CPAR :MS 9111b_CAPITAL BUDGETING BATCH MAY 2022

QUIZZER (DO-IT-YOURSELF DRILL)

THEORIES
1. A major difference between an investment in working capital and one in depreciable assets is that
A. an investment in working capital is never returned, while most depreciable assets have some
residual value.
B. an investment in working capital is returned in full at the end of a project's life, while an
investment in depreciable assets has no residual value.
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.
2. A company with cost of capital of 15% plans to finance an investment with debt that bears 10%
interest. The rate it should use to discount the cash flows is
A. 10%. C. 25%.
B. 15%. D. some other rate.
3. If income taxes are ignored, how is depreciation used in the following capital budgeting techniques?
Internal Rate of Return Net Present Value
A. Excluded Excluded
B. Excluded Included
C. Included Excluded
D. Included Included
4. Zonifugal Corporation needs to purchase a new conveyor system for its factory. Four different
conveyor systems have been proposed. Which calculation would be the best one for Zonifugal to use
to determine which system to purchase?
A. payback period C. net present value
B. simple rate of return D. project profitability index
5. Which of the following is the proper calculation of a company's depreciation tax shield?
A. Depreciation † tax rate. D. Depreciation x (1 - tax rate).
B. Depreciation † (1 - tax rate). E. Depreciation deduction + income taxes.
C. Depreciation x tax rate.
6. The accounting rate of return focuses on the:
A. total accounting income over a project's life.
B. average accounting income over a project's life.
C. average cash flows over a project's life.
D. cash inflows from a project.
E. tax savings from a project.
7. In computing cash flow after tax, which of the below statements is true?
I. Depreciation expense is relevant.
II. Receipts from investing activities are included.
III. Multiplying the depreciation deduction by the tax rate yields a measure of the depreciation tax
benefit.
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III
8. In relation to net present value, consider the following statements:
I. When cash flows are uneven and vary from year to year, the internal rate of return method is
easier to use than the net present value method.
II. For capital budgeting decisions, the net present value method is superior to the simple rate of
return method.
III. Net present value is used as a criterion whether to accept or reject a project and will result to
the same ranking as profitability index.
A. B. C. D.
Statement I True True False False
Statement II False True True True
Statement III True False False True
9. Which of the following techniques considers cash flows over the life of the investment in accepting
projects?
A. B. C. D. E.
Cash Payback Yes No Yes No Yes
Book Rate of Return Yes Yes Yes No No
Profitability Index Yes Yes No Yes Yes

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10. Which of the following shows proper treatment of an item on the net investment of a project?
I. tax on gain – deduct III. tax on avoidable repairs - add
II. gain on sale – ignore IV. additional investment on working capital - deduct
A. III only D. II and III
B. I and III E. None from A, B, C and D
C. III and IV
11. Statement 1: The internal rate of return method is, like the NPV method, a discounted cash flow
technique.
Statement 2: Using the internal rate of return method, a project is rejected when the rate of return is
greater than or equal to the required rate of return.
Statement 3: Capital budgeting decisions usually involve large investments and often have a
significant impact on a company's future profitability.
A. B. C. D.
Statement I True True False False
Statement II False True True True
Statement III True False False True
12. A characteristic of the payback method (before taxes) is that it (E)
A. incorporates the time value of money.
B. neglects total project profitability.
C. uses accrual accounting inflows in the numerator of the calculation.
D. uses the estimated expected life of the asset in the denominator of the calculation.
13. In capital budgeting, sensitivity analysis is used (E2)
A. To test the relationship of the IRR and NPV.
B. To evaluate mutually exclusive investments.
C. to determine whether an investment is profitable.
D. To see how a decision would be affected by changes in variables.
14. The bailout payback method (M2*)
A. incorporates the time value of money.
B. equals the recovery period from normal operations.
C. eliminates the disposal value from the payback calculation.
D. measures the risk if a project is terminated.
15. The following statements refer to the accounting rate of return (ARR)
1. The ARR is based on the accrual basis, not cash basis.
2. The ARR does not consider the time value of money.
3. The profitability of the project is considered.
From the above statements, which are considered limitations of the ARR concept? (M)
A. Statements 2 and 3 only. C. All the 3 statements.
B. Statements 3 and 1 only. D. Statements 1 and 2 only.
16. A post-audit should be performed using
A. a different evaluation technique than that used in making the original decision.
B. the same evaluation technique used in making the original decision.
C. estimated amounts instead of actual figures.
D. an independent CPA.

17. A company‟s discount rate is based on the

A. cost of capital and the internal rate of return.
B. cost of capital and the risk element.
C. cut-off rate and the risk element.
D. cut-off rate and the internal rate of return.
18. The cash payback technique
A. should be used as a final screening tool.
B. can be the only basis for the capital budgeting decision.
C. is relatively easy to compute and understand.
D. considers the expected profitability of a project.
19. If a project has a salvage value greater than zero, the salvage value will
A. have no effect on the net present value.
B. increase the net present value.
C. increase the payback period.
D. decrease the net present value.
20. The internal rate of return is the interest rate that results in a
A. positive NPV. C. zero NPV.
B. negative NPV. D. positive or negative NPV.

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21. If a project‟s profitability index is greater than 1, then the

A. project should always be accepted.
B. project‟s net present value is negative.
C. project‟s internal rate of return is less than the discount rate.
D. project should be accepted if funds are available.
22. If project A has a lower internal rate of return than project B, then project A will have a
A. lower NPV and a shorter payback period.
B. higher NPV and a longer payback period.
C. lower NPV and a longer payback period.
D. higher NPV and a shorter payback period.
23. Which of the following will cause the internal rate of return to increase?
A. An increase in the annual cash inflows C. An increase in the discount rate
B. A decrease in the annual cash inflows D. A decrease in the discount rate
24. Consider the following statements about the payback period:
I. As shown in your text, the payback period considers the time value of money.
II. The payback period can only be used if net cash inflows are uniform throughout a project's life.
III. The payback period ignores cash inflows that occur after the payback period is reached.
Which of the above statements is (are) correct?
A. I only. D. I and II.
B. II only. E. I, II, and III.
C. III only.
25. The internal rate of return:
A. ignores the time value of money.
B. equates a project's cash inflows with its cash outflows.
C. equates a project's cash outflows with its expenses.
D. equates the present value of a project's cash inflows with the present value of the cash
outflows.
E. equates the present value of a project's cash flows with the future value of the project's cash
flows.
26. Which of the following choices correctly states the rules for project acceptance under the net-present-
value method and the internal-rate-of-return method?
Net Present Value Internal Rate of Return
A. Positive total Greater than hurdle rate
B. Positive total Less than hurdle rate
C. Negative total Greater than hurdle rate
D. Negative total Less than hurdle rate
E. Greater than hurdle rate Positive number
27. Which of the following combinations is NOT possible?
Profitability Index NPV IRR
A. Equals 1 Zero Equals cost of capital
B. Greater than 1 Positive More than cost of capital
C. Less than 1 Negative Less than cost of capital
D. Less than 1 Positive Less than cost of capital
28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present value of
P450,000. The project has a life of 7 years with salvage value of P200,000. The company uses a
discount rate of 12%. Which of the following would decrease the net present value?
A. Increase the salvage value.
B. Increase discount rate to 15%.
C. Extend the project life and associated cash inflows.
D. Decrease the initial investment amount to P9.0 million.
29. A project‟s net present value, ignoring income tax considerations, is normally affected by the
A. Proceeds from the sale of the asset to be replaced.
B. Carrying amount of the asset to be replaced by the project.
C. Amount of annual depreciation on the asset to be replaced.
D. Amount of annual depreciation on fixed assets used directly on the project.
30. In capital budgeting decisions, the following items are considered among others:
1. Cash outflow for the investment.
2. Increase in working capital requirements.
3. Profit on sale of old asset
4. Loss on write-off of old asset.
For which of the above items would taxes be relevant?
A. Items 1 and 3 only. C. Items 3 and 4 only.
B. Items 1, 3 and 4 only. D. All items.

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PROBLEMS
1. BANE INC. is considering replacing a machine with a book value of P400,000, a remaining useful life
of 5 years, and annual straight-line depreciation of P80,000. The existing machine has a current
market value of P400,000. The replacement machine would cost P550,000, have a 5-year life, and
save P75,000 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 would be the net investment required to
replace the existing machine?
A. P90,000. C. P330,000
B. P150,000 D. P550,000
2. HARITH COMPANY is planning to purchase a new machine costing P50,000 with freight and
installation costs amounting to P1,500. The old unit is to be traded-in will be given a trade-in
allowance of P7,500. Other assets that are to be retired as a result of the acquisition of the new
machine can be salvaged and sold for P3,000. The loss on retirement of these other assets is P1,000
which will reduce income taxes of P400. If the new equipment is not purchased, repair of the old unit
will have to be made at an estimated cost of P4,000. This cost can be avoided by purchasing the new
equipment. Additional gross working capital of P12,000 will be needed to support operation planned
with the new equipment.
The net investment assigned to the new machine for decision analysis is
A. P50,200 C. P53,600
B. P52,600 D. P57,600
3. X.BORG CORP. faces a marginal tax rate of 35 percent. One project that is currently under evaluation
has a cash flow in the fourth year of its life that has a present value of P10,000 (after-tax). X.BORG
CORP. assumes that all cash flows occur at the end of the year 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.)
A. P9,868 C. P23,356
B. P15,181 D. P43,375
4. FARAMIS INC. is analyzing a capital investment proposal for new machinery to produce a new product
over the next ten years. At the end of the ten years, the machinery must be disposed of with a zero
net book value but with a scrap salvage value of P20,000. It will require some P30,000 to remove
the machinery. The applicable tax rate is 35%. The appropriate “end-of-life” cash flow based on the
foregoing information is
A. Inflow of P30,000. C. Outflow of P10,000.
B. Outflow of P6,500. D. Outflow of P17,000.
5. FANNY COMPANY is considering the purchase of wood cutting equipment. Data on the equipment are
as follows:
Original investment P30,000
Net annual cash inflow P12,000
Expected economic life in years 5
Salvage value at the end of five years P3,000
The company uses the straight-line method of depreciation with no mid-year convention.
What is the accounting rate of return on original investment rounded off to the nearest percent,
assuming no taxes are paid?
A. 20.0% C. 24.0%
B. 22.0% D. 40.0%
6. GUSION CORP. is planning to purchase a new machine that will take six years to recover 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 P3,500 a year of the last three years of the
payback period. Depreciation of P3,000 a year shall be charged to income of the six years of the
payback period. How much shall the machine cost?
A. P12,000 C. P24,000
B. P18,000 D. P36,000
7. LING INC. purchased a new machine on January 1 of this year for P90,000, with an estimated useful
life of 5 years and a salvage value of P10,000. The machine will be depreciated using the straight-
line method. The machine is expected to produce cash flow from operations, net of income taxes, of
P36,000 a year in each of the next 5 years. The new machine‟s salvage value is P20,000 in years 1
and 2, and P15,0000 in years 3 and 4. What will be the bailout period (rounded) for the new
machine?
A. 1.4 years. C. 2.2 years.
B. 1.9 years. D. 3.4 years.
8. The HANZO CORP. wants to purchase a new machine for its factory operations at a cost of P950,000.
The investment is expected to generate P350,000 in annual cash flows for a period of four years. The
required rate of return is 14%. The old machine can be sold for P50,000. The machine is expected to

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have zero value at the end of the four-year period. What is the net present value of the investment?
Would the company want to purchase the new machine? Income taxes are not considered.
A. P69,550; no C. P326,750; no
B. P119,550; yes D. P1,019,550; yes
9. The THAMUZ CORP. recently purchased a new machine for its factory operations at a cost of
P921,250. The investment is expected to generate P250,000 in annual cash flows for a period of six
years. The required rate of return is 14%. The old machine 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 replacement is zero. What is the internal rate of return?
A. 15% C. 17%
B. 16% D. 18%
10. TERIZLA INC. is considering an investment that would require an initial cash outlay of P400,000 and
would have no salvage value. The project would generate annual cash inflows of P75,000. The firm's
discount rate is 8 percent. How many years must the annual cash flows be generated for the project
to generate a net present value of P0?
A. between 5 and 6 years C. between 7 and 8 years
B. between 6 and 7 years D. between 8 and 9 years
11. HELCURT INC. is considering the purchase of a new ocean-going vessel that could potentially 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 end of 10 years, the ship will
have no value and will be sunk in some already polluted harbor. HELCURT INC.'s cost of capital is 12
percent, and its marginal tax rate is 40 percent. If the ship produces equal annual labor cost savings
over its 10-year life, how much do the annual savings in labor costs need to be to generate a net
present value of P0 on the project? (Round to the nearest dollar.)
A. P68,492 C. P114,154
B. P88,492 D. P147,487
12. The following data pertain to MIYA CORP., whose management is planning to purchase an automated
tanning equipment.
1. Economic life of equipment – 8 years.
2. Disposal value after 8 years – nil.
3. Estimated net annual cash inflows for each of the 8 years – P81,000.
4. Time-adjusted internal rate of return – 14%
5. Cost of capital of Sunlight Corp – 16%
6. The table of present values of P1 received annually for 8 years has these factors: at 14% =
4.639, at 16% = 4.344
7. Depreciation is approximately P46,970 annually.
Find the required increase in annual cash inflows in order to have the time-adjusted rate of return
approximately equal the cost of capital.
A. P4,344 C. P5,871
B. P5,501 D. P6,501
13. LAYLA INC. has the following investment opportunities:
Proposal Profitability Index Initial Cash Outlay
1 1.15 P200,000
2 1.13 125,000
3 1.11 175,000
4 1.08 150,000
The firm has a budget constraint of P300,000.
What proposal(s) should be accepted?
A. Proposal 4 because it has the lowest profitability index.
B. Proposal 1 because it has the highest profitability index.
C. Proposals 1 and 2 because their total net present values are the highest among all possible
proposal combinations.
D. Proposals 2 and 3 because their total net present values are the highest among all possible
proposal combinations.
Use the following information in answering the next item(s):
HAYABUSA CORP., a tax-exempt entity, plans to purchase a new machine which they project to
depreciate over a ten-year period without salvage value. The new machine will cost P200,000 and is
expected to generate cash savings of P60,000 per year in operating costs. HAYABUSA's cost of
capital is 12%.
For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an ordinary
annuity of P1 is P5.650.
14. What is the net present value of the proposed investment, assuming HAYABUSA uses a 12% discount
rate?
A. P69,980 C. P185,640
B. P139,000 D. None of the above.

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15. With the company‟s initial investment on the new machine, the accounting rate of return is
A. 15% C. 25%
B. 20% D. None of the above.
16. DYRROTH CORP. is taking into account the replacement of an old machine now in use with a new
machine costing P100,000. The replacement is expected to produce an annual cash savings of
P22,500 before income taxes.
The estimated useful life of the new machine is ten years with no residual value. The book value of
the old machine is P37,500 and is expected to last for another five years. It is being depreciated at
P8,000 per year. The income tax rate is 25%.
The annual cash savings after tax is (M)
A. P15,375 C. P17,375
B. P16,875 D. P20,520
17. LEOMORD INC. is considering a 10-year capital investment project with forecasted revenues of
P40,000 per year and forecasted cash operating expenses of P29,000 per year. The initial cost of the
equipment for the project is P23,000, and LEOMORD expects to sell the equipment for P9,000 at the
end of the tenth year. The equipment will be depreciated over 7 years. The project requires a
working capital investment of P7,000 at its inception and another P5,000 at the end of year 5.
Assuming a 40% marginal tax rate, the expected net cash flow from the project in the tenth year is
A. P32,000 C. P20,000
B. P24,000 D. P11,000
18. As a 19th century economist, you are faced with the following problem. The world's shipping fleet
consists of steamships and sailing ships. Each can be used to carry cargo or passengers. The ships
have similar sailing capacities but differ in their annual operating costs as follows:
Steam Sail
Cargo P80,000 P95,000
Passenger P90,000 100,000
Assume: (i) Fares are competitively determined, (ii) demand is not expected to change, (iii) each
vessel has a life of 15 years, (iv) current salvage value of either ship (sailing or steam) is P114,091,
and (v) Cost of capital is 10%, (vi) no taxes. What is the present value of a steam ship?
A. P190,152 C. P609,486
B. P251,326 D. None of the above
19. ZILONG CORP. is planning to purchase a new machine which it will depreciate for book purposes, on a
straight-line basis over a ten-year period with no salvage value and a full year-„s depreciation taken in
the year of acquisition. The new machine is expected to product cash flow from operations, net of
income taxes, of P175,000 a year in each of the next ten years. The accounting (book value) rate of
return on the average investment is expected to be 15%. How much will the new machine cost? (M)
A. P1,000,000 C. P1,666,667
B. P700,000 D. P1,800,000
20. FRANCO CORP. has just purchased a piece of equipment at a cost of P120,000. This equipment will
reduce operating costs by P40,000 each year for the next eight years. This equipment replaces old
equipment that was sold for P8,000 cash. The new equipment has a payback period of: (E)
A. 8.0 years. C. 10.0 years.
B. 2.8 years. D. 3.0 years.
21. TIGREAL INC. is considering the purchase of land and the construction of a new plant. The land,
which would be bought immediately (at t = 0), has a cost of P100,000 and the building, which would
be erected at the end of the first year (t = 1), would cost P500,000. It is estimated that the firm‟s
after-tax cash flow will be increased by P100,000 starting at the end of the second year, and that this
incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the
approximate payback period? (M)
A. 2 years D. 8 years
B. 4 years E. 10 years
C. 6 years
22. The payback reciprocal is an estimate of the internal rate of return. AURORA CORP. is considering the
acquisition of a merchandise picking system to improve customer service. Annual cash returns on
investment cost of P1.2 million is P220,000. Useful life is estimated at 8 years. The company‟s cost
of capital is 14% and income tax rate is 35%.
Calculate AURORA‟s payback reciprocal for this investment: (E)
A. 20.5% C. 11.9%
B. 18.3% D. 22.2%
23. Given the following cash flows for project Z: C0 = -2,000, C1 = 600, C2 = 2160 and C3 = 6000,
calculate the discounted payback period for the project at a discount rate of 20%. (E)
A. One year C. 3 years
B. 2 years D. None of the above

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24. JAWHEAD CORP. is considering a project with the following expected cash flows:
Year Project Cash Flow
0 -P700 million
1 200 million
2 370 million
3 225 million
4 700 million
The project‟s WACC is 10 percent. What is the project‟s discounted payback? (M)
A. 3.15 years D. 2.58 years
B. 4.09 years E. 3.09 years
C. 1.62 years
25. RUBY INC. bought a major equipment which is depreciable over 7 years on a straight-line basis
without any salvage value. It is estimated that it would generate cash flow from operations, net of
income taxes, of P800,000 in each of the seven years. The company‟s expected rate of return is
12%. Based on estimates, the project has a net present value of P127,200. What is the cost of the
equipment? (E)
To facilitate computations, below are present value factors:
Present value of P1 at 12% for seven years is 0.452.
Present value of an ordinary annuity of P1 at 12% for seven years is 4.564.
A. P3,651,200 C. P2,404,000
B. P3,524,000 D. P3,778,400
26. CYCLOPS CORP. operates consulting offices in Manila, Olongapo, and Cebu. The firm is presently
considering an investment in a new mainframe computer and communication software. The computer
would cost P6 million and have an expected life of 8 years. For tax purposes, the computer can be
depreciated using either straight-line method or Sum-of-the-Years‟-Digits (SYD) method over five
years. No salvage value is recognized in computing depreciation expense and no salvage value is
expected at the end of the life of the equipment. The company‟s cost of capital is 10% and its tax
rate is 40%.
The present value of an annuity of 1 for 5 periods is 3.791 and for 8 periods is 5.335. The present
values of 1 at the end of each period are:
1 0.9091 5 0.6209
2 0.8264 6 0.5645
3 0.7513 7 0.5132
4 0.6830 8 0.4665
The present value of the net advantage using SYD method of depreciation with a five-year life-
instead of straight-line method of depreciating the equipment is
A. P86,224 C. P115,168
B. P215,560 D. P287,893
27. EUDORA INC. is contemplating the purchase of a new machine on which the following information has
been gathered:
Cost of the machine P38,900
Annual cash inflows expected P10,000
Salvage value P 5,000
Life of the machine 6 years
The company's discount rate is 16%, and the machine will be depreciated using the straight-line
method. Given these data, the machine has a net present value of: (M)
A. -P26,100. C. P0.
B. -P23,900. D. +P26,100.
28. HANABI CORP. is considering to acquire a machine in order to reduce its direct labor costs. This
machine shall last for 4 years with no salvage value. Currently, the cash expenses amounted to
P120,000 per year. The initial analysis indicated that the time-adjusted rate of return is 15%. At
12% (cost of capital to finance the purchase of the machine), the company expects net present value
of P5,470.80.
The present value of 1 for four period at 12% is 3.03735 and at 15% is 2.85499. Ignoring income
tax considerations, the profitability index is (D)
A. 1.064 C. 1.047
B. 1.183 D. 1.250
29. An investment opportunity costing P300,000 is expected to yield net cash flows of P100,000 annually
for five years. The profitability index of the investment at a cutoff rate of 14% would be
A. 3.0. c. 0.33.
B. 1.14. d. 14%.

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30. WANWAN CORP. purchased a piece of equipment with the following expected results:
Useful life 7 years
Yearly net cash inflow P50,000
Salvage value -0-
Internal rate of return 20%
Discount rate 16%
The initial cost of the equipment was: (M)
A. P300,100.
B. P180,250
C. P190,600.
D. Cannot be determined from the information given.
31. NATALIA INC. proposes to invest P3 million in a new tour package. Fixed costs are P1 million per
year. The tour package costs P500 and can be sold at P1500 per package to tourists. This tour
package is expected to be attractive for the next five years. If the cost of capital is 20%, what is the
break-even number of tourists per year? (Ignore taxes, give an approximation.)
A. 2,000 C. 15,000
B. 1,000 D. None of the above
32. The following data pertain to an investment proposal:
Present investment required P26,500
Annual cost savings P 5,000
Projected life of the investment 10 years
Projected salvage value P -0-
The internal rate of return, interpolated to the nearest tenth of a percent, would be: (M)
A. 11.6%. C. 13.6%.
B. 12.8%. D. 12.4%.
33. The capital budgeting director of URANUS CORP. is evaluating a project which costs P200,000, is
expected to last for 10 years and produce after-tax cash flows, including depreciation, of P44,503 per
year. If the firm‟s cost of capital is 14 percent and its tax rate is 40 percent, what is the project‟s
IRR? (E)
A. 8% D. -5%
B. 14% E. 12%
C. 18%
34. The following table gives the available projects for a firm.
A B C D E F G
5.0 4.0 5.0 1.0 2.0 7.0 8.0 Initial investment
1.5 -0.5 1.0 0.5 0.5 1.0 1.0 NPV
The firm has only twenty million to invest. What is the maximum NPV that the company can obtain?
A. 3.5 C. 4.0
B. 4.5 D. None of the above
35. BELERICK CORP. plans to replace its company car with a new one. The new car costs 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 yield annual cash savings of P20,000
before income tax. Income tax rate is 25%. The net investment of the new car is
A. P108,000 C. P107,250
B. P108,750 D. P107,000
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Management Advisory Services by Karim G. Abitago, CPA Page 8 of 8