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THEORY
Basic concepts
1. Capital budgeting techniques are least likely to be used in evaluating the
A. Acquisition of new aircraft by a cargo company.
B. Trade for a star quarterback by a football team.
C. Design and implementation of a major advertising program.
D. Adoption of a new method of allocating non-traceable costs to product lines.
efficient. This equipment has an estimated useful life of six years. As part of this
acquisition, a P150,000 investment in working capital is required. In a discounted
cash flow analysis, this investment in working capital should be
A. Disregarded because no cash is involved.
B. Amortized over the useful life of the equipment.
C. Treated as an immediate cash outflow that is recovered at the end of six years.
D. Treated as a recurring annual cash flow that is recovered at the end of six years.

2. The “inflation element” refers to the Operating Cash Flows After Tax
A. Future increases in the general purchasing power of the monetary unit. 6. To approximate annual cash inflow, depreciation is
B. Future deterioration of the general purchasing power of the monetary unit. A. Subtracted from net income because it is an expense.
C. Fact that the real purchasing power of a monetary unit usually increases over B. Added back to net income because it is an inflow of cash.
time. C. Subtracted from net income because it is an outflow of cash.
D. Impact that future price increases will have on the original cost of a capital D. Added back to net income because it is not an outflow of cash.
expenditure.
7. In capital expenditures decisions, the following are relevant in estimating operating
3. Which of the following best identifies the reason for using probabilities in capital costs except
budgeting is A. Cash costs. C. Future costs.
A. Cost of capital. C. Time value of money. B. Differential costs. D. Historical costs.
B. Different life of projects. D. Uncertainty.
Accounting Rate of Return
4. In capital budgeting decisions, the following items are considered among others: 8. The following statements refer to the accounting rate of return (ARR)
1. Cash outflow for the investment. 1. The ARR is based on the accrual basis, not cash basis.
2. Increase in working capital requirements. 2. The ARR does not consider the time value of money.
3. Profit on sale of old asset 3. The profitability of the project is considered.
4. Loss on write-off of old asset. From the above statements, which are considered limitations of the ARR concept?
For which of the above items would taxes be relevant? A. Statements 1 and 2 only. C. Statements 3 and 1 only.
A. Items 1 and 3 only. C. Items 3 and 4 only. B. Statements 2 and 3 only. D. All the 3 statements.
B. Items 1, 3 and 4 only. D. All items.
Payback Period
Net Investments 9. The payback method assumes that all cash inflows are reinvested to yield a return
5. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more equal to

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A. the discount rate. C. the internal rate of return. strategy. The technical services department indicated that this equipment needs
B. the hurdle rate. D. zero. overhauling in year 4 or year 5 of its useful life. The overhauling cost will be expected
during the year the overhauling is done. The finance officer insists that the
overhauling be done in year 4, not in year 5.
10. As a capital budgeting technique, the payback period considers depreciation The most likely reason is
expenses (DE) and time value of money (TVM) as follows: A. There is lower tax rate in year 5. C. The time value of money is
A. B. C. D. considered.
DE relevant relevant Irrelevant irrelevant B. There is higher tax rate in year 5. D. Due to statements A and C
TVM relevant irrelevant Relevant irrelevant above.

Bailout Payback 15. In an investment in plant the return that should keep the market price of the firm stock
11. The bailout payback period is unchanged is
A. The payback period used by firms with government insured loans. A. Cost of capital C. Net present value
B. The length of time for payback using cash flows plus the salvage value to B. Discounted rate of return D. Payback
recover the original investment
C. (A) and (B) 16. If a firm identifies (or creates) an investment opportunity with a present value <List A>
D. None of the above. its cost, the value of the firm and the price of its common stock will <List B>
A. B. C. D.
Discounted Cash Flow Method List A Equal to Equal to Greater than Greater than
12. Which of the following methods measures the cash flows and outflows of a project as List B Decrease Increase Decrease Increase
if they occurred at a single point in time?
A. Capital budgeting. C. Discounted cash flow. 17. The common assumption in capital budgeting analysis is that cash inflows occur in
B. Cash flow based payback period. D. Payback method. lump sums at the end of individual years during the life of an investment project when
in fact they flow more or less continuously during those years
13. When using one of the discounted-cash-flow methods to evaluate the feasibility of a A. Results in understated estimates of NPV.
capital budgeting project, which of the following factors generally is not important? B. Results in higher estimate for the IRR on the investment.
A. The timing of cash flows relating to the project. C. Is done because present value tables for continuous flows cannot be
B. The amount of cash flows relating to the project. constructed.
C. The impact of the project on income taxes to be paid. D. Will result in inconsistent errors being made on estimating NPVs such that
D. The method of financing the project under consideration. project cannot be evaluated reliably.

14. Your company is purchasing a transport equipment as part of its territorial expansion 18. Polo Co. requires higher rates of return for projects with a life span greater than 5

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years. Projects extending beyond 5 years must earn a higher specified rate of return. B. Less than the amount of investment D. Cannot be determined
Which of the following capital budgeting techniques can readily accommodate this
requirement? 23. An advantage of the net present value method over the internal rate of return model
A. B. C. D. in discounted cash flow analysis is that the net present value method
Internal Rate of Return Yes Yes No No A. Computes a desired rate of return for capital projects.
Net Present Value Yes No Yes No C. Uses a discount rate that equates the discounted cash inflows with the outflows.
D. Uses discounted cash flows whereas the internal rate of return model does not.
B. Can be used when there is no constant rate of return required for each year of
19. Payback period (PP), profitability index (PI), and simple accounting rate of return the project.
(SARR) are some of the capital budgeting techniques. What is the effect of an
increase in the cost of capital on these techniques?
A. B. C. D.
24. When using the net present value method for capital budgeting analysis, the required
PP Decrease Increase No change No change
rate of return is called all of the following except the
PI No change Decrease Decrease Increase
A. Cost of capital. C. Discount rate.
SARR No change Increase No change Decrease
B. Cutoff rate. D. Risk-free rate.
Net Present Value 25. A project’s net present value, ignoring income tax considerations, is normally affected
20. A company had made the decision to finance next year’s capital projects through debt by the
rather than additional equity. The benchmark cost of capital for these projects should A. Proceeds from the sale of the asset to be replaced.
be B. Carrying amount of the asset to be replaced by the project.
A. The after-tax cost of new-debt financing. C. The cost of equity financing. C. Amount of annual depreciation on the asset to be replaced.
B. The before-tax cost of new-debt financing. D. The weighted-average cost of D. Amount of annual depreciation on fixed assets used directly on the project.
capital.
26. You have determined the profitability of a planned project by finding the present value
21. All of the following refer to the discount rate used by a firm in capital budgeting except of all the cash flows from that project. Which of the following would cause the project
A. Hurdle rate. C. Opportunity cost of capital. to look less appealing, that is, have a lower present value?
B. Opportunity cost. D. Required rate of return. A. The discount rate increases.
B. The cash flows are extended over a longer period of time.
22. The excess present value method is anchored on the theory that the future returns, C. The cash flows are accelerated and the project life is correspondingly shortened.
expressed in terms of present value, must at least be D. The investment cost decreases without affecting the expected income and life of
A. Equal to the amount of investment C. More than the amount of the project.
investment
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30. Which of the following characteristics represent an advantage of the internal rate of
27. Which of the following is always true with regard to the net present value (NPV) return techniques over the accounting rate of return technique in evaluating a project?
approach? I Recognition of the project’s salvage value.
A. The NPV and the IRR approaches will always rank projects in the same order. II Emphasis on cash flows.
B. The NPV and payback approaches will always rank projects in the same order. III Recognition of the time value of money.
C. If a project is found to be acceptable under the NPV approach, it would also be A. I only. C. II and III.
acceptable under the payback approach. B. I and II. D. I, II, and III.
D. If a project is found to be acceptable under the NPV approach, it would also be
acceptable under the internal rate of return (IRR) approach. 31. How are the following used in the calculation of the internal rate of return of a
proposed project? Ignore income tax considerations.
28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net A. B. C. D.
present value of P450,000. The project has a life of 7 years with salvage value of Residual sales value of Include Include Exclude Exclude
P200,000. The company uses a discount rate of 12%. Which of the following would project
decrease the net present value? Depreciation expense Include Exclude Include Exclude
A. Increase the salvage value.
B. Increase discount rate to 15%. 32. The discount rate that equates the present value of the expected cash flows with the
C. Extend the project life and associated cash inflows. cost of the investment is the
D. Decrease the initial investment amount to P9.0 million. A. Accounting rate of return C. Net present value
B. Internal rate of return D. Payback period.
Profitability Index
29. What is the effect of changes in cash inflows, investment cost and cash outflows on 33. A company has analyzed seven new projects, each of which has its own internal rate
profitability (present value) index (PI) of return. It should consider each project whose internal rate of return is _____ its
A. PI will increase with an increase in cash inflows, a decrease in investment cost, marginal cost of capital and accept those projects in _____ order of their internal rate
or a decrease in cash outflows. of return.
B. PI will increase with an increase in cash inflows, an increase in investment cost, A. Above; decreasing. C. Below; decreasing.
or an increase in cash outflows. B. Above; increasing. D. Below; increasing.
C. PI will decrease with an increase in cash inflows, a decrease in investment cost,
or a decrease in cash outflows. Relationship of NPV, PI & IRR
D. PI will decrease with an increase in cash outflows, an increase in investment 34. Which of the following combinations is NOT possible?
cost, or an increase in cash inflows. Profitability Index NPV IRR
A. Equals 1 Zero Equals cost of capital
Internal Rate of Return
B. Greater than 1 Positive More than cost of capital
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C. Less than 1 Negative Less than cost of capital Investment Decisions – Capital Rationing
D. Less than 1 Positive Less than cost of capital 38. Capital budgeting methods are often divided into two classifications: project screening
and project ranking. Which one of the following is considered a ranking method rather
Investment Decisions – Independent Projects than a screening method?
35. A company is evaluating three possible investments. Information relating to the A. Accounting rate of return. C. Profitability index.
company and the investments follow: B. Net present value. D. Time-adjusted rate of return.
Fisher rate for the three projects 7%
Cost of capital 8% 39. Several proposed capital projects which are economically acceptable may have to be
Based on this information, we know that ranked due to constraints in financial resources. In ranking these projects, the least
A. all three projects are acceptable. pertinent is this statement.
B. none of the projects are acceptable. A. If the internal rate of return method is used in the capital rationing problem, the
C. the net present value method will provide a ranking of the projects that is higher the rate, the better the project.
superior to the ranking obtained using the internal rate of return method. B. If the net present value method is used, the profitability index is calculated to
D. the capital budgeting evaluation techniques profitability index, net present value, rank the projects. The lower the index, the better the project.
and internal rate of return will provide a consistent ranking of the projects. C. In selecting the required rate of return, one may either calculate the
organization’s cost of capital or use a rate generally acceptable in the industry.
Investment Decisions – Mutually Exclusive Projects D. A ranking procedure on the basis of quantitative criteria may be established by
36. When ranking two mutually exclusive investments with different initial amounts, specifying a minimum desired rate of return, which rate is used in calculating the
management should give first priority to the project net present value of each project.
A. That has the greater profitability index.
B. That has the greater accounting rate of return. Optimal Capital Budget
C. Whose net after-tax flows equal the initial investment. 40. An optimal capital budget is determined by the point where the marginal cost of
D. That generates cash flows for the longer period of time. capital is
A. Minimized.
37. Which mutually exclusive project would you select, if both are priced at $1,000 and B. Equal to the average cost of capital.
your discount rate is 15%; Project A with three annual cash flows of $1,000, or C. Equal to the rate of return on total assets.
Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually? D. Equal to the marginal rate of return on investment.
A. Project A.
B. Project B.
C. The IRRs are equal, hence you are indifferent.
D. The NPVs are equal, hence you are indifferent.
PROBLEMS

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Net Investments machine, it needs to repair the old one at a cost of P200,000. Tax-wise, the trade-in
1. Acme is considering the sale of a machine with a book value of $80,000 and 3 years transaction will not have any implication but the cost to repair is tax-deductible. The
remaining in its useful life. Straight-line depreciation of $25,000 annually is available. effective corporate tax rate is 35% of net income subject to tax. For purposes of
The machine has a current market value of $100,000. What is the cash flow from capital budgeting, the net investment in the new machine is
selling the machine if the tax rate 40%. A. P540,000 C. P660,000
A. $25,000 C. $92,000 B. P610,000 D. P800,000
B. $80,000 D. $100,000
5. Great Value Company is planning to purchase a new machine costing P50,000 with
2 Hatchet Company is considering replacing a machine with a book value of $400,000, freight and installation costs amounting to P1,500. The old unit is to be traded-in will
a remaining useful life of 5 years, and annual straight-line depreciation of $80,000. be given a trade-in allowance of P7,500. Other assets that are to be retired as a
The existing machine has a current market value of $400,000. The replacement result of the acquisition of the new machine can be salvaged and sold for P3,000.
machine would cost $550,000, have a 5-year life, and save $75,000 per year in cash The loss on retirement of these other assets is P1,000 which will reduce income
operating costs. If the replacement machine would be depreciated using the straight- taxes of P400. If the new equipment is not purchased, repair of the old unit will have
line method and the tax rate is 40%, what would be the net investment required to to be made at an estimated cost of P4,000. This cost can be avoided by purchasing
replace the existing machine? the new equipment. Additional gross working capital of P12,000 will be needed to
A. $90,000. C. $330,000 support operation planned with the new equipment.
B. $150,000 D. $550,000 The net investment assigned to the new machine for decision analysis is
A. P50,200 C. P53,600
3. Diliman Republic Publishers, Inc. is considering replacing an old press that cost B. P52,600 D. P57,600
P800,000 six years ago with a new one that would cost P2,250,000. Shipping and
installation would cost an additional P200,000. The old press has a book value of 6. It is the start of the year and St. Tropez Co. plans to replace its old sing-along
P150,000 and could be sold currently for P50,000. The increased production of the equipment. These information are available:
new press would increase inventories by P40,000, accounts receivable by P160,000 Old New
and accounts payable by P140,000. Diliman Republic’s net initial investment for Equipment cost P70,000 P120,000
analyzing the acquisition of the new press assuming a 35% income tax rate would be Current salvage value 10,000 -
A. P2,250,000 C. P2,450,000 Salvage value, end of useful life 2,000 16,000
B. P2,425,000 D. P2,600,000 Annual operating costs 56,000 38,000
Accumulated depreciation 55,300 -
4. Key Corp. plans to replace a production machine that was acquired several years Estimated useful life 10 years 10 years
ago. Acquisition cost is P450,000 with salvage value of P50,000. The machine being The company’s income tax rate is 35% and its cost of capital is 12%. What is the
considered is worth P800,000 and the supplier is willing to accept the old machine at present value of all the relevant cash flows at time zero?
a trade-in value of P60,000. Should the company decide not to acquire the new A. (P54,000) C. (P120,000)
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B. (P110,000) D. (P124,700) investment of $200,000. The working capital would be liquidated at the end of the
project's 10-year life. If White Corp. has an after-tax cost of capital of 10 percent and
Operating Cash Flows After Tax a marginal tax rate of 30 percent, what is the present value of the working capital
7. C Corp. faces a marginal tax rate of 35 percent. One project that is currently under cash flow expected to be received in year 10?
evaluation has a cash flow in the fourth year of its life that has a present value of A. $23,130 C. $53,970
$10,000 (after-tax). C Corp. assumes that all cash flows occur at the end of the year B. $36,868 D. $77,100
and the company uses 11 percent as its discount rate. What is the pre-tax amount of
the cash flow in year 4? (Round to the nearest dollar.) Accounting Rate of Return
A. $9,868 C. $23,356 11. Lyben Inc. is planning to produce a new product. To do this, it is necessary to
B. $15,181 D. $43,375 acquire a new equipment that will cost the company P100,000. The estimated life of
the new equipment is five years with no salvage value. The estimated income and
8. Maxwell Company has an opportunity to acquire a new machine to replace one of its costs based on expected sales of 10,000 units per year are:
present machines. The new machine would cost $90,000, have a 5-year life, and no Sales @ P10.00 per unit P100,000
estimated salvage value. Variable operating costs would be $100,000 per year. The Costs @ P8.00 per unit 80,000
present machine has a book value of $50,000 and a remaining life of 5 years. Its Net income P 20,000
disposal value now is $5,000, but it would be zero after 5 years. Variable operating The accounting rate of return based on initial investment is 20%
costs would be $125,000 per year. Ignore income taxes. Considering the 5 years in What will be the accounting rate of return based on initial investment of P100,000 if
total, what would be the difference in profit before income taxes by acquiring the new management decrease its selling price of the new product by 10%?
machine as opposed to retaining the present one? A. 5% C. 15%
A. $10,000 decrease C. $35,000 increase B. 10% D. 20%
B. $15,000 decrease D. $40,000 increase
End-of-Life Cash Flows
9. Lor Industries is analyzing a capital investment proposal for new machinery to 12. Hooker Oak Furniture Company is considering the purchase of wood cutting
produce a new product over the next ten years. At the end of the ten years, the equipment. Data on the equipment are as follows:
machinery must be disposed of with a zero net book value but with a scrap salvage Original investment $30,000
value of P20,000. It will require some P30,000 to remove the machinery. The Net annual cash inflow $12,000
applicable tax rate is 35%. The appropriate “end-of-life” cash flow based on the Expected economic life in years 5
foregoing information is Salvage value at the end of five years $3,000
A. Inflow of P30,000. C. Outflow of P10,000. The company uses the straight-line method of depreciation with no mid-year
B. Outflow of P6,500. D. Outflow of P17,000. convention.
What is the accounting rate of return on original investment rounded off to the nearest
10. A project under consideration by the White Corp. would require a working capital percent, assuming no taxes are paid?

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A. 20.0% C. 24.0% the next 5 years. The new machine’s salvage value is $20,000 in years 1 and 2, and
B. 22.0% D. 40.0% $15,0000 in years 3 and 4. What will be the bailout period (rounded) for the new
machine?
Payback Period A. 1.4 years. C. 2.2 years.
13. APJ, Inc. is planning to purchase a new machine that will take six years to recover B. 1.9 years. D. 3.4 years.
the cost. The new machine is expected to produce cash flow from operations, net of
income taxes, of P4,500 a year for the first three years of the payback period and Net Present Value
P3,500 a year of the last three years of the payback period. Depreciation of P3,000 a 16. The McNally Co. is considering an investment in a project that generates a
year shall be charged to income of the six years of the payback period. How much profitability index of 1.3. The present value of the cash inflows on the project is
shall the machine cost? $44,000. What is the net present value of this project?
A. P12,000 C. P24,000 A. $10,154 C. $33,846
B. P18,000 D. P36,000 B. $13,200 D. $57,200
14. Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash
17. The Zeron Corporation wants to purchase a new machine for its factory operations at
outlay. Below are the projected after-tax cash inflow for the five year period covering
a cost of $950,000. The investment is expected to generate $350,000 in annual cash
the useful life. The company’s tax rate is 35%.
flows for a period of four years. The required rate of return is 14%. The old machine
Year 1 2 3 4 5 can be sold for $50,000. The machine is expected to have zero value at the end of
P’000 600 700 480 400 400 the four-year period. What is the net present value of the investment? Would the
The founder and president of the candy company believes that the best gauge for company want to purchase the new machine? Income taxes are not considered.
capital expenditure is cash payback period and that the recovery period should not be A. $69,550; no C. $326,750; no
more than 75% of the useful life of the project or the asset. Should the company B. $119,550; yes D. $1,019,550; yes
undertake the project?
A. No, since the payback period extends beyond the life of the project. 18. Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration
B. No, since the payback period is 4 years or 80% of the useful life of the project. device. The investment required is $80 million for a plant with a capacity of 15,000
C. Yes, since the payback period is 3.55 years or 71% of the useful life of the units a year for 5 years. The device will be sold for a price of $12,000 per unit. Sales
project. are expected to be 12,000 units per year. The variable cost is $7,000 and fixed costs,
D. Yes, since the payback period is 4 years and still shorter than the useful life of excluding depreciation, are $25 million per year. Assume Drillers employs straight-
the project. line depreciation on all depreciable assets, and assume that they are taxed at a rate
Bailout Payback of 36%.
15. Womark Company purchased a new machine on January 1 of this year for $90,000, If the required rate of return is 12%, what is the approximate NPV of the project?
with an estimated useful life of 5 years and a salvage value of $10,000. The machine A. $17,225,000 C. $26,780,000
will be depreciated using the straight-line method. The machine is expected to B. $21,511,000 D. $56,117,000
produce cash flow from operations, net of income taxes, of $36,000 a year in each of
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21. Cramden Armored Car Co. is considering the acquisition of a new armored truck. The
19. JJ Corp. is considering the purchase of a new machine that will cost P320,000. It has truck is expected to cost $300,000. The company's discount rate is 12 percent. The
an estimated useful life of 3 years. Assume that 30% of the depreciable base will be firm has determined that the truck generates a positive net present value of $17,022.
depreciated in the first year, 40% in the second year, and 30% in the third year. It However, the firm is uncertain as to whether it has determined a reasonable estimate
has a resale value of P20,000 at the end of its economic life. Savings are expected of the salvage value of the truck. In computing the net present value, the company
from the use of machine estimated at P170,000 annually. The company has an assumed that the truck would be salvaged at the end of the fifth year for $60,000.
effective tax rate of 40%. It uses 16% as hurdle rate in evaluating capital projects. What expected salvage value for the truck would cause the investment to generate a
Should the company proceed with the P320,000 capital investment? net present value of $0? Ignore taxes.
Year Present Value of Present Value of an Ordinary Annuity of A. $0 C. $42,978
P1 P1 B. $30,000 D. $55,278
1 0.862 0.862
2 0.743 1.605 22. Rohan Transport is considering two alternative buses to transport people between
3 0.641 2.246 cities that are in the Southeastern U.S., such as Baton Rouge and Gainesville. A gas-
A. Yes, due to NPV of P6,556. C. Yes, due to NPV of P61,820. powered bus has a cost of $55,000, and will produce end-of-year net cash flows of
B. Yes, due to NPV of P11,684. D. No, due to negative NPV of $22,000 per year for 4 years. A new electric bus will cost $90,000, and will produce
P1,136 cash flows of $28,000 per year for 8 years. The company must provide bus service
for 8 years, after which it plans to give up its franchise and to cease operating the
20. The following forecasts have been prepared for a new investment by Oxford route. Inflation is not expected to affect either costs or revenues during the next 8
Industries of $20 million with an 8-year life: years. If Rohan Transport's cost of capital is 17 percent, by what amount will the
Pessimistic Expected Optimistic better project increase the company's value?
A. -$17,441 C. $10,701
Market size 60,000 90,000 140,000
B. $5,350 D. $27,801
Market share, % 25 30 35
Unit price $750 $800 $875
23. Union Electric Company must clean up the water released from its generating plant.
Unit variable cost $500 $400 $350
The company's cost of capital is 11 percent for average projects, and that rate is
Fixed cost, $7 $4 $3.5
normally adjusted up or down by 2 percentage points for high- and low-risk projects.
millions
Clean-Up Plan A, which is of average risk, has an initial cost of $10 million, and its
Assume that Oxford employs straight-line depreciation, and that they are taxed at operating cost will be $1 million per year for its 10-year life. Plan B, which is a high-
35%. Assuming an opportunity cost of capital of 14%, what is the NPV of this project, risk project, has an initial cost of $5 million, and its annual operating cost over Years
based on expected outcomes? 1 to 10 will be $2 million. What is the approximate PV of costs for the better project?
A. $2,626,415 C. $6,722,109 (VD)
B. $4,563,505 D. $8,055,722 A. -$5.9 million. C. -$16.8 million.

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B. -$15.9 million. D. -$17.8 million. has a remaining life of six years. The new machine is expected to have zero value at
the end of the six-year period. The disposal value of the old machine at the time of
Fisher rate replacement is zero. What is the internal rate of return?
24. Berry Products is considering two pieces of machinery. The first machine costs A. 15% C. 17%
P50,000 more than the second machine. During the two-year life of these two B. 16% D. 18%
alternatives, the first machine has P155,000 more cash flow in year one and a 28. A tax-exempt foundation, Sincerely Foundation, Inc. intends to invest P1 million in a
P110,000 less cash flow in year two than the second machine. All cash flows occur five-year project. The foundation estimates that the annual savings from the project
at year-end. The present value of 1 at 15% end of 1 period and 2 periods are will amount to P325,000. The P1 million asset is depreciable over five (5) years on a
0.86957 and 0.75614, respectively. The present value of 1 at 8% end of period 1 is straight-line basis. The foundation’s hurdle rate is 12% and as a consultant of the
0.92593 and period 2 is 0.85734. foundation, you are asked to determine the internal rate of return and advise if the
At what discount rate would Machine 1 equally acceptable as machine 2? project should be pursued.
A. 9% C. 11% To facilitate computations, below are present value factors:
B. 10% D. 12% N=5 12% 14% 16%
Present value of P1 0.57 0.52 0.48
Internal Rate of Return Present value of an annuity of P1 3.60 3.40 3.30
25. Smoot Automotive has implemented a new project that has an initial cost, and then Your advice is
generates inflows of $10,000 a year for the next seven (7) years. The project has a A. To proceed due to an estimated IRR of more than 16%.
payback period of 4.0 years. What is the project's internal rate of return (IRR)? B. Not to proceed due to an estimated IRR of less than 12%.
A. 14.79% C. 16.33% C. To proceed due to an estimated IRR of less than 14% but not more than 12%.
B. 15.61% D. 18.54% D. To proceed due to an estimated IRR of less than 16% but not more than 14%.
26. MLF Corporation is evaluating the purchase of a P500,000 die attach machine. The 29. Para Co. is reviewing the following data relating to an energy saving investment
cash inflows expected from the investment is P145,000 per year for five years with no proposal:
equipment salvage value. The cost of capital is 12%. The net present value factor Cost $50,000
for five (5) years at 12% is 3.6048 and at 14% is 3.4331. The internal rate of return Residual value at the end of 5 years 10,000
for this investment is Present value of an annuity of 1 at 12% for 5 years 3.60
A. 2.04% C. 13.8% Present value of 1 due in 5 years at 12% 0.57
B. 3.45% D. 15.48% What would be the annual savings needed to make the investment realize a 12%
yield?
27. The Zeron Corporation recently purchased a new machine for its factory operations at A. $8,189 C. $12,306
a cost of $921,250. The investment is expected to generate $250,000 in annual cash B. $11,111 D. $13,889
flows for a period of six years. The required rate of return is 14%. The old machine

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30. Payback Company is considering the purchase of a copier machine for P42,825. The 2. Disposal value after 8 years – nil.
copier machine will be expected to be economically productive for 4 years. The 3. Estimated net annual cash inflows for each of the 8 years – P81,000.
salvage value at the end of 4 years is negligible. The machine is expected to provide 4. Time-adjusted internal rate of return – 14%
15% internal rate of return. The company is subject to 40% income tax rate. The 5. Cost of capital of Sunlight Corp – 16%
present value of an ordinary annuity of 1 for 4 periods is 2.85498. In order to realize 6. The table of present values of P1 received annually for 8 years has these
the IRR of 15%, how much is the estimated before-tax cash inflow to be provided by factors: at 14% = 4.639, at 16% = 4.344
the machine? 7. Depreciation is approximately P46,970 annually.
A. P15,000 C. P25,000
B. P17,860 D. P35,700
31. Salvage Co. is considering the purchase of a new ocean-going vessel that could Find the required increase in annual cash inflows in order to have the time-adjusted
potentially reduce labor costs of its operation by a considerable margin. The new ship rate of return approximately equal the cost of capital.
would cost $500,000 and would be fully depreciated by the straight-line method over A. P4,344 C. P5,871
10 years. At the end of 10 years, the ship will have no value and will be sunk in some B. P5,501 D. P6,501
already polluted harbor. The Salvage Co.'s cost of capital is 12 percent, and its
marginal tax rate is 40 percent. If the ship produces equal annual labor cost savings 34. Booker Steel Inc. is considering an investment that would require an initial cash
over its 10-year life, how much do the annual savings in labor costs need to be to outlay of $400,000 and would have no salvage value. The project would generate
generate a net present value of $0 on the project? (Round to the nearest dollar.) annual cash inflows of $75,000. The firm's discount rate is 8 percent. How many
A. $68,492 C. $114,154 years must the annual cash flows be generated for the project to generate a net
B. $88,492 D. $147,487 present value of $0?
A. between 5 and 6 years C. between 7 and 8 years
32. A company is considering putting up P50,000 in a three-year project. The company’s B. between 6 and 7 years D. between 8 and 9 years
expected rate of return is 12%. The present value of P1.00 at 12% for one year is
0.893, for two years is 0.797, and for three years is 0.712. The cash flow, net of Project Screening – Independent Projects
income taxes will be P18,000 (present value of P16,074) for the first year and 35. The following data relate to two capital-budgeting projects of equal risk:
P22,000 (present value of P17,534) for the second year. Assuming that the rate of Present Value of Cash Flows
return is exactly 12%, the cash flow, net of income taxes, for the third year would be Period Project A Project B
A. P7,120 C. P16,392 0 $(10,000) $(30,000)
B. P10,000 D. P23,022 1 4,550 13,650
2 4,150 12,450
33. The following data pertain to Sunlight Corp., whose management is planning to 3 3,750 11,250
purchase an automated tanning equipment. Which of the projects will be selected using the profitability index (PI) approach and
1. Economic life of equipment – 8 years. the NPV approach?
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A. B. C. D. Annual cash flows

PI B Either Either B Year 1 113 180 90 80
NPV A B A B 2 113 170 110 100
3 113 150 130 120
Project Screening – Mutually Exclusive Projects 4 113 110 140 130
36. Five mutually exclusive projects had the following information: 5 113 100 150 150
A B C D
Net present value P7,540 P59,654 P54,666 P(15,708)
NPV $500 $(200) $200 $1,000
Internal rate of return 12.7% 17.6% 17.2% 10.6%
IRR 12% 8% 13% 10%
Excess present value 1.02 1.13 1.14 0.96
index
Which project is preferred?
A. A C. C The company will choose
B. B D. D A. Projects L & M. C. Projects M & N.
B. Projects L & N. D. Projects M, N & O.
Capital Rationing & Optimal Capital Budget
37. Information on three (3) investment projects is given below: 39. The Nativity Corporation has the following investment opportunities:
Project Investment Required Net Present Value Proposal Profitability Index Initial Cash Outlay
X P150,000 P34,005 1 1.15 P200,000
G 100,000 22,670 2 1.13 125,000
W 60,000 13,602 3 1.11 175,000
Rank the projects in terms of preference: 4 1.08 150,000
A. 1st W; 2nd G; 3rd X. C. 1st X; 2nd G; 3rd W. The firm has a budget constraint of P300,000.
B. 1st G; 2nd W; 3rd X. D. The ranking is the same. What proposal(s) should be accepted?
A. Proposal 4 because it has the lowest profitability index.
38. Telephone Corp. is contemplating four projects: L, M, N, and O. The capital costs for B. Proposal 1 because it has the highest profitability index.
the initiation of each mutually-exclusive project and its estimated after-tax, net cash C. Proposals 1 and 2 because their total net present values are the highest among
flow are listed below. The company’s desired after-tax opportunity costs is 12%. It all possible proposal combinations.
has P900,000 capital budget for the year. Idle funds cannot be reinvested at greater D. Proposals 2 and 3 because their total net present values are the highest among
than 12%. all possible proposal combinations.
In Thousand Pesos
L M N O 40. A company's marginal cost of new capital (MCC) is 10% up to $600,000. MCC
Initial cost 400 470 380 420
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increases .5% for the next $400,000 and another .5% thereafter. Several proposed Daneche’s, a tax-exempt entity, plans to purchase a new machine which they project to
capital projects are under consideration, with projected cost and internal rates of depreciate over a ten-year period without salvage value. The new machine will cost
return (IRR) as follows: P200,000 and is expected to generate cash savings of P60,000 per year in operating
Project Cost IRR costs. Daneche's cost of capital is 12%.
A $100,000 10.5% For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an
B $300,000 14.0% ordinary annuity of P1 is P5.650.
C $450,000 10.8%
D $350,000 13.5% 42. What is the net present value of the proposed investment, assuming Daneche uses a
E $400,000 12.0% 12% discount rate?
What should the company's capital budget be? A. P69,980 C. P185,640
A. $0 C. $1,500,000 B. P139,000 D. None of the above.
B. $1,050,000 D. $1,600,000
43. With the company’s initial investment on the new machine, the accounting rate of
41. Mulva Inc. is considering the following five independent projects: return is
Project Required Amount of Capital IRR A. 15% C. 25%
B. 20% D. None of the above.
A $300,000 25.35%
Questions 43 and 44 are based on the following information.
B 500,000 23.22%
The construction of a waste treatment plant was arrived at after a careful cost-benefit
C 400,000 19.10%
analysis. During the construction period a status report was presented for your review:
D 550,000 9.25%
E 650,000 8.50%  completed cost as originally estimated, P5 million
 % of actual completion to date, 65%
The company has a target capital structure which is 40 percent debt and 60 percent
equity. The company can issue bonds with a yield to maturity of 10 percent. The  actual cost to date, P3.75 million
company has $900,000 in retained earnings, and the current stock price is $40 per
share. The flotation costs associated with issuing new equity are $2 per share. 44. Assuming cost is evenly distributed throughout the construction period, how much will
Mulva's earnings are expected to continue to grow at 5 percent per year. Next year's the completion cost be most likely?
dividend (D1) is forecasted to be $2.50. The firm faces a 40 percent tax rate. What is A. The original cost estimate of P5 million.
the size of Mulva's capital budget? B. P5 million plus a cost overrun of about P769,000
A. $800,000 C. $1,750,000 C. P500,000 less than the original cost at completion.
B. $1,200,000 D. $2,400,000 D. About P100,000 above the original cost at completion.

Comprehensive 45. What would be an appropriate action to take considering the situation in number 28?
Problem 42 and 43 are based on the following information. A. No need to take any action.

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B. Immediately stop further work on the project. 48. The net cash flow for year 1 is
C. Wait for the next quarterly status report on the project. A. P25,850 C. P31,250
D. Recommend immediate review with the project implementation team to B. P28,750 D. P34,450
determine the cause of overrun and the corrective actions to be taken.
49. The net cash flow for year 4 is
Questions 46 and 47 are based on the following information. A. P30,150 C. P35,950
Beta Company plans to replace its company car with a new one. The new car costs B. P35,850 D. P36,250
P120,000 and its estimated useful life is five years without scrap value. The old car has a
book value of P15,000 and can be sold at P12,000. The acquisition of the new car will 50. The payback period for the project is
yield annual cash savings of P20,000 before income tax. Income tax rate is 25%. (M) A. 3 years C. 3.5 years
B. 3.17 years D. 4 years.
46. The net investment of the new car is
A. P107,000 C. P108,000 51. The accounting rate of return of the project is
B. P107,250 D. P108,750 A. 7% C. 12%
B. 9% D. 15%

47. The payback period of the investment is (M)

A. 5.095 years C. 5.14 years 52. The present value of year two’s cash flow is
B. 5.11 years D. 5.18 years A. P23,747.50 C. P26,100.75
B. P25,856.25 D. P29,750.75
Questions 48 through 55 are based on the following information.
The Burgos Corporation is considering investing in a project. It requires an immediate 53. The present value of the project’s net cash flow is
cash outlay of P100,000. It has a life of four years and will be depreciated on a straight- A. P95,650.15 C. P101,863.75
line basis (no salvage value). The firm’s tax rate is 25% and requires a return of 10%. B. P98,151.25 D. P104,750.25
Income before depreciation is projected to be:
YEAR 1 2 3 4 54. The profitability index of the project (rounded to the nearest hundredth) is
Income before P30,000 P30,000 P40,000 P40,00 A. 0.96 C. 1.02
depreciation 0 B. 0.98 D. 1.05
The present value factors for P1 at 10% is
Year 1 2 3 4 55. The project would be accepted on the basis of the
Present Value Factor 0.909 0.826 0.751 0.683 A. Payback and present value results.
B. Accounting rate of return and profitability index results.

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C. Payback results only

D. A and B combined Theory Problem
1. D 21. B 1. C 21. B 41. C
2. B 22. A 2. B 22. D 42. B
3. D 23. B 3. B 23. B 43. B
4. C 24. D 4. B 24. B 44. B
5. C 25. A 5. A 25. C 45. D
6. D 26. A 6. B 26. C 46. B
7. D 27. D 7. C 27. B 47. B
8. A 28. B 8. D 28. A 48. B
9. D 29. A 9. B 29. C 49. D
10. D 30. C 10. D 30. B 50. B
11. B 31. B 11. B 31. C 51. D
12. C 32. B 12. B 32. D 52. A
13. D 33. A 13. C 33. B 53. C
14. A 34. D 14. C 34. C 54. C
15. A 35. D 15. B 35. B 55. D
16. D 36. A 16. A 36. D
17. A 37. A 17. B 37. D
18. A 38. C 18. B 38. C
19. C 39. B 19. B 39. D
20. D 40. D 20. B 40. B

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