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Information about Walher Company Inc utility cost for the last six months of 2011 follows. High

and low method was used to develop a cost formula to product 2012 utility charges, and the

number of machine hours has been found to be appropriate cost driver. Data are as follows

July 33,000 P6,450

August 34,000 6,100

September 32,990 4,995

October 32,000 5,980

November 31,250 5,750

December 31,000 5,860

How much will be the Utility cost if 33,715 machine hours are projected?

P6,077.20

CAPITAL BUDGETING

FACTORS

1. (Net Investment) The management of Maingat

Company plans to replace a sorting machine that was

acquired several years ago at a cost of P60,000. The

machine has been depreciated to its residual value of

P10,000. A new sorter can be purchased for P96,000.

The dealer will grant a trade-in allowance of P16,000 on

the old machine. If a new machine is not purchased,

Maingat Company will spend P10,000 to repair the old

machine. Gains and losses on trade-in transactions are

not subject to income taxes. The cost to repair the old

machine can be deducted in computing income taxes.

Income taxes are estimated at 40%. Additional working

capital required is P50,000. Compute the net investment

in this project. ANS: P124,000

2. (Net Investment) Great Value Company is planning to

purchase a new machine costing P50,000 with freight and

installation costs amounting to P1,500. The old unit 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

machine can be salvaged and sold for P3,000. The loss on the

retirement of these other assets is P1,000 which will reduce

income taxes by P400. If the new equipment is not

purchased, extensive repairs net of taxes on the old

equipment 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: ANS: P48,600

3. (Net Cash Returns) Alalay Company is considering

the acquisition of a machine which will cost

P120,000. It has an expected useful life of five years

at the end of which its scrap value will be P20,000.

The company expects to be able to generate annual

cash flow before taxes of P40,000. Estimated

income tax rate is 30%. What is the annual cash

flow after taxes on this investment?

ANS: P34,000

4. (Cash Returns) The Visayan Division of Mainam

Supply Company has been considering a new

production method that can reduce materials costs

by an estimated amount of P52,000 a year. The new

method is also expected to result in annual savings

of labor and overhead method of P64,000. The

depreciation is estimated at P40,000 a year over a

period of ten years. Income taxes are estimated at

30% of income before income taxes. What are the

annual net returns(savings) expected from the new

production. ANS: P93,200

5. (WACC - BASIC) Hector Corporation’s capital structure is as follows:

Source Amount

10%, Bank Payable, 10 years P1,000,000

10% Preferred Stock, P200 par value, 10,000 shares issued and outstanding P2,000,000

Common Stock, P50 per share, 30,000 shares issued and outstanding P1,500,000

Retained Earnings P500,000

common shares’ current market price is P60, while that of preferred

shares is P250. The income tax is 30%.

a. Individual Cost of Capital (Costs of Debt, PS, Common Equity)

b. Weighted Cost of Capital

6. (COC –growth rate) Harry

Corporation’s common stocks

currently sell for P40 per share. The

estimated dividend payment at the

end of the year is P4 per share. The

expected growth rate is 12%. Using

the dividend growth model, the cost

of capital is:

ANS: 22%

7. (COC –flotation cost) Harold

Corporation’s common stocks currently

sell for P50 per share. Flotation cost is

5%. In the past, the company paid

dividends of P4.50 per share. The

expected dividend growth rate is 10%.

a. Using the dividend growth model, the

cost of capital is:

b. What is the cost of retained earnings?

ANS: A. 20.42% ; B. 19.90%

8. (COC – CAPM) The return on

market portfolio is 12% and the

risk free rate is 5%. The beta

coefficient is 1.4. Using the

capital asset pricing model, what

is the cost of capital (or required

rate of return)?

ANS: 14.80%

9. (WACC - CAPM) KYLE Corporation’s capital structure is as follows:

Source Amount

Long Term Debt (12% interest rate) P140,000,000

Common Stocks, P10 par value P40,000,000

Additional Paid in Capital P400,000,000

Retained Earnings P420,000,000

current market return is 14% and the risk free rate is 10%. The beta

value for Kyle Corporation is 1.20. It pays income tax at the rate of

30% of taxable income.

Compute the following

a. After tax cost of debt ANS: A. 8.4%

b. CAPM, cost of common equity B. 14.8%

c. Weighted Average Cost of Capital

C.13.904%

10. (Payback Period)

A B

Net Investment P150,000 P300,000

Annual Cash Returns

Year 1-3 P75,000 P75,000

Year 4-5 100,000

Salvage Value 15,000 15,000

Economic Life 3 years 5 years

PROJECT A – 2 YEARS

PROBJECT B – 3.75 YEARS

11. (Bailout Period)

a. An investment of P150,000 with annual cash

inflow of P50,000 for 5 years. Salvage value at

the end of first year is P70,000 and is

expected to decline by P15,000 ANS: annually.

1.90 YEARS

Compute the Bailout Period.

b. An equipment costing P1,000,000 is expected

ANS: 3.53 YEARS

to yield the following:

Year Annual Cash Inflow Salvage Value

1 P300,000 P200,000

2 400,000 100,000

3 200,000 50,000

4 150,000 20,000

12. (ARR) Initial Investment – P65,000; Estimated

Life – 20 years; Annual Cash inflow – P10,000;

Salvage Value at the end – P0. Compute the

following.

a. ARR based on Initial Investment

b. Average ARR

A. 10.38%

B. 20.80 %

13. (ARR) The management of Beta Company is

considering the purchase of an automated

bottling machine for P120,000. The machine

would replace an old piece of equipment that

costs P30,000 per year to operate. The new

machine would cost P12,000 per year to

operate. The old machine currently in use

could be sold now for a scrap value of P40,000.

The new machine would have a useful life of 10

years with no salvage value. Compute the

simple rate of return on the new automated

bottling machine. ANS: 7.5%

14. (NPV) The management of Kyle Company is

considering the purchase of a P40,000 machine

that would reduce operating costs by P7,000

per year. At the end of the machine’s eight year

useful life, it will have a zero scrap value. The

company’s required rate of return is 12%.

Determine the NPV of the investment in the

machine.

NPV = P(5,226.80)

15. (NPV) Pier Company has P100,000 to invest. The

company is trying to decide between two

alternative uses of the funds. The alternatives are:

Project A Project B

Cost of equipment required P100,000 P0

Working Capital Investment required P0 P100,000

Annual Cash Inflow P21,000 P16,000

Salvage Value of equipment in six year P8,000 P0

Life of the project 6 years 6 years

released at the end of six years for investment

elsewhere. Pier Company discount rate is 14%.

Which alternative wouldPROJECT

your recommend to

A – P(14,692.50)

accept? PROJECT B – P7,779.20

16. WindTalker Ltd is contemplating the purchase of

equipment to exploit a mineral deposit on land to which

the company has mineral rights. An engineering and

cost analysis has been made, and it is expected that the

following cash flows will be associated with opening a

mine in the area: Cost of new equipment – P275,000;

Working capital required – P100,000; Annual cash

receipts - P120,000; Cost to construct new roads in year

3 – P40,000; Salvage value of equipment in 4 years –

P65,000. The mineral deposit would be exhausted after

four years of mining. At that point, the working capital

would be released for reinvestment elsewhere. The

company’s required rate of return is 20%. Determine the

NPV and decide whether to accept the project or not.

P(7,924.50)

17. Oxford Company has limited funds for investment and must ration the

funds among four competing projects. Selected information on the four

projects follows:

A P160,000 P44,323 7 18%

B P135,000 P42,000 12 16%

C P100,000 P35,035 7 20%

D P175,000 P38,136 3 22%

PI (1) – 1.28

PI(B) – 1.31

PI (C) – 1.35

PI (D) -1.22

18. Investment – P12,950; PV of Cash inflow –

P3,000; n=10 years; discount rate 12%.

Compute the following:

b. Internal Rate of return and determine to

accept or reject.

PBP (Dis) 6.45 years

IRR – 19.xxx%, accept

19.Investment – P3,000; Cash inflow (yr1) –

P1,000; Yr (2) – P2,500; Yr (3) – P1,400.

Discount Rate – 14%; n=3.

Compute the following:

DPBP – 2.13 years

b. IRR, accept or reject? IRR - 28.xxx%, accept

20. ACR Company, which operates a school canteen, is planning

to buy a doughnut-making machine for P300,000. The machine is

expected to produce 36,000 units of doughnuts per year which

can be sold for P10 each. Variable cost to produce and sell the

doughnut is P4 per unit. Incremental fixed costs, exclusive of

depreciation, is estimated at P56,000 per year. The doughnut

making machine will be depreciated on a straight line basis for 5

years to a zero salvage value. The company pays income tax at a

rate of 32%.

ARR – 22.67 %

a. Compute the PAYBACK PERIOD

b. Compute the ARR

21.The Super Carry, a domestic shipping line, has recently

commissioned a new passenger ship, the SC-20. The new

ship can carry up to 2,000 passengers. It was purchased by

Super Carry at a cost P300 million. Its estimated service life is

10 years, with a salvage value of P40 million at the end of

service life.

SC-20 is expected to have 300 voyage-days per year with

an average of 80% occupancy rate. The revenue from each

passenger is estimated at P250 per day, while daily variable

costs per passenger is P100. Annual fixed costs of operating

ship, exclusive of depreciation, is estimated at P20 million

per year. Tax is 32%

• Payback Period

• ARR

PBP – 6.87 YEARS

• ARR (average)

ARR – 5.89%

ARR (AVE) – 10.40%

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