Comprehensive MAS Reviewer by Bobadilla Chapter 11 – Capital Budgeting

Theory
Capital Budgeting Process 7. Competing investment projects where accepting one project eliminates the possibility of
1. The long-term planning process for making and financing investments that affects a taking the remaining projects is referred to as:
company’s financial results over a number of years is referred to as: A. Common projects C. Mutually-exclusive projects
A. capital budgeting C. master budgeting B. Independent projects D. Mutually-inclusive projects
B. long-range planning D. strategic planning
8. Mutually exclusive projects are those that
2. Capital budgeting is the process: A. require all managers to consider.
A. of eliminating unprofitable product line. B. if accepted, preclude the acceptance of competing projects.
B. of making capital expenditure decisions. C. if accepted, can have a negative effect on the company’s profit.
C. used in a sell or process further decision. D. if accepted, can also lead to the acceptance of a competing project.
D. of determining how much capital stock to issue.
9. The normal methods of analyzing investments
3. What does the term capital budgeting mean in the context of making capital expenditure A. cannot be used by not-for-profit entities.
decisions? B. do not apply if the project will not produce revenues.
A. The process of choosing assets. C. require forecasts of cash flows expected from the project.
B. The process of allocating the funds among assets. D. cannot be used if the company plans to finance the project with funds already available
C. The process of acquiring the funds to finance the business. internally.
D. None of the given choices.
10. Which of the following represents the biggest challenge in the decision to purchase new
4. A capital investment decision is essentially a decision to exchange current: equipment?
A. assets for current liabilities. A. Estimating cash flows for the future.
B. cash inflows for future cash outflows. B. Estimating employee training for the new project.
C. cash outflows for the promise of receiving future cash inflows. C. Estimating transportation costs of the new equipment.
D. cash flows from operating activities for future cash inflows from investing activities D. Estimating maintenance costs for the new equipment.

5. How should the following projects be listed in their order of increasing risk? 11. The only future costs that are relevant to deciding whether to accept an investment are those
A. Expansion, replacement, new venture. that will
B. New venture, replacement, expansion. A. be deductible for tax purposes.
C. Replacement, expansion, new venture. B. affect net income in the period that they are incurred.
D. Replacement, new venture, expansion. C. be saved if the project is accepted rather than rejected.
D. be different if the project is accepted rather than rejected.
6. A project that when accepted or rejected will not affect the cash flows of another project
refers to: 12. In which circumstances should the tax consequences be considered when making capital
A. dependent projects C. mutually exclusive projects investment decisions?
B. independent projects D. sustaining project A. Depreciation C. Positive net income

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B. Disposal of an asset D. All of the given choices A. is usually conclusive.

B. is done using different evaluation techniques than what were used in making the original
13. Cost of capital is the: capital budgeting decision.
A. amount the company must pay for its plant assets. C. provides a formal mechanism by which the company can determine whether existing
B. dividends a company must pay on its equity securities. projects should be supported or terminated.
C. cost the company must incur to obtain its capital resources. D. all of the given choices.
D. cost the company is charged by investment bankers who handle the issuance of equity
or long-term debt securities. Cash Flow Computation
19. In addition to incremental revenues, cash inflows from capital investments can be generated
14. The appropriate discount rate that the analysts use in computing the present value of future from all of the following sources except
cash flows is comprised of which of the following? A. cost savings
A. A risk factor reflecting the riskiness of the project. B. debt financing
B. A pure rate of interest reflecting the productive capability of the capital asset. C. salvage value
C. An increase in the rate reflecting the inflation expected to occur over the life of the D. reduction in the amount of working capital
project.
D. All of the given choices are components of the discount rate. 20. Which of the following is not a typical cash outflow associated with a capital investment?
A. Purchase price of the new equipment.
15. Problems associated with justifying investments in high-tech projects often include B. Repairs and maintenance needed for purchased equipment.
A. discount rates that are too low and time horizons that are too long C. Additional operating costs resulting from the capital investment.
B. discount rates that are too high and time horizons that are too long D. Salvage value received when the newly purchased equipment is sold.
C. discount rates that are too low and time horizons that are too short
D. discount rates that are too high and time horizons that are too short 21. Which of the following is not a typical cash inflow in capital investment decisions?
A. Additional working capital C. Incremental revenues
16. If Troy Company expects to get a one-year bank loan to help cover the initial financing of one B. Cost reductions D. Salvage value
of its capital projects, the analysis of the project should
A. ignore the loan 22. Which of the following is a cost that requires a future outlay of cash that is a relevant one for
B. show the loan as an increase in the investment. future decision making?
C. show the loan as a cash outflow in the second year of the project’s life. A. Incremental revenue C. Out-of-pocket cost
D. offset the loan against any investment in inventory or receivables required by the project. B. Opportunity cost D. Relevant benefits

17. A thorough evaluation of how well a project’s actual performance matches the projections 23. A major difference between an investment in working capital and one in depreciable assets is
made when the project was proposed is called a that
A. post-audit C. risk analysis A. an investment in working capital is never returned, while most depreciable assets have
B. pre-audit D. sensitivity analysis some residual value.
B. an investment in working capital is returned in full at the end of a project’s life, while an
18. Post-audit of capital projects: investment in depreciable assets has no residual value.

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C. an investment in working capital is not tax-deductible when made, nor taxable when
returned, while an investment in depreciable assets does allow tax deductions.
D. because an investment in working capital is usually returned in full at the end of the
project’s life, it is ignored in computing the amount of the investment required for the
project.
24. The proper treatment of an investment in receivables and inventory is to
A. ignore it
B. add it to the required investment in fixed assets
C. add it to the required investment in fixed assets and subtract it from the annual cash
flows
D. add it to the investment in fixed assets and add the present value of the recovery to the
present value of the annual cash flows
25. Which of the following would not be included as part of the periodic cash inflows associated
with an investment project?
A. Receipts from sales
B. Opportunity costs of undertaking the project
C. Savings for fixed and variable production costs
D. Savings in selling, general, and administrative costs
26. If there were no income taxes,
A. the NPV method would not work.
B. all potential investments would be desirable.
C. income would be discounted instead of cash flow.
D. depreciation would be ignored in capital budgeting.
27. Which statement is most correct concerning depreciation in a capital budgeting analysis?
A. Depreciation is a cash flow and does affect the tax cash flow.
B. Depreciation is not a cash flow but does affect the tax cash flow.
C. Depreciation is a cash flow but does not affect the tax cash flow.
D. Depreciation is not a cash flow and does not affect the tax cash flow.
taxes.
D. Can deduct depreciation expenses on their financial statements, reducing reported
income before tax.
29. When evaluating depreciation methods, the managers who are concerned about capital
investment decisions most likely
A. choose straight line depreciation so there is minimum impact on the decision.
B. use accelerated methods to have as much depreciation in the early years of an asset’s
life.
C. use units of production so more depreciation expense will be allocated to the later years.
D. Assume that the choice of depreciation method has no impact on the capital investment
decision.
30. The periodic cash flows associated with an investment project include which of the following?
A. Purchase of asset and freight cost
B. Savings in taxes caused by deductibility of depreciation on tax return
C. Income tax effect of gain (loss) on disposal of existing assets in an asset replacement
decision
D. All of these are periodic cash flows in an investment project
Non-discounted Methods
31. The primary advantages of the average rate of return method are its ease of computation and
the fact that:
A. Rankings of proposals are necessary
B. It is especially useful to managers whose primary concern is liquidity
C. It emphasizes the amount of income earned over the life of the proposal
D. There is less possibility of loss from changes in economic conditions and obsolescence
when the commitment is short-term

28. Depreciation charges indirectly affect the after-tax cash flow because the company 32. Which of the following capital budgeting methods is the least theoretically correct?
A. Cannot deduct depreciation expenses on their income tax returns. A. internal rate of return C. payback method
B. Can deduct depreciation expenses on their financial statements, increasing cash inflows. B. net present value D. none of the given choices
C. Can deduct depreciation expenses on their income tax returns, reducing cash outflow for

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33. The length of time needed for a long-term project to recapture its initial investment amount is 40. Which of the following capital budgeting methods assumes that intermediate cash inflows are
called the: reinvested at the minimum acceptable rate of return?
A. Discount period C. Payback period A. Internal rate of return method. C. Payback method.
B. Internal rate of return D. Present value B. Net present value method. D. Unadjusted rate of return method.

34. The technique which is most concerned with liquidity is the 41. The internal rate of return method assumes that intermediate cash flows are immediately
A. book rate of return C. net present value technique reinvested at:
B. internal rate of return D. payback method A. The company’s discount rate.
35. Which of the following is a potential use of the payback method? B. The actual rate of return earned by the project.
A. Help control the risk of obsolescence C. An average of the internal rate of return and the discount rate.
B. Help minimize the impact of the investment on liquidity D. The lower of the company’s discount rate or internal rate of return.
C. Help managers control the risks of estimating cash flows
D. All of the answers are correct 42. When using the net present value method, the interest rate used to discount cash flows
should not be thought of as the:
36. Which of the following is NOT a defect of the payback method? A. Discount rate C. Internal rate of return
A. It ignores profitability. B. Hurdle rate D. Minimum required rate of return
B. It ignores the present values of cash flows.
C. It ignores cash flows because it uses net income. 43. The profitability index
D. It ignores the pattern of cash flows beyond the payback period. A. will never be greater than 1.0.
B. does not take into account the discounted cash flows.
37. If a payback period for a project is greater than its expected useful life, the C. Is calculated by dividing total cash flows by the initial investment.
A. project will always be profitable. D. allows comparison of the relative desirability of projects that require varying initial
B. entire initial investment will not be recovered. investments.
C. project’s return will always exceed the company’s cost of capital.
D. project would only be acceptable if the company’s cost of capital was low. 44. Which of the following, when used as the discount rate, equates the net present value of a
series of cash flows to zero?
38. The payback method, as a capital budgeting technique, assumes that all intermediate cash A. Breakeven time C. Internal rate of return
inflows are reinvested to yield a return equal to: B. External rate of return D. Investment rate of return
A. The Cost-of-Capital C. The Time-Adjusted-Rate-of-Return
B. The Discount Rate D. Zero 45. Which of the following statements is false regarding the interest rate used in net present
value calculations?
Discounted Cash Flow Methods A. It may be adjusted for uncertainty.
39. The primary capital budgeting method that uses discounted cash flow technique is the: B. Some companies use their cost of capital as the discount rate.
A. annual rate of return method. C. net present value method. C. It may be higher or lower than the investment’s actual internal rate of return.
B. cash payback technique. D. profitability index method. D. It should be equal to the maximum required rate of return needed to make the
investment profitable.

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46. The rate that produces a zero net present value when a project’s discounted cash operating B. This investment offers an actual rate of return of 15 percent
advantage is compared to its discounted net investment is the: C. This investment offers an actual rate of return of less than 15 percent
A. Cost of capital C. Cutoff rate D. This investment offers an actual rate of return of more than 15 percent
B. Discount rate D. Internal rate of return
52. When using the net present value method for a particular investment decision, if the present
47. If the internal rate of return on an investment is zero:
value of all cash inflows is greater than the present value of all cash outflows, then:
A. its NPV is positive.
A. The discount rate was too low.
B. it is generally a wise investment.
B. The discount rate used was too high.
C. its cash flows decrease over its life.
C. The investment provides an actual rate of return equal to the discount rate.
D. its annual cash flows equal its required investment.
D. The investment provides an actual rate of return greater than the discount rate.
48. If the present value of the future cash flows for an investment equals the required investment,
the IRR
53. CBN Products, Inc. is considering to invest in one of two projects. Both projects have a net
A. equals zero.
present value of P25,000; however Project Alpha requires an initial investment of P700,000
B. equals the cutoff rate.
while Project Delta requires an initial investment of P300,000. Based on this information,
C. equals the cost of borrowed capital.
which of the following statements is true?
D. Is lower than the company’s cutoff rate return.
A. Project Alpha will have a higher profitability index
B. Project Delta will have a higher profitability index
49. If a company’s required rate of return is 12 percent and in using the profitability index method,
C. Both project will have the same profitability index
a project’s index is greater than 1.0, this indicates that the project’s rate of return is
D. There is not enough information to determine the profitability index of either project
A. equal to 12 percent.
B. less than 12 percent.
54. If the net present value (NPV) of an investment is zero, then the internal rate of return (IRR)
C. greater than 12 percent.
is:
D. dependent on the size of the investment.
A. Equal to the discount rate. C. Less than the discount rate.
B. Higher than the discount rate. D. Negative.
50. If a project has an internal rate of return of 12 percent and a positive net present value, which
of the following statements is true regarding the discount rate used for the net present value
55. The relationship between payback period and IRR is that
computation?
A. have been higher than the IRR.
A. The discount rate must
B. the payback period is the present value factor for the IRR.
B. The discount rate must have been equal to 12 percent.
C. a payback period of less than one-half the life of a project will yield an IRR lower than the
C. The discount rate must have been lower than 12 percent.
target rate.
D. The discount rate must have been greater than 12 percent.
D. a project whose payback period does not meet the company’s cutoff rate for payback will
not meet the company’s criterion for IRR.
51. White Bubbles, Inc. is considering the purchase of an equipment that costs P200,000.
Annual cash savings of P50,000, with a present value at 15 percent of P189,230, are
Project Screening, Project Ranking & Capital Rationing
expected for the next six years. Given this information, which of the following statements is
56. Deciding whether or not an investment meets a predetermined company standard is called a
true?
A. Payback decision C. Profitability decision
A. This investment offers a negative rate of return

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B. Preference decision D. Screening decision D. greater than the IRR on projects accepted in the past.
62. A weakness of the internal rate of return method for screening investment projects is that it:
57. In evaluating high-tech projects,
A. fails to consider the timing of cash flows
A. only tangible benefits should be considered.
B. does not consider the time value of money
B. only intangible benefits should be considered.
C. implicitly assumes that the company is able to reinvest cash flows from the project at the
C. both tangible and intangible benefits should be considered.
internal rate of return
D. neither tangible nor intangible benefits should be considered.
D. implicitly assumes that the company is able to reinvest cash flows from the project at
the company’s discount rate
58. The net present value (NPV) model can be used to evaluate and rank two or more proposed
projects. The approach that computes the total impact on cash flows for each option and then 63. The NPV and IRR methods give
converts these total cash flows to their present values is called the A. different rankings of projects with unequal lives.
A. contribution approach C. incremental approach B. the same choice from among mutually exclusive investments.
B. differential approach D. total project approach C. the same decision (accept or reject) for any single investment.
59. NPV indicates that a project is deemed desirable when the net present value is: D. the same rankings of projects with different required investments.
A. less than zero 64. In choosing from among mutually exclusive investments, the manager should normally select
B. greater than or equal to zero the one with the highest:
C. less than or equal to the risk-adjusted cost of capital A. Book rate of return C. Net present value
D. greater than or equal to the risk-adjusted cost of capital B. Internal rate return D. Profitability index

60. An analysis of a proposal by the net present value method indicated that the present value of
future cash inflows exceeded the amount to be invested. Which of the following statements
best describes the results of this analysis?
A. The proposal is desirable and the rate of return expected from the proposal exceeds the
minimum rate used for the analysis
B. The proposal is desirable and the rate of return expected from the proposal is less than
the minimum rate used for the analysis
C. The proposal is undesirable and the rate of return expected from the proposal exceeds
the minimum rate used for the analysis
D. The proposal is undesirable and the rate of return expected from the proposal is less
than the minimum rate used for the analysis
65. Project Alpha has an expected cash flow of P500,000 at the end of year 5. Project Bravo has
expected cash flows of P100,000 to be received at the end of each year for the next five
years. What can be said of the net present value of Project Alpha compared to Project
Bravo?
A. Project Alpha is preferred because of the largest lump-sum payment in year 5.
B. They are the same because both cash flows total P500,000 over the lives of the
projects.
C. Both Project Alpha and Project Bravo have the same internal rate of return and either
should be accepted.
D. Project Bravo is preferred because of the periodic payments made consistently
throughout the years and are made earlier.

61. Arbitrary Company uses IRR to evaluate long-term decisions and establishes a cutoff rate of 66. The calculation of the profitability index (PI) is most helpful for which type of decisions?
return. Such a cutoff rate is A. Preference C. Screening
A. at least equal to its cost of capital. B. Qualitative D. Short-term
B. greater than the current book rate of return.
C. at least equal to the rate used by similar companies. 67. Why do NPV method and the IRR method sometimes give different rankings of mutually

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exclusive investment projects?
A. The IRR method does not assume reinvestment of the cash flows while the NPV
assumes the reinvestment rate is equal to the discount rate.
B. The NPV method does not assume reinvestment of cash flows while the IRR method
assumes the cash flows will be reinvested at the internal rate of return.
C. The NPV method assumes a reinvestment rate equal to the discount rate while the IRR
method assumes a reinvestment rate equal to the internal rate of return.
D. The NPV method assumes a reinvestment rate equal to the bank loan interest rate while
the IRR method assumes a reinvestment rate equal to the discount rate.
68. When comparing NPV and IRR, which is incorrect?
A. Both NPV and IRR can be used for screening decisions
B. With IRR, cash flows can be adjusted to account for risk
C. NPV can be used to compare investments of various size or magnitude
D. With NPV, the discount rate can be adjusted to take into account increased risk and the
uncertainty of cash flows
Risk Analysis in Capital Budgeting
69. An approach that uses a number of outcome estimates to get a sense of the variability among
potential returns is
A. risk analysis. C. the discounted cash flow technique.
B. sensitivity analysis. D. the net present value method.
70. Sensitivity analysis is
A. typically conducted in the post investment audit
B. useful in measuring the variance of the Fisher rate
C. an appropriate response to uncertainty in cash flow projections
D. useful to compare projects requiring vastly different levels of initial investment
71. In capital budgeting, sensitivity analysis is used to:
A. test the relationship of the IRR and NPV.
B. evaluate mutually exclusive investments.
C. determine whether an investment is profitable.
D. see how a decision would be affected by changes in variables.
72. The higher the risk element in a project, the
Chapter 11 – Capital Budgeting
A. higher the cost of capitals is. C. higher the net present value is.
B. higher the discount rate required is. D. more attractive the investment is.
73. Which of the following would decrease the net present value of a project?
A. An increase in the discount rate
B. A decrease in the income tax rate
C. A decrease in the initial investment
D. An increase in the useful life of the project
74. XYZ Co. is adopting just-in-time approach. When evaluating an investment project that would
reduce inventory, how should XYZ treat the reduction?
A. Ignore it.
B. Decrease the cost of the investment.
C. Decrease the cost of the investment and decrease cash flows at the end of the project’s
life.
D. Decrease the cost of the investment and increase the cash flow at the end of the
project’s life.
75. All other things being equal, as cost of capital decreases:
A. More capital projects will probably be acceptable.
B. Fewer capital projects will probably be acceptable.
C. The company will probably want to borrow money rather than issue stock.
D. The number of capital projects that are acceptable will change, but the direction of the
change is not determinable just by knowing the direction of the change in the cost of
capital.
76. All other things being equal, as cost of capital increases
A. more capital projects will probably be acceptable.
B. fewer capital projects will probably be acceptable.
C. the company will probably want to borrow money rather than issue stock.
D. the number of capital projects that are acceptable will change, but the direction of the
change is not determinable just by knowing the direction of the change in cost of capital.
77. Diliman Plumbers, Inc. is considering the purchase of a machine costing approximately
P40,000. Using a discount rate of 20 percent, the present value of future cash inflows are
calculated to be P40,000. To yield at least a 20 percent return, the actual cost of the machine
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should not exceed the P40,000 estimated by more than: What is the amount of investment in the new equipment?
A. P 0 C. P40,000 A. P 68,000 C. P 80,000
B. P 8,000 D. P80,000 B. P 72,000 D. P160,000

78. Camel Company, a local company that specializes in home repairs, is considering replacing 2. It is the start of the year and Agudelo Company plans to replace its old grinding equipment.
its older van with a new and larger one. The estimated cost of the new van will be P65,0000. The following information is made available by the management:
Using a discount rate of 18 percent, the company calculates a net present value for the new Old New
van of P(5,000). Based on this information, which of the following statements is true? Equipment cost P70,000 P120,000
A. The actual rate of return on the new van is negative. Current salvage value 14,000 -
B. Using a higher discount rate should cause the net present value to become positive. Salvage value, end of useful 5,000 16,000
C. If the company purchases the van, they are guaranteed a rate of return of at least 18%. life
D. If the actual cost of the new van ends up being less than P60,000, the net present value Annual operating costs 44,000 32,000
becomes positive. Accumulated depreciation 55,300 -
Estimated useful life 10 years 10 years
79. Assuming that a project has already been evaluated using the following techniques, the The company is not subject to tax and its cost of capital is 12%. What is the present value of
evaluation under which technique is least likely to be affected by an increase in the estimated all the relevant cash flows at time zero?
residual value of the project? A. (P 54,000) C. (P120,000)
A. Internal Rate of Return C. Payback Period B. (P106,000) D. (P124,700)
B. Net Present Value D. Profitability Index
Depreciation Tax Shield
80. Which of the following is true of an investment? 3. Myriad Company is considering replacing its old machine with a new and more efficient one.
A. The lower the cost of capital, the higher the IRR. The old machine has book value of P100,000, a remaining useful life of 4 years, and annual
B. The longer the project’s life, the shorter its payback period. straight-line depreciation of P25,000. The existing machine has a current market value of
C. The higher the project’s net present value, the shorter its life. P80,000. The replacement machine would cost P160,000, have a 4-year life, and will save
D. The higher the cost of capital, the lower the net present value. P50,000 per year in cash operating costs. If the replacement machine would be depreciated
using the straight-line method and the tax rate is 40%, what should be the increase in annual
income taxes?
PROBLEMS A. P 4,000 C. P28,000
B. P14,000 D. P40,000
Cash Flows
Net Investment Accounting Rate of Return
1. Bravado Company is considering to replace its old equipment with a new one. The old 4. An asset was purchased for P66,000. The asset is expected to last for 6 years and will have
equipment had a net book value of P100,000 and 4 remaining useful years with P25,000 a salvage value of P16,000. The company expects the income before tax to be P7,200 and
depreciation each year. The old equipment can be sold at P80,000. The new equipment the tax rate applicable to the company is 30%. What is the average return on investment
costs P160,000, have a 4-year life. Cash savings on operating expenses before 40% taxes (accounting rate of return)?
amount to P50,000 per year. A. 7.6% C. 12.3%

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B. 10.9% D. 17.6% required investment. On the assumption of a uniform cash inflow, this investment is expected
to provide annual cash flow from operations, net of income taxes, of
5. A piece of labor saving equipment that Marubeni Electronics Company could use to reduce A. P35,000 C. P42,000
costs in one of its plants in Angeles City has just come onto the market. Relevant data B. P40,250 D. P77,000
relating to the equipment follow:
Purchase cost of the equipment P432,000 Payback Period
Annual cost savings that will be provided by the equipment 90,000 9. If an asset costs P35,000 and is expected to have a P5,000 salvage value at the end of its
Life of the equipment 12 years ten-year life, and generates annual net cash inflows of P5,000 each year, the cash payback
What is the simple rate of return to be provided by the equipment? period is
A. 12.50% C. 20.83% A. 5 years C. 7 years
B. Between 15% and 18% D. 25.00% B. 6 years D. 8 years
10. Machine Manufacturing Company considers a project that will require an initial investment of
Net Investment
P500,000 and is expected to generate future cash flows of P200,000 for years 1 through 3
6. The Miracle Company is planning to purchase a new machine which it will depreciate, for
and P100,000 for years 4 through 7. The project’s payback period is:
book purposes, on a straight-line basis over a ten-year period with no salvage value and a full
A. 1.67 years C. 3.33 years
year’s depreciation taken in the year of acquisition. The new machine is expected to produce
B. 2.50 years D. 3.50 years
cash flows from operations, net of income taxes, of P66,000 a year in each of the next ten
years. The accounting (book value) rate of return on the initial investment is expected to be 11. Consider a project that requires cash outflow of P50,000 with a life of eight years and a
12 percent. How much will the new machine cost? salvage value of P5,000. Annual before-tax cash inflow amounts to P10,000. Salvage value is
A. P300,000 C. P660,000 ignored in computing depreciation.
B. P550,000 D. P792,000 Assuming a tax rate of 30% and a required rate of return of 8%, what is the payback period
for the project?
7. The Fields Company is planning to purchase a new machine which it will depreciate, for book A. 5.0 years C. 6.0 years
purposes, on a straight-line basis over a ten-year period with no salvage value and a full B. 5.6 years D. 6.6 years
year’s depreciation taken in the year of acquisition. The new machine is expected to produce 12. Umali Corporation is considering an investment in a new cheese-cutting machine to replace
cash flow from operations, net of income taxes, of P66,000 a year in each of the next ten its existing cheese cutter. Information on the existing machine and the replacement machine
years. The accounting (book value) rate of return on the initial investment is expected to be follow:
12%. Cost of the new machine P400,000
How much will the new machine cost? Net annual savings in operating costs 90,000
A. P300,000 C. P660,000 Salvage value now of the old machine 60,000
B. P550,000 D. P792,000 Salvage value of the old machine in 8 years 0
Salvage value of the new machine in 8 years 50,000
Annual Cash Flow Estimated life of the new machine 8 years
8. The Hills Company, a calendar company, purchased a new machine for P280,000 on What is the expected payback period for the new machine?
January 1. Depreciation for tax purposes will be P35,000 annually for eight years. The A. 2.67 years C. 4.44 years
accounting (book value) rate of return (ARR) is expected to be 15% on the initial increase in B. 3.78 years D. 8.50 years

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installed in various amusement houses. The machines would cost a total of P300,000, have
13. Pale Products Company is considering the purchase of a new machine. The estimated cost an eight-year useful life, and have a total salvage value of P20,000 upon its retirement.
of the machine is P300,000. The machine is not expected to have a residual value at the Based on experience with other equipment, the company estimates that annual revenues and
end of four years. The machine is expected to generate annual cash inflows for the next four expenses associated with the machines would be as follows:
years as follows: Revenues from use P200,000
Year Annual Cash Inflow Less operating expenses
1 P150,000 Commissions to amusement houses P100,000
2 P120,000 Insurance 7,000
3 P 90,000 Depreciation 35,000
4 P 50,000 Maintenance 18,000 160,000
Pale Products has a policy of accepting a project only if it has a payback period of not longer Net income P 40,000
than 3 years. Ignoring the effect of income taxes, the payback period for the pinball machines would be
What is the expected payback period for this project? A. 3.2 years C. 4.0 years
A. 2.33 years C. 3.00 years B. 3.7 years D. 7.5 years
B. 2.93 years D. 3.60 years
Annual Cash Flows
14. For P4,500,000, Siren Corporation purchased a new machine with an estimated useful life of 16. Vinson Industries, Inc. requires all its capital investment projects to have a payback period of
five years with no salvage value at its retirement. The machine is expected to produce cash 5 years or shorter. Vinson is currently considering an equipment purchase that has an initial
flow from operations, net of income taxes, as follows: cost of P900,000. The equipment is expected to have a ten-year life and a salvage value of
First year P 900,000 P50,000. Assuming cash flows are equal, how much annual cash inflows are necessary in
Second year 1,200,000 order to meet the payback period requirement?
Third year 1,500,000 A. P 90,000 C. P180,000
Fourth year 900,000 B. P170,000 D. P190,000
Fifth year 800,000

Siren will use the sum-of-the-years-digits’ method to depreciate the new machine as follows:
First year P1,500,000 Bailout Payback
Second year 1,200,000 17. The Dwight Company plans to invest in a duplicating machine that costs P120,000. The
Third year 900,000 following are the expected annual cash inflows that are evenly received each month and the
Fourth year 600,000 estimated salvage value at any point of each year.
Fifth year 300,000 Year Cash Inflows Salvage Value
What is the payback period for the machine? 1 P40,000 P50,000
A. 2 years C. 4 years 2 36,000 40,000
B. 3 years D. 5 years 3 32,000 28,000
4 28,000 20,000
15. The Leisure Company is considering the purchase of electronic pinball machines to be 5 25,000 5,000

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 Comprehensive MAS Reviewer by Bobadilla Chapter 11 – Capital Budgeting

What is the bail-out period for this project? Third year 180,000
A. 1.83 years C. 2.50 years Fourth year 120,000
B. 2.43 years D. 2.57 years Fifth year 100,000
Maleen will use the sum-of-the-years-digits’ method to depreciate the new machine as
Depreciation Tax Shield
follows:
18. Grant Company is considering to invest in an equipment that costs P70,000. The equipment
First year P150,000
would be depreciated over 7 years using straight-line method, no salvage value and full
Second year 120,000
year’s depreciation to be recognized in the first year of the asset’s use. The present value of
Third year 90,000
annuity of 1, discounted at 14 percent for 7 years is 4.28843, and the present value of 1 end
Fourth year 60,000
of 7 years is 0.39963.
Fifth year 30,000
If the company has 40 percent tax rate and desires an after-tax rate of return of 14 percent on
The present value of 1 for 5 periods at 12 percent is 3.60478. The present values of 1 at 12
investments, the total present value of the tax shield is:
percent at end of each period are:
A. P17,153 C. P27,972
End of:
B. P25,731 D. P42,884
Period 1 0.89280
19. Prime Consulting, Inc. operates consulting offices in Manila, Olongapo, and Cebu. The firm Period 2 0.79719
is presently considering an investment in a new mainframe computer and communication Period 3 0.71178
software. The computer would cost P6 million and have an expected life of 8 years. For tax Period 4 0.63552
purposes, the computer can be depreciated using either straight-line method or Sum-of-the- Period 5 0.56743
Years’-Digits (SYD) method over five years. No salvage value is recognized in computing Had Maleen used straight-line method of depreciation instead of declining method, what is
depreciation expense and no salvage value is expected at the end of the life of the the difference in net present value provided by the machine at a discount rate of 12 percent?
equipment. The company’s cost of capital is 10 percent and its tax rate is 40 percent. A. Decrease of P 9,750 C. Increase of P 9,750
The present value of annuity of 1 for 5 periods is 3.791 and for 8 periods is 5.335. The B. Decrease of P24,376 D. Increase of P24,376
present values of 1 end of each period are:
1 0.9091 5 0.6209 Net Present Value
2 0.8264 6 0.5645 21. Consider a project that requires an initial cash outflow of P500,000 with a life of eight years
3 0.6513 7 0.5132 and a salvage value of P20,000 upon its retirement. Annual cash inflow before tax amounts to
4 0.6830 8 0.4665 P100,000 and a tax rate of 30 percent will be applicable. The required minimum rate of return
The present value of the net advantage of using SYD method of depreciation with a five-year for this type of investment is 8 percent. The present value of 1 and the annuity of 1,
life instead of straight-line method of depreciating the equipment is: discounted at 8 percent for 8 periods are 0.54 and 5.747, respectively. Salvage value is
A. P 86,224 C. P215,560 ignored in computing depreciation. The net present value amounts to
B. P115,168 D. P287,893 A. P 7,560 C. P 17,606
B. P 10,050 D. P 20,050
20. For P450,000, Maleen Corporation purchased a new machine with an estimated useful life of
five years with no salvage value. The machine is expected to produce cash flow from 22. Polar Company purchased an asset costing P90,000. Annual operating cash inflows are
operations, net of 40 percent income taxes, as follows: expected to be P20,000 each year for six years. No salvage value is expected at the end of
First year P160,000 the asset’s life. The company applies a 16 percent minimum acceptable rate of return for
Second year 140,000

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this kind of investment. The details of the present values at 16%, six periods are: five years. The equipment would be depreciated using straight-line method over its five-year
Present value of ordinary annuity of 1 3.6847 life. Upon retirement, the machine is expected to have a market value of P8,000. The
Present value of annuity due of 1 4.2743 company considers the maximum impact of income taxes in all of its capital investment
Assuming Polar’s cost of capital is 16 percent, what is the asset’s net present value? (ignore decisions. The company has a 35 percent income tax rate and desires an after-tax rate of
income taxes). return of 12 percent on its investment.
A. P(16,306) C. P 4,800 The present value of 1, end of 5 years at 12% is 0.56743 and for ordinary annuity is 3.60478.
B. P (4,514) D. P 30,000 The net present value of the equipment is:
A. P 4,539 C. P 7,042
23. Mid-Circle Products, Inc. purchased equipment costing P100,000. Annual operating cash B. P 5,453 D. P 21,248
inflows are expected to be P30,000 each year for five years. At the end of the equipment’s
life, the salvage value is expected to be P6,000. The present value of cash inflows per 1 at 1 26. Zambales Mines, Inc. is contemplating the purchase of a piece of equipment to exploit a
percent, 5 years are: mineral deposit that is located on land to which the company has mineral rights. Based on an
Present value of 1, end of 5 periods 0.51937 engineering and cost analysis, the following cash flows associated with opening and
Present value of ordinary annuity of 1, 5 periods 3.43308 operating a mine in the area are expected.
Present value of annuity due of 1, 5 periods 3.91371 Cost of new equipment and timbers 2,750,000
If Mid-Circle’s cost of capital is 14 percent, what is the asset’s net present value? (ignore Working capital required 1,000,000
income taxes). Net annual cash receipts* 1,200,000
A. P 6,109 C. P20,528 Cost to construct new road in three years 400,000
B. P 7,840 D. P23,592 Salvage value of equipment in 4 years 650,000
*Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, etc.
24. Blue Marine Aggregates, Inc. plans to replace one of its machines with a new efficient one. It is estimated that the mineral deposit would be exhausted after four years of mining. At that
The old machine has a net book value of P120,000 with remaining economic life of 4 years. point, the working capital would be released for reinvestment elsewhere. The company’s
This old machine can be sold for P80,000. If the new machine were acquired, the cash discount rate is 20%.
operating expenses will be reduced from P240,000 to P160,000 for each of the four years, The net present value for the project is:
the expected economic life of the new machine. The new machine will cost Blue Marine a A. P(561,553) C. P (79,303)
cash payment to the dealer of P300,000. The company is subject to 32 percent tax and for B. P(204,688) D. P 454,620
this kind of investment, a marginal cost of capital of 9 percent. The present value of annuity
of 1 and the present value of 1 for 4 periods using 9 percent are 3.23972 and 0.70843, 27. Zap Manufacturing has an investment opportunity to embark on a project where yearly
respectively. revenues for five years are to be P400,000 and operating costs of P104,800. The equipment
costs P1 million, and straight-line depreciation will be used for book and tax purposes. No
The net present value to be provided by the replacement of the old machine is salvage value is expected at the end of the project’s life. The company has a 40 percent
A. P15,693 C. P46,794 marginal tax rate and a 10 percent cost of capital. The equipment manufacturer has offered a
B. P28,493 D. P59,594 delayed payment plan of P560,500 per year at the end of the first and second years. There
will be no changes in working capital.
25. Paulina’s Products, Inc. is considering a new piece of equipment that costs P75,000. The The present value of annuity of 1 for 5 periods is 3.7908 at 10 percent.
equipment is expected to generate revenues before-tax cash inflows of P25,000 per year for The present values of 1 end of each period at 10 percent are:

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 Comprehensive MAS Reviewer by Bobadilla Chapter 11 – Capital Budgeting

Period 1 – 0.9091 4 P 50,000

Period 2 – 0.8264 Pale Products requires a 12 percent return on this investment. The present value of annuity
Period 3 – 0.7513 of 1 at 12 percent for 4 periods is 3.03735. The present values of 1, end of each period,
Period 4 – 0.6830 discounted at 12 percent follow:
Period 5 – 0.6209 Year Present Value of 1
The net present value if the equipment were purchased is 1 0.89286
A. P (87,977) C. P (25,310) 2 0.79719
B. P (61,094) D. P 1,922 3 0.71178
4 0.63552
28. By the end of December 31, 2005, Alay Foundation is considering the purchase of a copying Assuming that the company uses a discount rate of 12 percent, what is the expected net
machine for P80,000. The expected annual cash savings are expected to be P32,000 in the present value of the machine (ignore income taxes)?
next four years. At the end of the four years, the machine will be discarded without any A. P(27,570) C. P 31,013
salvage value. All the cash savings are stated in number of pesos at December 31, 2006. B. P 15,765 D. P 42,000
The company expected that the inflation rate is constantly 5 percent each year. Hence, the
first year’s cash inflow was adjusted for 5 percent inflation. For simplicity, all cash inflows are Profitability Index
assumed to be at year-end. 30. The Mejicano Company is planning to purchase a piece of equipment that will reduce annual
The present value at 14 % of 1 for 4 periods is 2.91371. The present value of 1 at end of cash expenses over its 5-year useful life by equal amounts. The company will depreciate the
each period are: equipment using straight-line method of depreciation based on an estimated life of 5 years
Period 1 - 0.87719 without any salvage value. The company is subject to 40 percent tax. The marginal cost of
Period 2 - 0.76947 capital for this acquisition is 11.055 percent. The management accountant calculates, based
Period 3 - 0.67497 on the estimated after-tax cash flows, that the internal-rate of return is 12.386 percent and net
Period 4 - 0.59208 present value of P10,000. The president, however, wants to know the profitability index
Using the nominal rate of return of 14 percent, the net present value for this machine is before he finally decides.
A. P12,239 C. P19,670 What is the profitability index for this investment?
B. P13,419 D. P27,936 A. 1.011 C. 1.034
B. 1.022 D. 1.044
29. Pale Products Company is considering the purchase of a new machine. The estimated cost
of the machine is P250,000. The machine is not expected to have a residual value at the 31. The Premiere Corporation has to replace its completely damaged boiler machine with a new
end of four years. The machine is expected to generate annual cash inflows for the next four one. The old machine has a net book value of P100,000 with zero market value; therefore it
years as follows: will give a tax shield, based on 35% tax rate if replaced, by P35,000. The company has a 10
percent cost of capital. Understandably, the new machine, through a uniform decrease in
cash operating costs, will give a positive net present value because this machine will provide
Year Annual Cash Inflow an internal rate of return of 12 percent.
1 P150,000 The present values at 10% and 12%, respectively, are:
2 P100,000 10% 12%
3 P 50,000 Annuity of 1, 6 periods 4.35526 4.11141

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1 end of 6 periods 0.56447 0.50663 B. 12.00% D. 16.00%

If the machine were to be depreciated using straight-line method for 6 years without any
salvage value, the estimated profitability index is: Net Investment
A. 0.94 C. 1.07 34. Kipling Company has invested in a project that has an eight-year life. It is expected that the
B. 1.06 D. 1.20 annual cash inflow from the project will be P20,000. Assuming that the project has a
internal rate of return of 12%, how much was the initial investment in the project if the
32. Rainbow Company has a project that requires an initial investment of P100,000 and has the present value of annuity of 1 for 8 periods is 4.968 and the present value of 1 is 0.404?
following expected stream of cash inflows: A. P 64,640 C. P 99,360
Year Annual Cash Inflow B. P 80,800 D. P160,000
1 P80,000
2 P60,000 35. Capital Company requires all capital investment to generate an internal rate of return of 16
3 P20,000 percent. Capital is currently considering an investment in a machine that is expected to
The present value of annuity of 1 at 12 percent for 3 periods 2.40183 is and the details are: generate annual cash inflows of P15,000 for 7 years. The present value of ordinary annuity
Year Annual Cash Inflow of 1, 16 percent for 7 years is 4.03856. Applying the discounted technique, the amount of
1 0.89286 investment should not exceed:
2 0.79719 A. P16,800 C. P60,580
3 0.71178 B. P37,150 D. P95,500
Assuming the company adopts the cost of capital of 12 percent as the discount rate, what is
36. Camel Company invests in a machine with a useful life of six years and no salvage value.
the profitability index for the project?
The machine will be depreciated using the straight-line method. It is expected to produce
A. 0.749 C. 1.600
annual cash inflow from operations, net of income taxes, of P6,000. The present value of an
B. 1.335 D. 2.985
ordinary annuity of P1 for six periods at 10% is 4.355. The present value of P1 for six periods
at 10% is 0.564. Assuming that Camel uses a time-adjusted rate of return of 10%, how much
Internal Rate of Return
is the original investment?
33. Vendo Company is planning to buy a coin-operated machine costing P400,000. For book
A. P10,640 C. P26,130
and tax purposes, this machine will be depreciated P80,000 each year for five years. Vendo
B. P22,750 D. P29,510
estimates that this machine will yield an annual inflow, net of depreciation and income taxes,
of P120,000. Vendo’s desired rate of return on its investments is 12%. At the following Annual Cash Flow
discount rates, the NPVs of the investment in this machine are: 37. Taal Company is considering the purchase of a machine that promises to reduce operating
Discount Rate NPV costs by equal amounts every year of its 6-year useful life. The machine will cost P840,000
12% +P3,258 and has no salvage value. The machine has a 20% internal rate of return. Taal Company is
14% + 1,197 subject to 40% income tax rate. The present value of annuity of 1 for 6 periods at 20% is
16% - 708 3.326, and the present value at the end of 6 periods is 0.3349.
18% - 2,474 The approximate annual cash savings before tax is closest to:
A. P112,555 C. P252,555
Vendo’s expected IRR on its investment in this machine is B. P187,592 D. P327,592
A. 3.25% C. 15.30% 38. An asset is purchased for P120,000. It is expected to provide an additional P28,000 of annual

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net cash inflows. The asset has a 10-year life and an expected salvage value of P12,000.
The hurdle rate is 10%. The present value of an annuity factor of 10% for 10 years is 6.1446, The PV of annuity of 1, 15% for 10 periods 5.01877
and the present value of P1, discounted for 10 years at 10% is 0.3855. The PV of 1, end 10 period 0.24718
Given the data provided, the minimum amount of annual cash inflows that would provide the What is the annual peso value of the intangible benefits in order to make the equipment an
10% time-adjusted return is approximately acceptable investment?
A. P18,776 C. P24,400 A. P 49,440 C. P 61,331
B. P22,535 D. P26,600 B. P 55,000 D. P248,123

39. Pacau, Inc. requires all its capital investments to generate an internal rate of return of 14 Increase in Annual Cash Flow
percent. The company is considering an investment costing P80,000 that is expected to 42. Altas, Inc., is considering investing in automated equipment with a ten-year useful life.
generate equal annual cash inflows for 5 years. The present value of 1, end of 5 years is Managers at Altas have estimated the cash flows associated with the tangible costs and
0.51937 and the present value of annuity of 1 is 3.4331 based on 14 percent required rate of benefits of automation, but have been unable to estimate the cash flows associated with
return. the intangible benefits. Using the company’s 10% discount rate, the net present value of
To meet the 14 percent minimum acceptable rate of return, the estimated annual cash inflow the cash flows associated with just the tangible costs and benefits is a negative P184,350.
(ignoring income taxes) is: The present value of annuity of 1 at 10 percent for ten years is 6.145 while the present
A. P 23,303 C. P154,033 value of 1 is 0.386. How large would the annual net cash inflows from the intangible
B. P 51,550 D. P274,648 benefits have to be to make this a financially acceptable investment?
A. P18,435 C. P35,000
40. Aloha Co. is considering the purchase of a new ocean-going vessel that could potentially B. P30,000 D. P37,236
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 43. The following data pertain to Julian Corp. whose management is planning to purchase a unit
end of 10 years, the ship will have no value and will be sunk in some already polluted harbor. of equipment.
The Aloha Co.’s cost of capital is 12 percent, and its marginal tax rate is 40 percent. If the  Economic life of equipment – 8 years.
ship produces equal annual labor cost savings over its 10-year life, how much do the annual  Disposal value after 8 years – Zero.
savings in labor costs need to be to generate a net present value of P0 on the project?  Estimated net annual cash inflows for each of the 8 years – P81,000.
Use the following PV: annuity of 1, 10 periods at 12% - 5.6502; end of 10th period –  Time-adjusted internal rate of return – 14%
0.32197.  Cost of capital for Julian Corp. – 16%
A. P 68,492 C. P114,154  The table of present values of P1 received annually for 8 years has these factors: at 14%
B. P 88,492 D. P147,487 = 4.639, at 16% = 4.344
 Depreciation is approximately P46,970 annually.
41. Solidum Company is investigating the purchase of a piece of automated equipment that will
Find the required increase in annual cash inflows in order to have the time-adjusted rate of
save P100,000 each year in direct labor and inventory carrying costs. This equipment costs
return approximately equal the cost of capital.
P750,000 and is expected to have a 10-year useful life with no salvage value. The company
A. P4,344 C. P5,871
requires a minimum of 15% internal-rate of return on all equipment purchases. Management
B. P5,501 D. P6,501
anticipates that this equipment will provide intangible benefits such as greater flexibility and
higher quality output.

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End-of-Life Cash Flows

44. A company is considering putting up P50,000 in a three-year project. The company’s 47. Suppose the 20,000 estimated sales volume is sound, but the price is in doubt, what is the
expected rate of return is 12%. The present value of P1.00 at 12% for one year is 0.893, for selling price (rounded to nearest peso) needed to earn a 12 percent internal rate of return?
two years is 0.797, and for three years is 0.712. The cash flows, net of income taxes are A. P70.00 C. P90.00
P18,000 (present value of P16,074) for the first year and P22,000 (present value of P17,534) B. P81.00 D. P95.00
for the second year. Assuming that the rate of return is exactly 12%, the cash flow, net of
income taxes, for the third year would be Project Screening, Project Ranking & Capital Rationing
A. P 7,120 C. P16,392 48. Perpetual Foundation, Inc., a nonprofit organization, has one of its activities, the production of
B. P10,000 D. P23,022 cookies for its snack food store. Several years ago, Perpetual Foundation, Inc. purchased a
special cookie-cutting machine. As of December 31, 2008, this machine would have been
Salvage Value used for three years. Management is considering the purchase of a newer, more efficient
45. Mermaid, Inc. requires all its capital investments to generate an internal rate of return of 12 machine. If purchased, the new machine would be acquired on December 31, 2008.
percent. The company is considering an investment costing P150,000 that is expected to Management expects to sell 300,000 dozen cookies in each of the next six years. The selling
generate equal annual cash inflows of P40,000 for 5 years . The present value of 1, end of 5 price of the cookies is expected to average P1.15 per dozen.
years is 0.56743 and the present value of annuity of 1 is 3.60478 based on 12 percent
required rate of return. Perpetual Foundation, Inc. has two options: continue to operate the old machine, or sell the
To meet the 12 percent minimum acceptable rate of return required by Mermaid, the old machine and purchase the new machine. No trade-in was offered by the seller of the new
estimated salvage value at the end of 5 years(ignoring income taxes) should be: machine. The following information has been assembled to help management decide which
A. P 1,611 C. P10,237 option is more desirable.
B. P 3,296 D. P20,940 Old Machine New Machine
Original cost of machine at acquisition P80,000 P120,000
Comprehensive Remaining useful life as of 12/31/08 6 years 6 years
The next two questions are based on the following information. Expected annual cash operating expenses:
Paper Products Company is considering a new product that will sell for P100 and has a variable Variable cost per dozen P0.38 P0.29
cost of P60. Expected volume is 20,000 units. New equipment costing P1,500,000 and having a Total fixed costs P21,000 P 11,000
five-year useful life and no salvage value is needed, and will be depreciated using the straight-line Estimated cash value of machines:
method. The machine has fixed cash operating costs of P200,000 per year. The firm is in the 40 December 31, 2008 P40,000 P120,000
percent tax bracket and has cost of capital of 12 percent. The present value of 1, end of five December 31, 2014 P 7,000 P 20,000
periods is 0.56743; present value of annuity of 1 for 5 periods is 3.60478. Assume all operating revenues and expenses occur at the end of the year.
The net advantage in present value, using a 16% rate, of the better alternative is:
46. How many units per year the firm must sell for the investment to earn 12 percent internal rate A. Buy New Machine, P16,345. C. Retain Old Machine, P16,345.
of return? B. Buy New Machine, P61,675. D. Retain Old Machine, P61,675.
A. 9,838 C. 17,338
B. 12,338 D. 28,897 The next two questions are based on the following information.
Savior Products is considering a purchase of any of two types of machinery. The first machine

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 Comprehensive MAS Reviewer by Bobadilla Chapter 11 – Capital Budgeting

costs P50,000 more than the second machine. During the two-year life of these two alternatives, 52. The net present value of the advertising program would be
the first machine has a P155,000 more cash flow in year one and a P110,000 less cash flow in A. P(37,064) C. P 29,136
year two than the seconds machine. All cash flows occur at year-end. The present value of 1 at 15 B. P(29,136) D. P 37,064
percent end of 1 period and 2 periods are 0.86957 and, 0.75614, respectively. The present value The next three question Nos. are based on the following information.
of 1 at 8 percent end of period 1 is 0.92593, and Period 2 is 0.85734. Cayco Medical Center is considering purchasing an ultrasound machine for P950,000. The
machine has a 10 – year life and an estimated salvage value of P55,000. Installation costs and
49. Which machine should be purchased if the relevant discount rates are 15 percent and 8 freight charges will be P24,200 and P800, respectively. Cayco uses straight-line depreciation.
percent, respectively?
A. B. C. D. The medical center estimates that the machine will be used five times a week with the average
15% Discount Machine 1 Machine 1 Machine 2 Machine 2 charges to the patient for ultrasound of P800. There are P10 in medical supplies and P40 of
8% Discount Machine 1 Machine 2 Machine 1 Machine 2 technician costs for each procedure performed using the machine. The present value of an annuity
of 1 for 10 years at 9% is 6.418 while the present value of 1 for 10 years at 9% is 0.42241
50. At what discount rate would Machine 1 be equally acceptable as machine 2’s?
A. 9% C. 11% 53. What is the accounting rate of return provided by the project?
B. 10% D. 12% A. 10.6 percent C. 20.0 percent
B. 11.2 percent D. 38.0 percent
Comprehensive
The next two questions are based on the following information. 54. The cash payback period is:
Vivo Insurance Company’s management is considering an advertising program that would require A. 3.0 years C. 5.0 years
an initial expenditure of P165,500 and bring in additional sales over the next five years. The cost B. 4.8 years D. 6.0 years
of advertising is immediately recognized as expense. The projected additional sales revenue in
Year 1 is P75,000, with associated expenses of P25,000. The additional sales revenue and 55. The project is expected to generate net present value of:
expenses from the advertising program are projected to increase by 10 percent each year. Vivo A. P253,277 C. P299,743
Insurance Company’s tax rate is 40 percent. B. P276,510 D. P331,510
The present value of 1 at 10 percent, end of each period:
Period Present value of 1 The next three question are based on the following information.
1 0.90909 Kabalikat Company has the opportunity to introduce a new product. Kabalikat expects the product
2 0.82645 to sell for P75 with variable cost per unit of P50. The annual fixed costs, excluding the amount of
3 0.75131 depreciation is P4,500,000. The company expects to sell 300,000 units. To produce the new
4 0.68301 product line, the company needs to purchase a new machine that costs P6,000,000. The new
5 0.62092 machine is expected to last for four years with a very negligible salvage value. The company has a
policy of depreciating its machine for both book and tax purposes for four years. The company has
51. The payback period for the advertising program is a marginal cost of capital of 13.75 percent and is subject to tax rate of 40 percent.
A. 1.9 years C. 3.0 years 56. The amount of annual after-tax cash flows is:
B. 2.5 years D. 4.6 years A. P 900,000 C. P2,400,000
B. P1,500,000 D. P3,000,000

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57. The machine’s net present value is: 62. The present value index for this investment is:
A. P 150,270 C. P1,028,900 A. 0.70 C. 1.14
B. P 928,500 D. P2,786,100 B. 0.88 D. 1.45
58. Assuming that some of the 300,000 units that are expected as sales would be to group of
customers who currently buy K-Z, another product of Kabalikat Company. This Product K-Z The next five question are based on the following:
sells for P35 with variable cost of P20. How many units of K-Z can Kabalikat afford to lose Lakewood Company is considering the purchase of a special-purpose bottling machine for
before the purchase of the new machine becomes unattractive? P280,000. It is expected to have a useful life of 7 years with a zero terminal disposal price. The
A. 10,029 units C. 23,400 units plant manager estimates the following savings in cash-operating costs:
B. 16,714 units D. 39,000 units Year Annual Cash Savings
1 P140,000
The next four questions are based on the following information. 2 110,000
The management of Queen Corporation is considering the purchase of a new machine costing 3 80,000
P400,000. The company’s desired rate of return is 10%. The present value of P1 at compound 4 60,000
interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively, and 5 40,000
the present value of annuity of 1 for 5 periods at 10 percent is 3.79. In addition to the foregoing
6 30,000
information, use the following data in determining the acceptability in this situation:
7 30,000
Income from Net Cash
Year Operations Flow
1 P100,000 P180,000 Lakewood uses a required rate of return of 12% in its capital-budgeting decisions. Incremental tax
rate is 40%. The company uses straight-line depreciation. The present value of annuity of 1, at 12
2 40,000 120,000
percent for 7 years is 4.56376. The details of the present value at 12 percent in 7 years are:
3 20,000 100,000 Year Annual Cash Savings
4 10,000 90,000 1 0.89286
5 10,000 90,000 2 0.79719
3 0.71178
59. The average rate of return for this investment is: 4 0.63552
A. 6 percent C. 18 percent 5 0.56743
B. 10 percent D. 58 percent 6 0.50663
7 0.45235
60. The cash payback period for this investment is:
A. 3 years. C. 5 years 63. What is the accounting rate of return based on initial investment?
B. 4 years D. 20 years A. 6.43% C. 20.71%
B. 12.86% D. 41.42%
61. The net present value for this investment is:
A. Negative P 99,600 C. Positive P 36,400 64. What is the amount of after-tax cash flow in year 7?
B. Negative P126,800 D. Positive P 55,200 A. P22,000 C. P34,000
B. P30,000 D. P36,400

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 The new sanding machine would provide substantial annual savings in cash operating costs.
65. The number of years to recover the amount investment is: It would require an operator at an annual salary of P16,350 and P5,400 in annual maintenance
A. 2.38 years C. 4.00 years costs. The current, hand-operated sanding procedure costs the company P78,000 per year in
B. 3.65 years D. 4.83 years total.

66. What is the net advantage of applying sum-of-the-years’-digits method instead of using
straight-line depreciation? Pinewood Craft Company requires a simple rate of return of 15% on all equipment purchases.
A. P2,491 C. P6,379 Also, the company will not purchase equipment unless the equipment has a payback period of 4.0
B. P4,154 D. P8,188 years or less.
(In all the following questions, please ignore income tax effect)
67. What is the net present value for this investment?
A. P (2,159) C. P 4,723 68. The expected income each year from the new shelving products (Machine A) is:
B. P 0 D. P 8,559 A. P 52,500 C. P 92,500
B. P 84,000 D. P240,000
The next six questions are based on the following information.
Pinewood Craft Company is considering the purchase of two different items of equipment, as 69. The simple rate (%) of return for Machine A is:
described below: A. 12.5 percent C. 20.0 percent
Machine A. A compacting machine has just come onto the market that would permit Pinewood B. 18.0 percent D. 25.0 percent
Craft Company to compress sawdust into various shelving products. At present the sawdust is
disposed of as a waste product. The following information is available on the machine: 70. The simple rate of return for Machine B is:
 The machine would cost P420,000 and would have a 10% salvage value at the end of its 12- A. 16.3 percent C. 25.0 percent
year useful life. The company uses straight-line depreciation and considers salvage value in B. 17.0 percent D. 34.0 percent
computing depreciation deductions.
 The shelving products manufactured from use of the machine would generate revenues of 71. The annual savings in cost if Machine B is purchased is
P300,000 per year. Variable manufacturing costs would be 20% of sales. A. P21,750 C. P43,250
 Annual fixed expenses associated with the new shelving products would be: advertising, B. P38,250 D. P56,250
P40,000; salaries, P110,000; utilities, P5,200; and insurance, P800.
72. The payback period for Machine A is:
Machine B. A second machine has come onto the market that would allow Pinewood Craft A. 3.0 years C. 5.0 years
Company to automate a sanding process that is now done largely by hand. The following B. 4.5 years D. 7.5 years
information is available:
 The new sanding machine would cost P234,000 and would have no salvage value at the end 73. The payback period for Machine B is:
of its 13-year useful life. The company would use straight-line depreciation on the new A. 4.0 years C. 5.9 years
machine. B. 4.2 years D. 6.1 years
 Several old pieces of sanding equipment that are fully depreciated would be disposed of at a
scrap value of P9,000. The next six questions are based on the following:

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Turkey Company’s average production of valve stems over the past three years has been 80,000
units each year. Expectations are that this volume will remain constant over the next four years. Referring to the figures above, the production manager stated, “These numbers look great until you
Cost records indicate that unit product costs for the valve stem over the last several years have consider the difference in volume. Even with the reduction in labor and variable overhead cost, I’ll
been as follows: bet our total unit cost figure would increase to over P20 with the new tools.”
Direct materials P 3.60
Direct labor 3.90 Although the old tools being used by Turkey Company are now fully depreciated, they have a
Variable manufacturing overhead 1.50 salvage value of P45,000. These tools will be sold if the new tools are purchased; however if the
Fixed manufacturing overhead* 9.00 new tools are not purchased, then the old tools will be retained as standby equipment. Turkey
Unit product cost P18.00 Company’s accounting department has confirmed that total fixed manufacturing overhead costs,
other than depreciation, will not change regardless of the decision made concerning the valve
* Depreciation of tools (that must now be replaced) accounts for one-third of the fixed overhead. stems. However, the accounting department has estimated that working capital needs will
The balance is for other fixed overhead costs of the factory that require cash expenditures. increase by P60,000 if the new tools are purchased due to the higher quality of material required in
the manufacture of the valve stems.
If the specialized tools are purchased, they will cost P2,500,000 and will have a disposal value of
P100,000 at the end of their four-year useful life. Turkey Company has a 30% tax rate, and The present values of 1 at the end of each period using 12 percent are:
management requires a 12% after-tax return on investment. Straight-line depreciation would be Period 1 0.89286
used for financial reporting purposes, but for tax purposes, the following amounts of variable Period 2 0.79719
depreciation will be used. Period 3 0.71178
Year 1 P 832,500 Period 4 0.63552
Year 2 1,112,500 PV of annuity of 1, 4 periods 3.03735
Year 3 370,000
Year 4 185,000 74. The net investment in new tools amounted to:
A. P1,873,300 C. P2,528,500
The sales representative for the manufacturer of the specialized tools has stated, “The new tools B. P2,515,000 D. P2,546.500
will allow direct labor and variable overhead to be reduced by P1.60 per unit.” Data from another
company using identical tools and experiencing similar operating conditions, except that annual 75. How much annual cost savings will be generated if the Turkey Company purchases the new
production generally averages 100,000 units, confirms the direct labor and variable overhead cost tools?
savings. However, the other company indicates that it experienced an increase in raw material A. P128,000 C. P936,000
cost due to the higher quality of material that had to be used with the new tools. The other B. P216,000 D. P1,008,000
company indicates that its unit product costs have been as follows:
76. The present value of tax benefits expected from the use of the new machine tools is:
Direct materials P 4.50 A. P 603,333 C. P1,407,777
Direct labor 3.00 B. P 804,444 D. P2,011,111
Variable manufacturing overhead 0.80
Fixed manufacturing overhead 10.80 77. The present value of the salvage value of the new tools to be received at the end of fourth
Unit product cost P19.10 year is

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 Comprehensive MAS Reviewer by Bobadilla Chapter 11 – Capital Budgeting

A. P 19,065 C. P 63,552 Alternative 2. Home’s sales manager feels that the company needs to diversify its operations. He
B. P 44,486 D. P212,615 has suggested that an opening be cut in the wall between the pizza shop and the vacant space
and that video games be placed in the space, along with a small snack bar. Costs for remodeling
78. Using the minimum acceptable rate of return of 12 percent, the net present value of the and for the snack bar facilities would be P290,000. The games would be leased from a large
investment in new tools is distributor of such equipment. The distributor has stated that based on the use of game centers
A. P108,913 C. P147,073 elsewhere, Home’s could expect about 26,000 people to use the center each year and to spend an
B. P127,979 D. P166,139 average of P5 each on the machines. In addition, it is estimated that the snack bar would provide a
net cash inflow of P15,000 per year. An investment of P4,000 in working capital would be needed.
This working capital investment would be released at the end of the lease term. The snack bar
79. The net advantage of the use of declining method of depreciation instead of straight-line equipment would have a salvage value of about P12,000 in 15 years.
method is
A. P 33,830 C. P112,767 Home’s management is unsure which alternative to select and has asked you to help in making the
B. P 56,610 D. P147,731 decision. You have gathered the following information relating to added costs that would be
incurred each year under the two alternatives:
The next six questions are based on the following information. Expand the Pizza Shop Install the Game Center
Home’s Pizza’s, Inc., operates pizza shops in several cities. One of the company’s most profitable Rent- building space P18,000 P18,000
shops is located adjacent to the large CPA review center in Manila. A small bakery next to the shop Rent- video games --- 30,000
has just gone out of business, and Home’s Pizzas has an opportunity to lease the vacated space Salaries 54,000 17,000
for P18,000 per year under a 15-year lease. Home’s management is considering two ways in which Utilities 13,200 5,400
the available space might be used. Insurance and other 7,800 9,600

Alternative 1. The pizza shop in this location is currently selling 40,000 pizzas per year. The company is currently using a 16 percent minimum acceptable rate of return for its capital
Management is confident that sales could be increased by 75% by taking out the wall between the investment. The present value of annuity of 1 at 16 percent for 15 periods is 5.575 and end of 15
pizza shop and the vacant space and expanding the pizza outlet. Costs for remodeling and for new periods is 0.108. The company is not liable to pay income taxes.
equipment would be P550,000. Management estimates that 20% of the new sales would be small
pizzas, 50% would be medium pizzas, and 30% would be large pizzas. Selling prices and costs for 80. The incremental annual cash inflows from Alternative 1 is:
ingredients for the three sizes of pizzas follow (per pizza): A. P 90,000 C. P108,000
Selling Price Cost of Ingredients B. P100,200 D. P201,000
Small P 6.70 P1.30
Medium 8.90 2.40 81. The incremental annual cash inflows from Alternative 2 is:
Large 11.00 3.10 A. P 17,000 C. P 65,000
B. P 59,600 D. P145,000
An additional P7,500 of working capital would be needed to carry the larger volume of business.
This working capital would be released at the end of the lease term. The equipment would have a 82. The net present value for Alternative 1 is:
salvage value of P30,000 in 15 years, when the lease ends. A. P32,500 C. P48,650
B. P45,000 D. P47,840

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83. The net present value for Alternative 2 is: ANSWER KEY
A. P12,807 C. P68,375
B. P21,021 D. P70,103 Theory
1. A 21. A 41. B 61. A
84. Assume that the company decides to accept alternative 2. At the end of the first year, the 2. B 22. C 42. C 62. C
company finds that only 21,000 people used the game center during the year (each person 3. A 23. C 43. D 63. C
spent P5 on games). Also, the snack bar provided a net cash inflow of only P13,000. In light 4. C 24. D 44. C 64. C
of this information, what is the net present value for alternative 2? 5. C 25. B 45. D 65. D
A. P(76,422) C. P(80,854) 6. B 26. D 46. D 66. A
B. P(80,422) D. P(82,150) 7. C 27. B 47. D 67. C
8. B 28. C 48. B 68. C
85. The sales manager has suggested that an advertising program be initiated to draw another 9. C 29. B 49. C 69. B
5,000 people into the game center each year. Assuming that another 5,000 people can be 10. A 30. B 50. C 70. C
attracted into the center and that the snack bar receipts increase to the level originally 11. D 31. C 51. C 71. D
estimated, how much can be spent on advertising each year and still allow the game center
12. D 32. C 52. D 72. B
to provide a 16% rate of return?
13. C 33. C 53. B 73. A
A. P12,574.53 C. P58,953.00
14. D 34. D 54. A 74. B
B. P 4,673.53 D. P70,103.00
15. D 35. D 55. C 75. A
16. A 36. C 56. D 76. B
17. A 37. B 57. C 77. A
18. C 38. D 58. D 78. D
19. B 39. C 59. B 79. C
20. D 40. B 60. A 80. D

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SOLUTION TO PROBLEMS

Problem
1. B 21. C 41. A 61. D 81. C
2. B 22. A 42. B 62. C 82. C
3. B 23. A 43. B 63. A 83. D
4. C 24. A 44. D 64. C 84. B
5. A 25. B 45. C 65. B 85. A
6. A 26. C 46. C 66. D
7. A 27. C 47. D 67. D
8. D 28. C 48. B 68. A
9. C 29. C 49. B 69. A
10. B 30. C 50. B 70. B
11. B 31. B 51. C 71. D
12. B 32. B 52. D 72. C
13. A 33. C 53. C 73. A
14. C 34. C 54. C 74. C
15. C 35. C 55. C 75. C
16. C 36. C 56. C 76. A
17. C 37. D 57. C 77. B
18. A 38. A 58. D 78. C
19. B 39. A 59. C 79. A
20. A 40. C 60. A 80. C

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