CAPITAL BUDGETING

NO NEED TO SHOW YOUR SOLUTIONS. ROUND OFF YOUR ANSWERS TO THE NEAREST SECOND DECIMAL POINT.

1. Gamma Electronics is considering the purchase of testing equipment that will cost P500,000 to replace old
equipment. Assume the new equipment will generate after-tax savings of P250,000 per year over the next four
years.
[A] What’s the payback period for the investment? 2.0 years
[B] If the firm has a 15% cost of capital, what’s the discount payback period of the investment? 2.6 years
[C] If Gamma Electronics has a 15% cost of capital, what’s the NPV of the investment? 213,745
[D] If Gamma Electronics has a 15% cost of capital, what’s the IRR of the investment? 34.9%
[E] If Gamma Electronics has a 15% cost of capital, what’s the profitability index of the investment? 1.4

2. The cash flows associated with an investment project are as follows:

Cash Flows
Initial Outflow - P 70,000
Year 1 20,000
Year 2 30,000
Year 3 30,000
Year 4 30,000
[A] What’s the payback period of the project? If a firm’s cut-off payback period is 3 years, should it accept the
project? 2.7 years; accept the project
[B] If a firm uses discounted payback with a 15% discount rate and a 3-year cut-off period, what’s the discount
payback period of the project? Should the firm accept the project? 3.6 years; reject the project

3. A piece of equipment costs P1,200,000. The equipment has a useful life of 4 years. In each of the four years, the
investment generates a cash inflow of P500,000. The impact of the investment project on net income is derived by
subtracting depreciation from cash flow each year.
[A] Assume the equipment is depreciated on a straight-line basis over 4 years, what is the average contribution to
net income across all four years? P200,000
[B] Assume the equipment is depreciated on a straight-line basis over 4 years, what is the average accounting rate of
return? 33.3%
4. Suppose a particular investment project will generate an immediate cash inflow of P1,000,000 followed by cash
outflows of P500,000 in each of the next three years. What is the project’s IRR? Suppose a company’s hurdle rate is
15%, should it accept the project? 23%; reject the project

5. Suppose a particular investment project will require an initial cash outlay of P1,000,000 and will generate a cash
inflow of P500,000 in each of the next three years. What is the project’s IRR? Suppose a company’s hurdle rate is
15%, should it accept the project? 23%; accept the project

6. Future Semiconductors is evaluating a new etching tool. The equipment costs P1,000,000 and will generate after-tax
cash inflows of P400,000 per year for six years. Assume the firm has a 15% cost of capital. What’s the NPV of the
investment? P510,000
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7. A firm has 10 million shares outstanding with a current market price of P20 per share. There is one investment
project available to the firm. The initial investment of the project is P20 million, and the NPV of the project is P10
million. What will be the firm’s stock price if capital markets fully reflect the value of undertaking the project? P21

8. Delta Pharmaceuticals has 200 million shares outstanding with a current market price of P30 per share. Its stock rose
to P32 on the news that Delta Pharmaceuticals’ long-awaited new drug AntiCovid is to hit the market next month.
What’s the market’s consensus of the NPV that the new drug will generate for Delta Pharmaceuticals? P400,000,000

9. CJA Industries has 100 million shares of common stock outstanding with a current market price of P50. The firm is
contemplating undertaking an investment project which requires an initial cash outflow of P100 million. The IRR of
the project is equal to the firm’s cost of capital. What will be the firm’s stock price if capital markets fully reflect the
value of undertaking the project? P50

10. Consider a project with the following cash flows.

Year Cash Flow
0 -P16,000
1 42,000
2 -27,000

What’s the IRR of the project? If a firm’s cost of capital is 15%, should the firm accept the project? 12.5% and 50%;
accept the project

11. Consider a project with the following stream of cash flows.

Year Cash Flow
0 P80
1 -388
2 700
3 -557
4 165

What’s the IRR of the project? If a firm’s cost of capital is 15%, should the firm accept the project? 0%, 10%, 25%,
50%; accept the project

12. A firm is evaluating two investment proposals. The following data is provided for the two investment alternatives.
Initial cash outflow IRR NPV (@18%)
Project 1 P250,000,000 28% P80,000,000
Project 2 P 50,000,000 36% P20,000,000
[A] If the two projects are independent, which project should the firm choose based on the IRR rule ? Both Project 1
and Project 2
[B] If the two projects are mutually exclusive, which project should the firm choose? What is the problem that the
firm should be concerned with in making this decision? The firm should choose Project 1; the firm should be
concerned of the project scale
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13. CJA Industries is evaluating two investment proposals. The scale of Project 1 is roughly 4 times that of the Project 2.
The following data is provided for the two investment alternatives.
IRR
Project 1 28%
Project 2 50%
Incremental Project 26%

[A] If the two projects are mutually exclusive, and the firm’s hurdle rate is 18%, which project should the firm
choose? The firm should choose Project 1.

14. Princess Manufacturing is considering two investment proposals. The first involves a quality improvement project,
and the second is about an advertising campaign. The cash flows associated with each project appear below.
Quality Improvement Project Advertising Campaign
Cash Outflow -100,000 -100,000
Year 1 10,000 P80,000
Year 2 30,000 45,000
Year 3 125,000 10,000

[A] Suppose the hurdle rate of the firm is 10%. Calculate the cash flows of the “incremental project” by subtracting
the cash flows of the second project from the cash flows of the first project. What is the IRR of the incremental
project? 17.9%
[B] Suppose the hurdle rate of the firm is 10%. If the two projects are mutually exclusive, which project should be
chosen? What is the problem that the firm should be concerned with in making this decision?

15. The following information is given on three mutually exclusive projects. Assume a cost of capital of 15%. What are
the Profitability Indexes of the following projects and which has highest PI?
Project 1 Project 2 Project 3
Cash flow
Year 0 -P400,000 -P500,000 -P1,000,000
Year 1 200,000 300,000 500,000
Year 2 300,000 300,000 700,000
Year 3 300,000 350,000 700,000
P1 = 598,011/400,000 = 1.495 or 1.50
P2 = 717,843/500,000 = 1.436 or 1.44
P3 = 1,424,345/1,000,000 = 1.424 or 1.42
Project 1 is the highest.

16. You are provided with the following data on two mutually exclusive projects. The cost of capital is 15%.
Project 1 Project 2
Initial cash outflow -P5,000 -P1,000
Year 1 cash inflow P5,000 P1,000
Year 2 cash inflow P2,500 P 850
NPV P1,238 P 512
PI 1.25 1.51
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Which project should you accept? What is the problem that you should be concerned with in making this decision?
Project 1; The problem is because of project scale.

17. CJA Company is considering a project with the following cash flows.
Year Cash Flow
1 (P20,000)
2 P 3,000
3 P 4,000
4 P 5,000
5 P 6,000
6 P 7,000
[A] What is the payback period of the proposed CJA Company project? 4.28 years
[B] What is the net present value of the proposed CJA Company project if the discount rate is 6%? P572
[C] What is the profitability index of the proposed CJA Company project if the discount rate is 6%? 1.03
[D] What is the IRR of the proposed CJA Company project? 6.91%
[E] What is the discounted payback period of the proposed CJA Company project if the discount rate is 6%? 4.89%
[F] What is the profitability index of the proposed CJA Company project if the discount rate is 6%? 1.03

18. CJA is considering a new cat food factory with the following cash flows,
Year Cash Flows
0 P (250,000.00)
1 40,000.00
2 120,000.00
3 80,000.00
4 30,000.00
5 25,000.00
6 15,000.00
[A] What is the payback?
[B] If CJA’s discount rate is 10% what is the NPV?
[C] If the discount rate is 10% what is the PI?
[D] What is the IRR?

19. Clarizze Pharma Unlimited is considering a vaccine for the Covid 19 new cat nip factory with the following cash
flows, if the discount rate is 7%, what are the PI and the IRR?
Year Cash Flows
0 (P2,000,000)
1 200,000
2 650,000
3 500,000
4 500,000
5 500,000
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6 350,000
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