital is a combination of

explicit interest cost on the notes and the additional cost of earnings that must occur to

compensate the common stockholders for the decline in the earnings multiple. The 14% return in

this project should be compared with the new weighted average cost of capital if the issuance of

note is undertaken.

2. New level of annual earnings of the earnings multiple declines to 9 =?

1.

**Present market price per share = 10(P2.70) = P27.00
**

Required EPS (new) = P27/9 = P3.00

Required earnings before tax

(P3.00 x 10,000,000 shares / 50%)

P 60,000,000

Interest expense

**[(P10 M x 8%) + (P50M x 10%)]
**

5,800,000

Required earnings before interest and taxes

65,800,000

Less: Old earnings before interest and taxes

{[(P2.70 x 10,000,000 shares) / 50%] + P800,000} 54,800,000

Additional earnings before interest and taxes

P 11,000,000

**Additional informational analysis:
**

If the earnings multiple declines to 9, the additional earnings provided by the new

assets to maintain the same market price per share of P27 shall be:

X = additional earnings

(new P/E) (new EPS) = P27

9 ( P2.70 + X) = P27

2.70 + X = P3

X = P0.30

[Problem14]

1. Breaks = ?

Breaks or increases in weighted marginal cost of capital will recur as follows:

For Debt = Debt / Debt Ratio

= P100,000 / 40% = P250,000

For Equity = Equity / Equity Ratio = P150,000 / 60% = P350,000

2. WACOC = ?

a. Before the break (P1 – P250,000 amount of financing)

i. Debt = 7% x 40% = 3.2%

ii. Equity = 18% x 60% = 10.8%

iii. WACOC

14.0%

b. After the break (P250,001 – above amount of financing)

Debt = 10% x 40% = 4.0%

Equity = 22% x 60% = 13.2%

WACOC

17.2%

3. Graph of marginal cost of capital (MCC) schedule and investment opportunities schedule

(IOC):

26

24

IRR (

)

22

A

MCC (------)

20

18

B

MCC

16

14

12

C

10

8

6

4

2

0

100

200 225 300

**400 450 500 (new financing,
**

thousands of

pesos)

**4. Projects are to be accepted as long as the IRR is greater than the MCC. Projects A and B are
**

acceptable; based on the following:

Project

A

B

C

IRR

19%

15%

12%

MCC

14%

14%

17.20%

Advise

Accept

Accept

Reject

[Problem15]

1. EPS and market price per share = ?

a. Raise P100,000 by issuing 10-year, 12% bonds

Case 1

Sales

P 400,000

- Costs and operating expenses (90%)

360,000

EBIT

40,000

-Interest charges

[P2,000 + (12% x P100,000)]

14,000

IBIT

26,000

- Tax (50%)

13,000

Net Income

P 13,000

Earnings per share

(NI / 10,000 shares)

Price / earnings rates

Market price per share

EPS (old)

= P36 / 12

=

No. of shares = P30,000 / P3 =

b.

P1.30

10x

P13

Case 2

P 600,000

540,000

60,000

Case 3

P 800,000

720,000

80,000

14,000

46,000

23,000

23,000

14,000

66,000

33,000

33,000

P

P

P2.30

10x

P23

P3.30

10x

P33

Case 1

P 400,000

360,000

40,000

2,000

38,000

19,000

P 19,000

Case 2

P 600,000

540,000

60,000

2,000

58,000

29,000

P 29,000

Case 3

P 800,000

720,000

80,000

2,000

78,000

39,000

P 39,000

P1.46

12x

P17.52

P2.23

12x

P26.76

P3.00

12x

P36

13,000

13,000

13,000

3

10,000 sh

**Raise P100,000 by issuing new column stock
**

Sales

- Costs and D Exp (90%)

EBIT

-Interest expense

IBIT

- Tax (50%)

Net Income

Earnings per share

(NI / 13,000Shares)

Price / earnings rates

Market price per share

No. of shares

(P100,000 / P33.33 + 10,000)

2. Recommended proposal = ?

The recommendation shall be based on the following criteria:

• Brief desorption of

the criteria

• The proposal chosen

Wealth Maximization

• Wealth maximization is

primordial

among

shareholders in as much

as this is the end

objective of business.

This wealth maximization

principle is represented

by the market price per

share.

• The total sales of the

firm should be higher

than P600,000, since its

sales last year was

already at P600,000. At

this level and more, the

market price per share is

higher by issuing a new

share of stock. Wealth

maximization

is

a

strategic

reason

of

managing a business,

hence,

at

guides

organization in its longterm decisions, such as

financing decision.

Profit Maximization

• Profit maximization

is a short-run strategy

to satisfy the interest

of shareholders. This

profit

maximization

strategy

is

.best

represented by the

earnings per share.

**3. No, the financing package chosen would be the same. The higher the level of sales in
**

excess of P600,000, the more favorable it is on the part of the business!

4. The investment banker would rationalize that issuance of more debt securities would mean

a greater variability in earnings and higher risk of bankruptcy created by the fixed commitment

to pay debt interest and principal. This would bring restrain by diminishing the earnings

multiple to compensate the increased risk in leverage.

[Problem 16]

1.

Sales

P600,000

Out-of-pocket costs

( 450,000)

Depreciation expense (P500,000/5)

( 100,000)

IBIT

50,000

Tax (40%)

( 20,000)

Net income

30,000

Depreciation expense

100,000

Annual cash inflows

P130,000

Payback period

= P500,000 / P130,000

=

3.85 yrs

2.

3.

4.

25.97%

6%

12%

Payback reciprocal

ARR (original)

ARR (average)

[Problem 17]

= 1 / 3.85

= P30,000/P500,000

= [P30,000 / (P500,000/2)[

=

=

=

Year

1

2

3

4

Annual

Cash

Income,

Net of Tax

P 70,000

90,000

85,000

160,000

Total

Cash to

Date

P 70,000

160,000

245,000

400,000

Payback

Period

1

1

1

0.97

(155,000/160,000)

3.97

yrs.

[Problem 18]

Year

1

2

3

4

**Net Cash Cash to
**

Inflows

Date

P300,000 P300,000

400,000

700,000

200,000

900,000

150,000 1,000,000

Salvage

Total

Value

Cash

P200,000 P500,000

100,00

800,000

50,000

950,000

20,000 1,000,000

Total

Payback

Period

1

1

1

0.53

3.53

[Problem 19]

1.

Cash flows before tax

Depreciation expense (P1,000,000/ 10)

IBIT

Tax (40%)

Net income

2.

**(100,000 - 20,000
**

150,000

yrs.

P200,000

( 100,000)

100,000

( 40,000)

P 60,000

**ARR (original) = P60,000 / P1 million
**

=

ARR (average) = [P60,000 / (P1 million/2)] =

6%

12%

[Problem 20]

1.

Sales

P4,000,000

Out-of-pocket costs

( 3,100,000)

Depreciation expense [(P2M x 80%)/5]

( 320,000)

IBIT

580,000

Tax (40%)

( 232,000)

Net income

348,000

Add: Depreciation expense

320,000

inflows

P 668,000

Payback period = P 2 million / P668,000

=

2.99 yrs.

2.

Payback reciprocal = 1 / 2.99

=

33.44%

3.

Payback bailout period = [(P4 4M x 80%) / P668,000] = 4.79 yrs.

4.

ARR (original) = P348,000 / P4 M

= 8.7%

5.

ARR (average) = [(P348,000 / (P4 M + P800,000) / 2] = 14.5%

[Problem 21]

1.

Cash flows before tax

- Tax [(P15,000 – P5,000) 40%]

Cash flows after tax

Payback period (P40,000 / P11,000)

P15,000

4,000

P11,000

3.64 yrs.

Annual net cash

2.

**Cash flows after tax
**

P11,000

Less: Depreciation expense

5,000

Net income

P 6,000

ARR (original) = P6,000 / P40,000 = 15%

[Problem 22]

1.

PVCI:

Annual cash inflows (P300,000 x 3.127) P938,100

Salvage value (P20,000 x 0.437)

8,740 P946,840

Less: COI

800,000

Net present value

P146,840

2.

Profitability index = P946,840 / P800,000 = 1.184

3.

NPV index = P146,840 / P800,000

= 0.184

[Problem 23]

1.

Year

1

2

3

4

5

SV

2.

3.

Annual

PVF at

Cash

12%

PVCI

Inflows

P350,000

0.893

P312,550

250,000

0.797

199,250

150,000

0.712

106,800

100,000

0.636

63,600

50,000

0.567

28,350

30,000

0.567

17,010

Total

727,560

Less: Cost of investment 600,000

Net present value

P 127,560

**Profitability index = (P727,560/P600,000) = 1.21
**

NPV index

= P127,560 / P600,000 = 0.21

[Problem 24]

PVF at

Year

14%

Proj. 1

Proj. 2

Proj. 3

1

0.877

P2,104,800 P4,823,500 P175,400

2

0.769

1,691,800

1,999,400

461,400

3

0.675

1,215,000

472,500

675,000

4

0.592

651,200

118,400

473,600

SV

0.592

118,400

118,400

47,360

Total PVCI

P5,781,200 P7,532,200 P1,832,760

COI

P5,000,000 P8,000,000 P1,400,000

Profitability index

1.16

0.94

1.31

The company should make investments on the following projects:

Rank 1

Proj. 3

P 1,400,000

Rank 2

Proj. 1

5,000,000

Total investment

P 6,400,000

[Problem25]

1.

**Annual cash inflows:
**

(P500,000 x 3.889)

(P400,000 x 3.889)

Salvage value

(P100,000 x 0.456)

Recovery of working capital

(P200,000 x 0.456)

(P1,400,000 x 0.456)

Total PV of cash inflows

Less: COI

(P1,400,000 + P200,000)

(P200,000 + P1,400,000)

Net present value

2.

Profitability index (PVCI / COI)

Produce

Distribute

Wooden

Toy

an Imported

Product

P 1,944,500

P

1,555,600

45,600

91,200

638,400

2,194,000

2,081,300

1,600,000

P

481,300

1.30

P

1,600,000

594,000

1.37

**3. The net advantage of investing in distributing an imported product is P112,700 (i.e., P534,000
**

– P481,300).

{Problem 26]

Year

1

2

3

4

Project X

Project Y

Cash to

Cash to

PVFC 14%

PVCI

PVCI

Date

Date

0.887 P 1,754,000 P 1,754,000 P 3,069,500 P 3,069,500

0.769

1,538,000 3,292,000

1,922,500

4,992,000

0.675

1,350,000 4,642,000

1,012,500

5,000,000

0.592

1,184,000 5,000,000

**Payback period – Proj X
**

Payback period – Proj Y

**[3 yrs. + (P358,000/P1,184,000)] 3.30 yrs.
**

[2 yrs. + (P8,000/P1,012,500)]

2.01 yrs.

[Problem 27]

a.

PVF Annuity =

b.

P520,000

P200,000

=

2.6

**Using Table 2 (PVFA Table), the IRR is computed as follows:
**

18%

2.690

0.090

2.600

2%

0.102

?

0.012

20%

IRR

=

18%

2.588

+

0.090

x 2%

= 19.75%

0.102

[Problem 28]

a.

PVF Annuity =

P800,000

P234,000 *

= 3.419

*** (P234,000 = [(Total cash inflows + SV) ÷ 5]
**

b.

**Using Table 2, the PVF of 3.419 is between 14% and 16%
**

b.1.

Using 16% and 18% discount rates we have:

PVCI @ 16%

Year

1

2

3

4

5

SV

Totals

b.2.

Cash Inflows

P

350,000

300,000

250,000

150,000

80,000

40,000

PVF

0.862 P

0.743

0.641

0.552

0.476

0.476

P

PVCI @ 18%

Amount

301,700

222,900

160,250

82,800

38,080

19,040

824,770

PVF

0.847 P

0.718

0.609

0.516

0.437

0.437

P

Amount

296,450

215,400

152,250

77,400

34,960

17,480

793,940

**Since the cost of investment of P800,000 is found the present value of cash inflows
**

(PVCI) of 16% and 18%, then by interpolation, the IRR, could be determined as:

Discount

rate

PVCI

16%

2%

P824,770

800,000

24,770

?

30,830

6,060

18%

IRR

=

16%

793,940

+

24,770

x 2%

30,830

= 17.61%

[Problem 29]

1.

PV of cash dividends (1,400 shares x P20 x 3.791)

PV of stock sales (P200,000 x 0.621)

PV of the shares of stock

Less: Cost of the share of stock

Net present value

2

P106,148

124,200

230,348

203,000

P 27,348

a)

PV

Annuity

b)

P230,000

=

**= P203,000 = 2.988
**

{[(1,400 x P20) x 5 + P200,000] + 5}

P68,000

Using Table 2 (PVFA Table), we have:

20%

2.991

2.985

0.006

2%

0.127

?

22%

IRR

=

20%

0.121

2.864

+

0.006

0.127

x 2%

= 20.09%

[Problem 30]

Background analysis:

Cash savings before depreciation (P138,600 - P91,300) P47,300

Less: Depreciation expense

20,000

Income before income tax

27,300

Less: Tax (40%)

10,920

Net Income

16,380

Add: Depreciation expense

20,000

Annual Cash Inflows

P36,380

1.

2.

3.

4.

5.

6.

7.

Payback period

= P160,000/P36380

= 4.40 yrs.

Payback reciprocal = 1/.P4.40

= 22.73%

ARR (original)

= P16,380/P160,000

= 10.24%

ARR (average)

= P16,380/(P160,000/2)

= 20.48%

PVCI (P36,380 x 5.747)

P209,076

Less: Cost of Investment

160,000

Net Present Value

P 49,076

Profitability index = P209,076/P160,000

= 1.31

NPV index

= P49,076/P160,000

= 0.31

a. PVF annuity = P160,000/P36,380

= 4.398

b. Using Table 2, we have:

14%

2%

4.639

4.398

0.241

0.295

?

0.054

16%

IRR

=

14%

4.344

+

0.241

0.295

x 2%

[Problem 31]

Depreciation

Expense

Tax Effect

PV of Tax

PVF

at

Year

8% Savings

SY

SL

P(444,480

1 P3.2M P2.0M P1.2M P(480,000) 0.926

)

2 2.4M 2.0M 0.4M (160,000) 0.857 (137,120)

= 15.63%

3

4

1.6M

0.8M

Total

2.0M (0.4M)

2.0M (1.2M)

160,000

480,000

**0.794 127,040
**

0.735 352,800

P101,760

[Problem 32]

Straight Line

Method

(P2,400,000 P1,430,000)

Sum-of-theyears-digit

method

Cash

Net Cash

Flows

Inflows

Before

Dep.

Tax

Expense

IBIT

Tax (30%)

Net

Dep.

After

Income

Expense

Tax

P970,000

P360,000

P610,000

P183,000 P427,000 P360,000

Year 1

P970,000

640,000

330,000

99,000

231,000

640,000

871,000

Year 2

P970,000

560,000

410,000

123,000

287,000

560,000

847,000

Year 3

P970,000

480,000

490,000

147,000

343,000

480,000

823,000

Year 4

P970,000

400,000

570,000

171,000

399,000

400,000

799,000

Year 5

P970,000

320,000

650,000

195,000

455,000

320,000

775,000

Year 6

P970,000

240,000

730,000

219,000

511,000

240,000

751,000

Year 7

P970,000

160,000

810,000

243,000

567,000

160,000

727,000

Year 8

P970,000

80,000

890,000

267,000

623,000

80,000

703,000

1.a. Annual

cash inflows

after tax:

P787,000

**Alternately, cash inflows after tax may be computed by deducting the corresponding income
**

tax from the cash flows before tax. The tax expense equals cash flows before tax less

depreciation expense.

b.

**Net present values, straight-line method and SYD method
**

PVCI:

Regular(P787,000 x 5.747)

Y1 (P871,000 x 0.926)

Y2 (P847,000 x 0.857)

Y3 (P823,000 X 0.794)

Y4 (P799,000 X 0.735)

Y5 (P775,000 X 0.681)

Y6 (P751,000 X 0.630)

Y7 (P727,000 X 0.583)

Y8 (P703,000 X 0.540)

SV (P120,000 X 0.540)

Recovery of working capital

(P400,000 x 0.540)

Cost of investment(P3M +

P400,000)

Net present value

**Advantage of the SYD method
**

2.

Straight-line

P4,523,889

SYD

P806,546

725,879

653,462

587,265

527,775

473,130

423,841

379,620

64,800

64,800

216,000

(3,40

0,000)

P1,403.689

216,000

(3,400,000)

P1,458,328

P

54,639

**The tax benefit using SYD method instead of the straight-line method is P54,639 (i.e.,
**

P1,458,328 - P1,403,689).

[Problem 33]

1.

Purchase price

PV of lease payments (P30,000 x 5.650)

PV of salvage value (P200,000 x 0.322/64,400)

PV of tax savings on depreciation expense

(P200,00 x 35% x 5.650)

PV of tax savings on lease payments

(P300,000 x 35% x 4.65)

PV of relevant costs

2.

Buy

P2,200,000

(

64,400)

(

395,500)

P1,740,100

**Net Advantage of leasing
**

PV of annual savings (P638,350/5.65)

Lease

P1,695,000

( 64,400)

( 93,250)

P1,101,750

P638,350

P112,982

[Problem 34]

1.

Payback period = P35,000/P10,000 = 3.5 yrs.

2.

**PVCI (P10,000 x 3.785)
**

Less: Cost of investment

Net present value

3.

Amount of investment

six years ago

P37,850

35,000

P 2,850

=

=

=

P35,000

Future Value Factor @ 15%, n = 6

P35,000

2.313

P15.132

[Problem 35]

1.

PV of cash dividends (20,000 shares x P4 x 3.605) P288,400

PV of stock sales (P500,000 x 115% x 0.567)

326,025

PV of shares of stock

614,425

Less: cost of investment

500,000

Net present value – common stock

P114,425

2.

**PV of interest receipts (P500,000 x 14% x 3.605)
**

PV of bond redemption (P500,000 x 150% x 0.567)

PV of bonds

Less: Cost of investment

Net present value – bonds

P252,350

425,250

677,600

500,000

P177,600

**3. The investment in bonds is more advantageous by P63,175 (i.e., P177,600 – P114,425) than
**

the investment in stock.

[Problem 36]

1.

Cost of investment

Less: Present values of inflows:

Y1 (P120,000 x 0.893)

Y2 (P240,000 x 0.797)

Y3 (P360,000 x 0.712)

Present value of year 4 inflows

÷ PVFC 12%, year 4

P681,960

(107,160)

(191,280)

(256,320)

127,200

0.636

Cash inflows, year 4

P200,000

2.

**PV of savings (P700,000 x 5.197)
**

Less: Cost of investment

Net present value of intangible benefits

**P3,637,900
**

3,000,000

P 637,900

3.

**PVF Annuity = P1,027,750 = 4.11*
**

P250,000

*Using table 2, 4.11 at 12% = 6 yrs.

[Problem 37]

1.

Y1 - Y3

Savings from labor and

materials

Increase in maintenance

(P6,000 x 12)

**Annual cash savings
**

2.

Y4 - Y5

P 820,000

P 820,000

(72,000)

P 784,000

(72,000)

P 784,000

PVCI

Regular cash (P784,000 x 3.433)

P2,567,884

Salvage value (P180,000 x 0.579)

93,420

Less: Cost of investment (P2,700,000 – P70,000)

Net present value

.

**P2,661,304
**

2,630,000

P (31,304)

3.

Annual cash savings

Depreciation expense

P

**P2,700,000 - P180,000
**

5 yrs.

Y1 - Y3

748,000

Y4 - Y5

748,000

(504,000)

[P504,000 + (P150,000/2)]

**Income before income tax
**

Less: Tax (40%)

Net income

Add: Depreciation expense

Annual cash inflows

P

P

244,000

97,600

146,400

504,000

650,400

(579,000)

169,000

67,600

101,400

579,000

P 680,400

PVCI

Y1 – Y3 (P650,400 x 2.322)

P1,510,229

Y4 (P680,400 x 0.592)

402,797

Y5 (P680,400 x 0.519)

353,128

Salvage value – new (P150,000 x 0.519)

77,850

Less: Cost of investment (P2,700,000 – P70,000

Net present value

[Problem 38]

1.

Make

Relevant cost to buy / make

Buy

**P2,344,004
**

2,630,000

P (285,996)

Year 1 (50,000 x P22 x 0.893)

982,300 P

1,294,850 (50,000 x P29 x 0.893)

Year 2 (50,000 x P22 x 0.797)

P

876,700

1,155,650 (50,000 x P29 x 0.797)

Year 3 (52,000 x P22 x 0.712)

814,528

1,032,400 (50,000 x P29 x 0.712)

Year 4 (55,000 x P22 x 0.636)

769,560

1,014,400 (55,000 x P29 x 0.636)

Year 5 (55,000 x P22 x 0.567)

686,070

904,365 (55,000 x P29 x 0.567)

**Avoidable fixed overhead
**

(P45,000 x 3.605)

162,225

Salvage value - old asset

(1,500)

Salvage value - new (P12,000 x 0.567)

(6,804)

**Tax savings on depreciation expense
**

Year 1 (P384,000 x 40% x 9.893)

(137,165)

Year 2 (P230,400 x 40% x 0.797)

(73,452)

Year 3 (P138,240 x 40% x 0.712)

(39,371)

Year 4 (P82,944 x 40% x 0.636)

(21,101)

Year 5 (P 124,416 x 40% x 0.567)

(28,218)

PV of relevant costs - 5 yrs.

P

3,883,772 P

Net advantage of making in 5 yrs.

P

1,517,913

2.

5,401,685

**Some of the non-financial and qualitative factors to be considered before deciding whether
**

to make or buy a part are:

a.

Availability of materials from supplier.

b.

Stability of prices of material.

c.

Quality of parts to be supplied.

d.

Dependability of past supplier.

e.

Impact of new technology.

[Problem 39]

1. Increase in direct materials [(P4.50 – P3.80) x 80,000]

Decrease in direct labor and variable

overhead (P1.60 x 80,000)

Net operating cash savings before tax

P (56,000)

128,000

P 72,000

Years

1

Cash savings before tax

Less: Depreciation expense using SYD

P72,000

800,000

2

P72,000

640,000

3

4

P72,000

480,000

Income before income tax

(728,000)

(568,000)

(408,000)

Less: Tax (40%)

(291,200)

(227,200)

(163,200)

Net income (loss)

(436,800)

(340,800)

(244,800)

**Add: Depreciation expense
**

Annual cash inflows

2.

800,000

P363,200

640,000

P299,200

480,000

P235,200

P72,000

320,000

(248,000)

(99,200)

(148,800)

320,000

P171,200

**Regular operating cash inflows
**

(P363,200 + P299,200 + P235,200 + P171,200 + P107,200)

**Salvage value (P100,000 x 60%)
**

Total cash inflows

Less: Cost of investment

Net cash inflows

P 1,176,000

60,000

1,236,000

2,500,000

P(1,264,000)

5

P72,000

160,000

(88,000)

(35,200)

(52,800)

160,000

P107,200

**Zero, there is no excess of after tax cash inflows over the cost of initial investment because
**

the total cash inflow is even lower than the cost of investment.

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