ACC 223

Capital Budgeting
PS Q– Problem Solving

1. Happy Corporation bought a piece of machinery with the following data:

Useful life 6 years

Yearly net cash inflow P45,000
Salvage value -0-
Internal rate of return 18%
Cost of capital 14%

The initial cost of the machinery was

a. P157,392.
b. P174,992.
c. P165,812.
d. impossible to determine from the information given.

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2. Leslie Industries is considering the purchase of a P100,000 machine that is expected to result in a decrease
of P15,000 per year in cash expenses. This machine, which has no residual value, has an estimated
useful life of 10 years and will be depreciated on a straight-line basis. For thi s machine, the
accounting rate of return would be
a. 10 percent.
b. 15 percent.
c. 30 percent.
d. 35 percent.
3. An investment project is expected to yield P10,000 in annual revenues, has P2,000 in fixed costs per
year, and requires an initial investment of P5,000. Given a cost of goods sold of 60 percent of
sales, what is the payback period in years?
a. 2.50
b. 5.00
c. 2.00
d. 1.25
4. A project has an initial cost of P100,000 and generates a present value of net cash inflows of P 120,000.
What is the project's profitability index?
a. .20
b. 1.20
c. .80
d. 5.00
5. Clarisse Corporation. faces a marginal tax rate of 35 percent. One project that is currently under
evaluation has a cash flow in the fourth year of its life that has a present value of P10,000 (after-tax).
Clarisse Corporation. assumes that all cash flows occur at the end of the year and the company uses 11
percent as its discount rate. What is the pre-tax amount of the cash flow in year 4? (Round to the
nearest peso.)

a. P15,181
b. P23,356
c. P9,868
d. P43,375
6. Sunny Corporation is considering the purchase of a new ocean-going vessel that could potentially
reduce labor costs of its operation by a considerable margin. The new ship would cost P500,000 and
would be fully depreciated by the straight-line method over 10 years. At the end of 10 years, the ship
will have no value and will be scuttled. Sunny Company’s cost of capital is 12 percent, and its
marginal tax rate is 40 percent.

What is the present value of the depreciation tax benefit of the new ship? (Round to the nearest
peso.)
a. P113,004
b. P282,510
c. P169,506
d. P200,000
7. If the ship produces equal annual labor cost savings over its 10-year life, how much do the annual
savings in labor costs need to be to generate a net present value of $0 on the project? (Round to the
nearest pesp.)

a. 68,492
b. P114,154

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 c. P88,492
d. P147,487
8. Sierra Corporation recently sold a used machine for P40,000. The machine had a book value of
P60,000 at the time of the sale. What is the after-tax cash f low from the sale, assuming the
company's marginal tax rate is 20 percent?
a. P40,000
b. P60,000
c. P44,000
d. P32,000
9. Faye 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.

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 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. P180,000
b. P210,000
c. P187,500
d. P144,996
10. Assume the company pays P250,000 for the machine. What is the expected internal rate of return on the
machine?

a. between 8 and 9 percent

b. between 3 and 4 percent
c. between 17 and 18 percent
d. less than 1 percent

11. A project under consideration by Cathryn Corporation would require a working capital investment of
P200,000. The working capital would be liquidated at the end of the project's 10-year life. If Close
Corporation has an after-tax cost of capital of 10 percent and a marginal tax rate of 30 percent, what is
the present value of the working capital cash flow expected to be received in year 10?

a. P36,868
b. P77,100
c. P53,970
d. P23,130
12. Braine Industries is considering two alternative ways to depreciate a proposed investment. The investment
has an initial cost of P100,000 and an expected five-year life. The two alternative depreciation
schedules follow:

Method 1 Method 2
Year 1 depreciation P20,000 P40,000
Year 2 depreciation P20,000 P30,000
Year 3 depreciation P20,000 P20,000
Year 4 depreciation P20,000 P10,000
Year 5 depreciation P20,000      P0

Assuming that the company faces a marginal tax rate of 40 percent and has a cost of capital of 10
percent, what is the difference between the two methods in the present value of the depreciation tax
benefit?

a. P7,196
b. P0
c. P2,878
d. P6,342
Sandy Creations is considering an investment in a computer that is capable of producing various
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images that are useful in the production of commercial art. The computer would cost P20,000 and have
an expected life of eight years. The computer is expected to generate additional annual net cash
receipts (before-tax) of P6,000 per year. The computer will be depreciated according to the straight-
line method and the firm's marginal tax rate is 25 percent.

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13. What is the after-tax payback period for the computer project?
a. 7.62 years
b. 3.90 years
c. 4.44 years
d. 3.11 years
14. What is the after-tax net present value of the proposed project (using a 16 percent discount
rate)?
a. P2,261
b. P(454)
c. P6,062
d. P(4,797)
Walter Corporation is considering an investment in a labor-saving machine. Information on this
machine follows:

Cost P30,000
Salvage value in five years P0
Estimated life 5 years
Annual depreciation P6,000
Annual reduction in existing costs P8,000

15. What is the internal rate of return on this project (round to the nearest 1/2%)?
a. 37.5%
b. 25.0%
c. 10.5%
d. 13.5%

16. Assume for this question only that Walter Co. uses a discount rate of 16 percent to evaluate
projects of this type. What is the project's net present value?
a. P(6,283)
b. P(3,806)
c. P(23,451)
d. P(22,000)
17. What is the payback period on this investment?
a. 4 years
b. 2.14 years
c. 3.75 years
d. 5 years

Resty Ironworks is considering a proposal to sell an existing lathe and purchase a new computer-
operated lathe. Information on the existing lathe and the computer-operated lathe follow:

Existing Computer-operated
lathe lathe
Cost P100,000 P300,000
Accumulated depreciation   60,000        0
Salvage value now   20,000
Salvage value in 4 years        0   60,000
Annual depreciation   10,000   75,000
Annual cash operating costs  200,000   50,000
Remaining useful life  4 years  4 years

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 18. What is the payback period for the computer-operated lathe?
a. 1.87 years
b. 2.00 years
c. 3.53 years
d. 3.29 years

19. If the company uses 10 percent as its discount rate, what is the net present value of the
proposed new lathe purchase?
a. P236,465
b. P256,465
c. P195,485
d. P30,422
20. The Willow Corporation has recently evaluated a proposal to invest in cost-reducing production
technology. According to the evaluation, the project would require an initial investment of P17,166
and would provide equal annual cost savings for five years. Based on a 10 percent discount rate, the
project generates a net present value of P1,788. The project is not expected to have any salvage value
at the end of its five-year life.

What are the expected annual cost savings of the project?

a. P3,500
b. P4,000
c. 4,500
d. P5,000
21. What is the project's expected internal rate of return?
a. 10%
b. 11%
c. 13%
d. 14%
Raymond Corporation is involved in the evaluation of a new computer-integrated manufacturing
system. The system has a projected initial cost of P1,000,000. It has an expected life of six years, with
no salvage value, and is expected to generate annual cost savings of P250,000. Based on Raymond
Corporation's analysis, the project has a net present value of P57,625.

22. What discount rate did the company use to compute the net present value?
a. 10%
b. 11%
c. 12%
d. 13%
23. What is the project's profitability index?
a. 1.058
b. .058
c. .945
d. 1.000
24. What is the project's internal rate of return?
a. between 12.5 and 13.0 percent
b. between 11.0 and 11.5 percent
c. between 11.5 and 12.0 percent
d. between 13.0 and 13.5 percent

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25. Carmie Jane recently invested in a project that promised an internal rate of return of 15 percent. If
the project has an expected annual cash inflow of P12,000 for six years, with no salvage value, how
much did Carol pay for the project?
a. P35,000
b. P45,414
c. P72,000
d. P31,708
26. Jillian Claire recently invested in a project that has an expected annual cash inflow of P 7,000 for
10 years, and an expected payback period of 3.6 years. How much did John invest in the
project?
a. P19,444
b. P36,000
c. P25,200
d. P40,000
27. The Renna Corporation is considering an investment in a project that generates a profitability
index of 1.3. The present value of the cash inflows on the project is P44,000. What is the net present
value of this project?
a. P10,154
b. P13,200
c. P57,200
d. P33,846
28. Kardo’s Retail is considering an investment in a delivery truck. Kardo has found a used truck that
he can purchase for P8,000. He estimates the truck would last six years and increase his store's net
cash revenues by P2,000 per year. At the end of six years, the truck would have no salvage value and
would be discarded. Kardo will depreciate the truck using the straight-line method.

What is the accounting rate of return on the truck investment (based on average profit and average
investment)?
a. 25.0%
b. 50.0%
c. 16.7%
d. 8.3%
29. Armand’s Armored Car Co. is considering the acquisition of a new armored truck. The truck is
expected to cost P300,000. The company's discount rate is 12 percent. The firm has determined that
the truck generates a positive net present value of P17,022. However, the firm is uncertain as to
whether its has determined a reasonable estimate of the salvage value of the truck. In computing the
net present value, the company assumed that the truck would be salvaged at the end of the fifth year
for P60,000. What expected salvage value for the truck would cause the investment to generate a net
present value of P0? Ignore taxes.

a. P30,000
b. P0
c. P55,278
d. P42,978

30. James Publishers is considering an investment that would require an initial cash outlay of
P400,000 and would have no salvage value. The project would generate annual cash inflows of
P75,000. The firm's discount rate is 8 percent. How many years must the annual cash flows be
generated for the project to generate a net present value of P0?
a. between 5 and 6 years

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b. between 6 and 7 years
c. between 7 and 8 years
d. between 8 and 9 years

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