ACCOUNTING 14 – MANAGEMENT ACCOUNTING

CAPITAL BUDGETING

EXERCISES:

PROBLEM 1
Jempoy Company is planning to purchase a new machine P100,000 with freight and installation costs
amounting P3,000. The old unit to be traded in will be given a trade-in allowance of P15,000. Other
assets that are to be retired as a result at the acquisition of the new machine can be salvaged and sold
for P6,000. The loss on retirement of these other assets is P2,000 which will reduce income taxes by P
800. If the new equipment is not purchased, extensive repairs on the old equipment will have to be
made at an estimated cost of P 8,000. This cost can be avoided by purchasing the new equipment.
Additional gross working capital of P24,000 will be needed to support operations planned with the new
equipment.

REQUIRED: Determine the net investment assigned to the new machine for decision analysis.

PROBLEM 2
Andit Company is planning to buy a new machine that can produce additional 20,000 units of product
per year. The product sells for P50 each. The cost associated with the product is P 30 per unit, exclusive
of depreciation on the new machine.

The new machine which is expected to last for 10 years will cost P500,000. No salvage value is expected
to be recovered at the end of its life.

The income tax rate is 35%

REQUIRED:
1. Accounting net income expected to be earned from the new machine.
2. Annual net cash flows from the new machine.

PROBLEM 3
RAM Company wants to compute its weighted average cost of capital for use in evaluating capita,
investment projects. The following data were provided by the company’s accountant.

Income after tax P 50,000

Income tax rate 35%
Capital Structure
Bonds payable, 12% 8 years P150,000
Preferred stock , 10% P 100 par
value 200,000
(current market price is P125)
Common stock: P 10 par value 100,000
(current market price is P30 50,000
Retained earnings
Total P500,000

REQUIRED: Determine the weighted average cost of capital.

PROBLEM 4
May Company is evaluating an investment proposal to acquire two new machine to be used its
manufacturing operations. The machines cost P60,000 each, inclusive of the value added tax of 12%.
There is a P3,000 total installation cost for the machines. The useful life of the machines is 5 years, no
salvage value. Annual net cash savings from the two machines is P20,000.

REQUIRED: Determine the payback period for the machines.

PROBLEM 5
Sisa Company is evaluating a plan, to expand its store space due to the expected increase in volume of
activities in the next few months. The expansion would cost P200,000 and would have a useful of 20
years with no salvage value. The expected increase in sales revenue is P 55,000 a year, and cash
expenses are P20,000 a year. The income tax rate is 35%

REQUIRED:
1. Compute the accounting rate of return
2. If Sisa’s cost of capital is 15% should the project be accepted?

PROBLEM 6
Below are cash flow data for two investment project that are being evaluated:

Project A Project B
Cash Flows:
Year 0 P(500,000) P(200,000)
Year 1 to 5 P180,000 per year P90,000 per year
Cost of Capital 20% 20%

REQUIRED:
1. Compute the net present value of the both projects.
2. Compute the profitability index for both projects.
3. Which project is more acceptable?

PROBLEM 7
An investment of P 200,000 can bring in the following annual cash income, net of tax:

First year P40,000

Second year 45,000
Third year 42,500
Fourth year 50,000
Fifth year 37,500
Sixth year 35,000

REQUIRED: Determine the payback period.

PROBLEM 8
An equipment costing P180,000 expected to have the following net cash inflows and scrap values:

Year Net Cash Salvage Value

Inflows End of Year
1 P 36,000 P90,000
2 54,000 60,000
3 60,000 30,000
4 48,000 6,0000

REQUIRED: Determine the payback bail-out period.

PROBLEM 9
An equipment costing P120,000 with an estimated economic life of five years, no salvage value is
expected to bring in net cash inflow of P 70,000 in the first year of operations, P50,000 in the second
year, P30,000 in the third year P 20,000 in the fourth year and P10,000 in the fifth year.
REQUIRED: Determine the net present value, assuming that the desired rate of return is 18%

PROBLEM 10
Using the data given in Problem 9 compute the net present value, assuming that the asset is expected to
have a scrap value of P 10,000 at the end of the 5 th year.

PROBLEM 11
Fermin Company plans to replace its machinery with a new one costing P200,000 with an estimated
useful life of ten years without scrap value. The old machinery has a book value of P20,000 and can be
sold for P 15,000. The acquisition of the new machinery will yield an annual cash savings of P 45,000
before income tax. Income tax rate is 35%

REQUIRED:
1. Net investment on the new machine
2. Net income (after tax)
3. Annual net cash inflows expected from the new machine
4. Payback period
5. Accounting rate of return based on:
a. Original Investment
b. Average investment
6. Net present value, assuming that the minimum desired rate of return is 15%
7. The discounted cash flows rate of return
8. Present value payback
9. Profitability Index
10. Payback reciprocal