SMARTS CPA REVIEW - DAVAO

(Southern Mindanao Academic Review & Training Services Inc.)

SMARTS Building, Rizal Street Extension, Davao City
LEOPOLDO D. MEDINA, CPA, MSA
October 2018 Examination

MANAGEMENT ADVISORY SERVICES –CAPITAL BUDGETING

Time value of money : A peso today is worth more than a peso a year from now
Projects that promise earlier returns are preferable to those that promise later returns

Methods that IGNORE the time value of money : Accounting rate of return
Payback period

Methods that CONSIDER the time value of money : Net present value
Internal rate of return
Profitability Index (preference decisions)
Accounting rate of return or
Simple rate of return or
Original investment outlay∨average investment∗¿
Annual Net Income After Tax ANIAT
Book value rate of return= ¿
originalinvestment + salvage value at the end
¿ ave . investment =
2

Investment outlay (original)

payback period=
Annual cash income after tax ACIAT → if cash inflows areuniform
If cash inflows are not uniform

Cash flow in a year Cumulative cash flows Payback period

1
1
1
Fractional part *

balance
¿ fractional part=
Cash flow for that year
Methods that consider the time value of money

Net present value : Future cash flows are discounted to their present value ;
The discount rate in the NPV method is usually based on a minimum required rate of
return such as a company’s cost of capital

PV of Net inflows
Less : PV of Net outflows
Net present value

Internal rate of return : the rate of return that equates the present value of the cash inflows and the present
value of the cash outflows, resulting in a zero NPV.

At IRR, NPV = 0
Thus,
PV of Net inflows = PV of Net outflows

3 steps
1. Calculate the IRR factor (basically the same as payback period)
2. Locate in the PVA table (usually, an excerpt of the table will be given)
3. Interpolate (if IRR expressed in 2 decimal places i.e. 11.83%, interpolation is required ; but if not,
then there’s no need to interpolate)

Numerato Denominat
r or
Lower rate X X
IRR factor (X)
Higher rate (X)
MANAGEMENT ADVISORY SERVIC ES OCTOBER 2018

X / X multiply by the difference in rate;

then the result is added to the lower rate

Profitability index = PV of Net inflows / PV of Net outflows

or NPV / PV of Net outflows

ACIAT : Annual cash inflow after tax

Approach 1 Approach 2

Annual cash inflows before tax Annual cash inflows before tax x (1-tax rate)
Less depreciation plus Depreciation tax shield
Annual net income before tax Depreciation x tax rate
Less tax ACIAT
Annual net income after tax ANIAT
Add depreciation
Annual cash income after tax ACIAT

Cash inflows → may be in the form of differential operating costs or savings or

incremental contribution margin

Depreciation tax shield is always based on differential depreciation (new vs old)

IF THERE IS NO TAX RATE GIVEN, THERE IS NO DEPRECIATION TAX SHIELD

SUMMARY OF INFLOWS, NET

ACIAT X tax rate X PVA factor =
Salvage value (new) X (1-tax rate) X PV factor =
Working capital X PV factor =
released
Less : Cash expense
during the life of the
asset (i.e. future
overhaul/repair of new)
X (1-tax rate) X PV factor = ( )
Net inflows
SUMMARY OF OUTFLOWS, NET
Cost of investment x1.0
Less : Salvage value
(old)* x1.0
Add : Working capital
required x1.0
Less : Overhaul of old
Needed now x1.0
Net outflows
*Salvage value (old)

Proceeds Proceeds
-Book value of old -Book value of old
Gain on sale (if P > BV) Loss on sale (if P < BV)
X Tax rate X Tax rate
Tax on gain Tax savings on loss

Salvage value Salvage value

Less : tax on gain Add : tax savings on loss
*Salvage value to be deducted from *Salvage value to be
Investment outlay deducted from Investment
outlay

How to determine increase or decrease in units given an NPV

NPV (positive)
Divide by PVA factor
Divide by (1-tax rate)
Divide by CM per unit
Increase in units if NPV is negative → decrease in units

PROBLEMS

1. AA Company is considering a new product that will sell for P11 per unit and have variable costs of P8 per
unit and annual cash fixed costs of P90,000. Equipment required to produce the product costs P210,000
and is expected to last, and be depreciated on a straight-line basis, for 6 years, with no expected salvage

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value. AA estimates that sales of the new product will be 60,000 units per year for six years. AA's income
tax rate is 40% and its cost of capital is 14%.

a. What is the expected increase in future annual after-tax cash flows if the project is accepted?

b. What is the NPV of the project?

c. For this question only, suppose the project also involves an increase in inventories and receivables
totaling P40,000. What is the NPV of the project?

d. What is the profitability index for the project?

e. What is the payback period for project?

f. What is the approximate IRR for the project?

Excerpt of PVA table
Periods 20% 21% 22% 23% 24% 25%
6 3.326 3.245 3.167 3.092 3.020 2.951

g. What annual unit volume must the company sell to earn a return just equal to the 14% cost capital?

2. BB Company is considering machinery that costs P282,000 and has a useful life of four years. The
production manager believes that the machinery could reduce annual material and labor costs by
P100,000. BB pays a 30% income tax rate and requires a 12% return. BB uses straight-line depreciation.

a. What is the IRR of this project ?

Excerpt of PVA table
Periods 9% 10% 11% 12% 13% 14%
4 3.240 3.170 3.102 3.037 2.974 2.914

b. What is the NPV of this project?

c. What is the PI on this project?

d. What must annual savings be for the project to have a 12% IRR?

e. For this question only, assume that BB could depreciate the asset evenly over three years for tax
purposes, though the life of the project and the asset are still four years. What would the NPV of this
project be?

f. For this question only, assume that undertaking this project means BB must increase its working capital
by P12,000. What effect would this new information have on the NPV of this project?

g. Assume that the asset in this project is actually a replacement for one now in use that has a remaining
life of four years, a book value (and tax basis) of P25,000, and a current market value of P40,000, what is
the NPV of the project?

3. CC Company is considering purchasing an asset for P60,000 that would have a useful life of 5 years and
would have a salvage value of P7,000. For tax purposes, the entire original cost of the asset would be
depreciated over 5 years using the straight-line method and the salvage value would be ignored. The
asset would generate annual net cash inflows of P27,000 throughout its useful life. The project would
require additional working capital of P1,000, which would be released at the end of the project. The
company's tax rate is 30% and its discount rate is 10%.

What is the net present value of the asset?

4. DD Company is considering purchasing an asset for P50,000 that would have a useful life of 5 years and
no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 5
years using the straight-line method. The asset would generate annual net cash inflows of P20,000
throughout its useful life. The project would require additional working capital of P7,000, which would be
released at the end of the project. The company's tax rate is 30% and its discount rate is 13%.

What is the net present value of the asset?

5. EE Inc. has provided the following data concerning a proposed investment project:
Initial investment.............. P861,000
Annual cash receipts .......... 603,000
Life of the project............. 5 years
Annual cash expenses......... 332,000
Salvage value ................... 129,000

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The company's tax rate is 30%. For tax purposes, the entire initial investment without any reduction for
salvage value will be depreciated over 3 years. The company uses a discount rate of 18%

Compute the net present value of the project.

6. FF Inc. is considering a project that would require an initial investment of P462,000 and would have a
useful life of 7 years. The annual cash receipts would be P300,000 and the annual cash expenses would
be P120,000. The salvage value of the assets used in the project would be P69,000. The company's tax
rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 5 years. The company uses a discount rate of 18%.

Compute the net present value of the project.

7. GG Company purchased a new machine to stamp the company logo on its products. The cost of the
machine was P250,000 and it has an estimated useful life of 5 years with an expected salvage value at
the end of its useful life of P50,000. The company uses the straight-line depreciation method.

The new machine is expected to save P125,000 annually in operating cost. The company's tax rate is
40%, and it uses a 10% discount rate to evaluate capital expenditures.

a. What is the traditional payback period for the new stamping machine?

b. What is the accounting rate of return on the average investment in the new stamping machine?

c. What is the net present value of the new stamping machine?

8. HH Co. is considering an investment in a new product line. The Investment would require an immediate
outlay of P100,000 for equipment, and an immediate investment of P200,000 in working capital. The
Investment is expected to generate a net cash inflow of P100,000 In year 1, P150,000 in year 2, and
P200,000 in years 3 and 4. The equipment would be scrapped (for no salvage) at the end of the fourth
year and the working capital would be liquidated. The equipment would be fully depreciated by the
straight line method over its four-year life.

a. If HH uses a discount rate of 16 percent, what is the NPV of the proposed product line investment?

b. What is the traditional payback period for the investment?

c. What is the discounted payback period for the investment?

9. Indochine Company has an opportunity to invest in a project that will yield four annual payments of
P12,000 with no salvage. The first payment will be received in exactly one year. On low-risk projects
of this type, the company requires a return of 6 percent. Based on the requirement, the project
generates a profitability index of 1.03953 or 103.953%

a. How much is required to invest in this project?

b. What is the internal rate of return on the project?

Excerpt of PVA table
Periods 5% 6% 7% 8% 9% 10%
4 3.546 3.465 3.387 3.312 3.240 3.170

10. JJ Company has an auxiliary generator that is used when power failures occur. The generator is in bad
repair and must be either overhauled or replaced with a new generator. The hospital has assembled the
following information:
Present Generator New Generator
Purchase cost new P16,000 P20,000
Remaining book value 9,000 -
Overhaul needed now 8,000 -
Annual cash operating cost 12,500 7,500
Salvage value-now 4,000 -
Salvage value-eight years from now 3,000 6,000

If the company keeps and overhauls its present generator, then the generator will be useable for eight
more years. If a new generator is purchased, it will be used for eight years, after which It will be replaced.
The new generator would be diesel powered, resulting in a substantial reduction in annual operating costs,
as shown above.

The company computes depreciation on a straight-line basis. All equipment purchases are evaluated using
a 16% discount rate. INCOME TAX IS IGNORED.

Compute the net present value

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11. KK Company is considering replacing old computer system with a new one. Assume that the company
will be operating for only 3 more years.
New Computer:
Purchase price P108,000
installation cost 12,000
Estimated life, in year 3
Operating costs
Year 1 5,000
2 20,000
3 30,000

Old Computer:
Cost of old computer P 60,000
Market value of old computer 20,000
Estimated life, in years 6
Operating costs
Year 1 5,000
2 10,000
3 20,000
4 30.000
5 35,000
6 40,000

The old machine has been in use for 3 years. Both machines will be worthless at the end of three years.
The company uses the straight-line method of depreciation, the tax rate is 30% and its cost of capital is
10%,

a. How much is the relevant cash flow from the disposal the old asset?
b. How much is the incremental investment outlay?

c. How much is the incremental after-tax operating cash flows in the first year?

d. How much is the Net Present Value for the new computer system?

12. LL Co. is considering the acquisition of a new, more efficient press. The cost of the press is P360,000, and
the press has an estimated 6-year life with zero salvage value. LL uses straight-line depreciation for both
financial sporting and income tax reporting purposes and has a 40% corporate income tax rate. In
evaluating equipment acquisitions of this type, LL uses a goal of a 4-year payback period. To meet LL's
desired payback period, the press must produce a minimum annual before-tax operating cash savings of
_____________________

13. MM Industries is replacing a grinder purchased 5 years ago for P15,000 with a new one costing P25,000
cash. The original grinder is being depreciated on a straight-line basis over 15 years to a zero salvage
value; MM will sell this old equipment to a third party for P6,000 cash. The new equipment will be
depreciated on a straight-line basis over 10 years to a zero salvage value: Assuming a 40% marginal tax
rate, MM's net cash investment at the time of purchase if the old grinder is sold and the new one
purchased is _______________

14. Shimano Company has an opportunity to manufacture and sell one of two new products for a 5-year
period. The company’s tax rate is 30% and its after-tax cost of capital is 14%. The cost and revenue
estimates for each product are as follows :
Product A Product B
Initial investment in equipment P 400,000 P 550,000
Initial investment in working 85,000 60,000
capital
Annual sales 370,000 390,000
Annual cash operating expenses 200,000 170,000
Cost of repairs needed in 3 years 45,000 70,000

The equipment pertaining to both products has a useful life of 5 years and no salvage value. The company
uses the straight-line depreciation method for financial reporting and tax purposes. At the end of 5 years, each
product’s working capital will be released for investment elsewhere within the company.

What is the NPV of each investment opportunity? Which of the 2 products should the company pursue?

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QUIZZER : PART 1

1. In a plant expansion capital budgeting decision, which of the following amounts would be affected by a change
in the tax rate?
A. the present value of the cash inflows from increased sales.
B. the present value of the tax savings from the depreciation tax shield.
C. the present value of the cost of building repairs needed in Year 8 of the project.
D. all of these.

2. The calculation of the net present value of an investment project requires that the depreciation tax shield be
included at:
A. the amount of the depreciation with no adjustment for taxes.
B. the amount of the depreciation times one minus the tax rate.
C. the amount of the depreciation times the tax rate.
D. zero, since depreciation is not relevant to the calculation of net present value.

3. Which of the following would decrease the net present value of a project?
A. A decrease in the income tax rate.
B. A decrease in the initial investment.
C. An increase in the useful life of the project.
D. An increase in the discount rate.

4. In a net present value analysis of an equipment upgrade using a 30% tax rate, what amount of cash savings
would have the same present value as a P168,000 depreciation deduction?
A. 35,280
B. 50,400
C. 72,000
D. 117,600

5. Uzzle Corporation uses a discount rate of 10% and has a tax rate of 30%. The following cash flows occur in the
last year of an 8-year equipment selection investment project:

The assumed salvage value was zero when the depreciation deductions were computed for tax purposes. The total
after-tax present value of the cash flows above is closest to:
A. 12,189
B. 24,518
C. 26,199
D. 28,440

6. A company anticipates a taxable cash receipt of P20,000 in year 4 of a project. The company's tax rate is 30%
and its discount rate is 14%. The present value of this future cash flow is closest to:
A. 14,000
B. 6,000
C. 3,552
D. 8,289

7. A company anticipates a taxable cash expense of P50,000 in year 2 of a project. The company's tax rate is 30%
and its discount rate is 14%. The present value of this future cash flow is closest to:
A. (26,931)
B. (11,542)
C. (15,000)
D. (35,000)

8. A company anticipates a depreciation deduction of P30,000 in year 2 of a project. The company's tax rate is 30%
and its discount rate is 10%. The present value of the depreciation tax shield resulting from this deduction is
closest to:
A. 9,000
B. 17,355
C. 7,438
D. 21,000

9. A company needs an increase in working capital of P30,000 in a project that will last 2 years. The company's tax
rate is 30% and its discount rate is 14%. The present value of the release of the working capital at the end of the
project is closest to:

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A. 16,159
B. 9,000
C. 21,000
D. 23,084
10. Aardvik Corporation is considering renting a new building at an annual rent of P10,000. At a tax rate of 40%,
the after-tax cost of the proposed rent would be:
A. 4,000
B. 6,000
C. 10,000
D. 5,000

11. Eyring Industries has a truck purchased seven years ago at a cost of P6,000. At the time of purchase, the
ultimate salvage value was estimated at P500, but salvage value was ignored in depreciation deductions. The truck
is now fully depreciated. Assuming a tax rate of 40%, if the truck is sold for P500, the after-tax cash inflow for
capital budgeting purposes will be:
A. 500
B. 300
C. 200
D. 100

12. Suppose a machine that costs P80,000 has a useful life of 10 years. Also suppose that depreciation on the
machine is P8,000 for tax purposes in year 4. The tax rate is 40%. The tax savings from the depreciation tax shield
in year 4 would be:
A. 4,800 inflow
B. 3,200 inflow
C. 4,800 outflow
D. 3,200 outflow

13. An investment of P180,000 made now will yield an annual net after-tax cash operating inflow of P24,000 for
each of the next ten years. The tax rate is 40%. The annual net before-tax cash operating inflow is:
A. 60,000
B. 14,400
C. 9,600
D. 40,000

14. All of Schnider Company's sales and expenses last year were for cash. The tax rate was 30%. If the net cash
inflow (after taxes) last year was P18,900, and if the total gross cash sales were P75,000, then the total cash
expenses before taxes must have been:
A. 27,000
B. 48,000
C. 52,000
D. 37,000

15. Last year a firm had taxable cash receipts of P800,000 and the tax rate was 30%. The after-tax net cash inflow
from these receipts was:
A. 800,000
B. 640,000
C. 560,000
D. 240,000

16. Brownell Inc. currently has annual cash revenues of P240,000 and annual expenses of P185,000. The expenses
are all cash except for P35,000 of depreciation. The company is considering the purchase of a new mixing machine
costing P120,000 that would increase cash revenues to P290,000 and expenses (including depreciation) to
P205,000 in year two. The new machine would increase depreciation expense to P50,000 per year. The company's
tax rate is 40%. Brownell's incremental after-tax cash flow from the new mixing machine in year two would be:
A. 33,000
B. 24,000
C. 30,000
D. 18,000

17. Kane Company is in the process of purchasing a new machine for its production line. It is near the end of the
year, and the machine is being offered at a special discount if purchased before the end of the year. Kane has
determined that the depreciation deduction for tax purposes on the new machine for the year of purchase would
be P13,000. The tax rate is 30%. If Kane purchases the machine and reports a positive net operating income for
the year, then the tax savings from the deprecation tax shield related to this machine for the year of purchase
would be:
A. 3,900
B. 9,100
C. 13,000
D. 0

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Wable Inc. has provided the following data to be used in evaluating a proposed investment project:

For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 5
years. The company uses a discount rate of 16%.

18. When computing the net present value of the project, what are the annual after-tax cash receipts?
A. 165,000
B. 231,000
C. 99,000
D. 57,750

19. When computing the net present value of the project, what are the annual after-tax cash expenses?
A. 94,000
B. 193,700
C. 44,700
D. 104,300

20. When computing the net present value of the project, what is the annual amount of the depreciation tax
shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the
depreciation deduction is taken?
A. 27,500
B. 77,000
C. 33,000
D. 64,167

21. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in
the final year?
A. 55,000
B. 38,500
C. 16,500
D. 0

22. The net present value of the project is closest to:

A. 24,931
B. -67,326
C. -83,111
D. 40,716

Littau Inc. has provided the following data concerning an investment project that has been proposed:

The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 7 years
without any reduction for salvage value. The company uses a discount rate of 19%.

23. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in
the final year?
A. 0
B. 3,000
C. 10,000
D. 7,000

24. The net present value of the project is closest to:

A. -4,949
B. 25,780

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C. 23,766
D. -6,412
Demirjian Inc. is considering an investment project that would require an initial investment of P290,000 and that
would last for 8 years. The annual cash receipts from the project would be P189,000 and the annual cash expenses
would be P85,000. The equipment used in the project could be sold at the end of the project for a salvage value of
P29,000. The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 7
years without any reduction for salvage value. The company uses a discount rate of 13%.

25. When computing the net present value of the project, what are the annual after-tax cash receipts?
A. 56,700
B. 104,000
C. 132,300
D. 147,571

26. The net present value of the project is closest to:

A. 121,972
B. 114,339
C. 59,367
D. 67,000

QUIZZER : PART 2

Questions 1 through 3 are based on the following information. Hendz Inc. has purchased a new fleet of trucks to
deliver its merchandise. The trucks have a useful life of 8 years and cost a total of P500,000. Hendz expects its net
Increase in after-tax cash flow to be P150,000 in Year 1, P175,000 in Year 2, P125,000 in Year 3, and P100,000 in
each of the remaining years.

1. Ignoring the time value of money, how long will it take Hendz to recover the amount of investment?
a. 3.5 years.
b. 4.0 years,
c. 4.2 years.
d. 5 years

2. What is the payback reciprocal for the fleet trucks?

a. 29%
b. 25%
c. 24%
d. 20%

3. Assume the net cash flow to be P130,000 a year. What is the payback time for the fleet of trucks?
a. 3 years.
b. 3.15 years.
c. 3.85 years.
d. 4 years

4. Which one of the following statements about the payback method of investment analysis is correct? he
payback method
a. Does not consider the time value of money.
b. Considers cash flows after the payback has been reached.
c. Uses discounted cash flow techniques.
d. Generally leads to the same decision as other methods for long-term projects.

5. The payback reciprocal can be used to approximate a project's

a. Profitability index
b. Net present value.
c. Accounting rate of return if the cash flow pattern is relatively stable.
d. Internal rate of return if the cash flow pattern is relatively stable.

6. The bailout payback method

a. Incorporates the time value of money.
b. Equals the recovery period from normal operations.
c. Eliminates the disposal value from the payback calculation.
d. Measures the risk if a project is terminated.

7. WH Co. is considering the acquisition of a new, more efficient press. The cost of the press is P360,000, and
the press has an estimated 6-year life with zero salvage value. WH uses straight-line depreciation for both
financial sporting and income tax reporting purposes and has a 40% corporate income tax rate. In evaluating
equipment acquisitions of this type, WH uses a goal of a 4-year payback period. To meet Whitney's desired
payback period, the press must produce a minimum annual before-tax operating cash savings of
A. 90,000
B. 110,000
C. 114,000
D. 150,000

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8. When evaluating projects, breakeven time is best described as

a. Annual fixed coats - monthly contribution margin.
b. Project investment — annual net cash inflows.
c. The point where cumulative cash inflows on a project equal total cash outflows.
d. The point at which discounted cumulative cash inflows on a project equal discounted total cash outflows.

Questions 9 through 12 are based on the following information.

In order to increase production capacity, Gio Industries is considering replacing an existing production machine
with a new technologically improved machine effective January 1. The following information is being considered
by Gio Industries:
 The new machine would be purchased for P160,000 in cash. Shipping, installation, and testing would cost
an additional P30,000.
 The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per unit.
 Incremental operating costs include P30 per unit in variable costs and total fixed costs of P40,000 per year.
 The investment in the new machine will require an immediate increase in working capital of P35,000. This
cash outflow will be recovered at the end of year 5.
 Gio uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has
an estimated useful life of 5 years and zero salvage value.
 Gio is subject to a 40% corporate income tax rate. Its discount rate is 10%.

9. Gio Industries' net cash outflow in a capital budgeting decision is

a. 190,000
b. 195,000
c. 204,525
d. 225,000

10. Gio Industries' discounted annual depredation tax shield for the year of replacement is
a.13,817
b.16,762
c. 20,725
d.22,800

11. The acquisition of the new production machine by Gio industries will contribute a discounted net-of-tax
contribution margin of
a. 242,624
b. 303,280
c. 363,936
d. 454,920

12. The overall discounted cash flow impact of Gio Industries' working capital investment for the new production
machine would be
a. (7,959)
b. (10,080)
c. (13,265)
d. (35,000)

13. The net present value (NPV) method of investment project analysis assumes that the project's cash flows are
reinvested at the
a. Computed internal rate of return.
b. Risk-free Interest rate.
c. Discount rate used in the NPV calculation.
d. Firm's accounting rate of return.
14. Royal Industries is replacing a grinder purchased 3 years ago for P13,000 with a new one costing P23,000
cash. The original grinder is being depreciated on a straight-line basis over 15 years to a zero salvage value;
Royall will sell this old equipment to a third party for P6,000 cash. The new equipment will be depreciated on a
straight-line basis over 10 years to a zero salvage value. Assuming a 40% marginal tax rate. Royal's net-cash
investment at the time of purchase if the old grinder is sold and the new one purchased is
a. 19,000
b. 15,000
c. 17,400
d. 25,000
15. Garf Inc. is considering a 10-year capital investment project with forecasted revenues of P40,000 per year
and forecasted cash operating expenses of P29,000 per year. The initial cost of the equipment for the project
is P23,000 and Garf expects to sell the equipment for P9,000 at the end of the tenth year. The equipment will
be depreciated over 7 years. The project requires a working capital investment of P7,000 at its inception and
another P5,000 at the end of year 5. Assuming a 40% marginal tax rate, the expected net cash flow from the
project in the tenth year is
a. 32,000
b. 24,000
c. 20,000

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d. 11,000
16. The rankings of mutually exclusive investments determined using the internal rate of return method (IRR) and
the net present value method (NPV) may be different when
a. The lives of the multiple projects are equal and the size of the required investments are equal.
b. The required rate of return equals the 1RR of each project.
c. The required rate of return is higher than the 1RR of each project.
d. Multiple projects have unequal lives and the size of the investment for each project is different.

17. The proper discount rate to use to calculating certainty equivalent net present value is the
a. Risk-adjusted discount rate.
b. Cost of capital.
c. Risk-free rate.
d. Cost of equity capital.

18. Amo Corporation has not yet decided on its hurdle rate for use In the evaluation of capital budgeting projects.
This lack of information will prohibit Amo from calculating a project's
Accounting Net Internal
Rate of Return Present value Rate of Return
A. No No No
B. Yes Yes Yes
C. No Yes Yes
D. No Yes No

19. When determining net present values in an inflationary environment, adjustments should be made to
a. Increase the discount rate only. .
b. Increase the estimated cash inflows and increase the discount rate.
c. Increase the estimated cash inflows but not the discount rate.
d. Decrease the estimated cash inflows and increase the discount rate.

20. All of the following items are included in discounted cash flow analysis except
a. Future operating cash savings.
b. The current asset disposal price.
c. The future asset depreciation expense.
d. The tax effects of future asset depreciation.

21. The capital budgeting model that is ordinarily considered the best model for long-range decision making is
a. Payback model.
b. Accounting rate of return model.
c. Unadjusted rate of return model
d. Discounted cash flow model.

22. The use of an accelerated method instead of the straight-line method of depreciation in computing the net
present value of a project has the effect of
a. Raising the hurdle rate necessary to justify the project.
b. Lowering the net present value of the pro
c. Increasing the present value of the depreciation tax shield.
d. increasing the cash outflows at the initial point of the project

Question 23 through 25 are based on the following information.

Cape Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects
for the upcoming year.
Project 1 Project 2 Project 3 Project 4
Initial capital outlay P200,000 P298,000 P248,000 P272,000
Annual net cash inflows
Year 1 65,000 100,000 80,000 95,000
Year 2 70,000 135,000 95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000

Net present value (3,798) 4,276 14,064 14,662

Profitability index 98% 101% 106% 105%
Internal rate of return 11% 13% 14% 15%

23. Which project(s) should Cape Inc. undertake during the upcoming year assuming it has no budget restrictions?
a. All of the projects.
b. Projects 1, 2, and 3.
c. Projects 2, 3, and 4.
d. Projects 1, 3. and 4.
24. Which project(s) should Cape Inc. undertake during the upcoming year if it has only P600,000 of funds
available?
a. Projects 1 and 3.
b. Projects 2, 3, and 4.

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c. Projects 2 and 3.
d. Projects 3 and 4.
25. Which project(s) should Cape Inc. undertake during the upcoming year if it has only P300,000 of capital funds
available?
a. Project 1.
b. Projects 3, and 4.
c. Projects 3 and 4,
d. Project 3.

26. The NPV of a project has been calculated to be P215,000. Which one of the following changes in assumptions
would decrease the NPV?
a. Decrease the estimated effective income tax rate.
b. Decrease the initial investment amount.
c. Extend the project life and associated cash Inflows.
d. Increase the discount rate,

27. Dawson Inc. is expanding its manufacturing plant, which requires an investment of P4 million in new
equipment and plant modifications. Dawson’s sales are expected to increase by P3 million per year as a result of
the expansion. Cash investment in current assets averages 30% of sales; accounts payable and other current
liabilities are 10% of sales. What is the estimated total investment for this expansion?
a. 3.4 million.
b. 4.3 million.
c. 4.6 million.
d. 4.9 million.

28. A disadvantage of the net present value method of capital expenditure evaluation is that it
a. Is calculated using sensitivity analysis.
b. Computes the true interest rate.
c. Does not provide the true rate of return on investment.
d. Is difficult to apply because it uses a trial-and- error approach.

29. Parker Inc. has no capital rationing constraint and Is analyzing many independent investment alternatives.
Packer should accept all investment proposals
a. If debt financing is available for them.
b. That have positive cash flows.
c. That provide returns greater than the before tax cost of debt.
d. That have a positive net present value.

30. Jac Corporation uses net present value techniques in evaluating its capital investment projects. The company
is considering a new equipment acquisition that will cost P100,000, fully installed, and have a zero salvage value
at the end of its five-year productive life. Jac will depreciate the equipment on a straight-line basis for both
financial and tax purposes. Jackson estimates P70,000 in annual recurring operating cash income and P20,000 in
annual recurring operating cash expenses. Jac’s cost of capital is 12% and its effective income tax rate is 40%.
What is the net present value of this investment on an after-tax basis?
a. 28,840
b. 8,150
c. 36,990
d. 80,250

31. Will Inc. has a cost of capital of 15% and is considering the acquisition of a new machine which costs P400,000
and has a useful life of 5 years. Will projects that earnings and cash flow will increase as follows:
Net After-Tax
Year Earnings Cash Flow
1 P100,000 P160,000
2 100,000 140,000
3 100,000 100,000
4 100,000 100,000
5 200,000 100,000

The net present value of this investment is

a. Negative, 64,000.
b. Negative, 14,000.
c. Positive, 18,600.
d. Positive, 200,000.

32. A weakness of the internal rate of return (IRR) approach for determining the acceptability of investments is
that it
a. Does not consider the time value of money.
b. Is not a straightforward decision criterion.
c. Implicitly assumes that the firm is able to reinvest project cash flows at the firm’s cost of capital.
d. Implicitly assumes’ that the firm is able to reinvest project cash flows at the project’s internal rate of
return.

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33. The internal rate of return (IRR) is the

a. Hurdle rate.
b. Rate of interest for which the net present value is greater than 1.0.
c. Rate of interest for which the net present value is equal to zero.
d. Rate of return generated from the operational cash flows.

Questions 34 and 35 are based on the following information. A firm with an 18% cost of capital is
considering the following projects ( January 1, year 1):
January 1, Year 1 December 31, Year 5 Project’s Internal
Cash Outflow Cash inflow Rate of Return
Project A 3,500,000 7,400,000 16%
Project B 4,000,000 9,950,000 ?

34. Using the net-present-value (NPV) method project A's net present value is ,
a. 316,920 c. (265,460)
b. 23,140 d. (316,920)

35. Project B’s internal rate of return is closest to

a. 15% c. 18%
b. 16% d. 20%

END..

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