50 COPIES
CAPITAL BUDGETING
COLLEGE OF MARY IMMACULATE
POBLACION, PANDI, BULACAN
FIRST SEMESTER-AY 2020 - 2021
STUDENT NUMBER
COURSE
SURNAME
YRLVL/SECTION ROOM
GIVEN NAME
MIDDLE NAME
DATE
PROCTOR
SCORE
VALUATION CONCEPTS AND METHODS (ELEC 1)
MULTIPLE CHOICE
1. Bruell Company is considering to replace its old equipment with a new one. The old equipment had a net
book value of P100,000, 4 remaining useful life with P25,000 depreciation each year. The old equipment
can be sold at P80,000. The new equipment costs P160,000, have a 4-year life. Cash savings on
operating expenses before 40% taxes amount to P50,000 per year. What is the amount of investment in
the new equipment?
a. P160,000
b. P 72,000
c. P 80,000
d. P 68,000
Answer: B
Initial amount of investment
Less Cash inflow (decrease in outflow) at period 0:
MV of old equipment
Tax benefits on loss on sales (20,000 x .4)
Net investment
160,000
80,000
8,000
88,000
72,000
2. Prime Consulting, Inc. 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 percent and its tax rate is 40 percent.
The present value of annuity of 1 for 5 periods is 3.791 and for 8 periods is 5.335. The present
values of 1 end of each period are:
1
0.9091
5
0.6209
2
0.8264
6
0.5645
3
0.6513
7
0.5132
4
0.6830
8
0.4665
The present value of the net advantage of using SYD method of depreciation with a five-year life
instead of straight-line method of depreciating the equipment is:
a. P 86,224
b. P115,168
c. P215,560
d. P287,893
Answer: B
Year
SYD
Straight Line
Difference
1
2,000,000
1,200,000
800,000
2
1,600,000
1,200,000
400,000
3
1,200,000
1,200,000
4
800,000
1,200,000
(400,000)
5
400,000
1,200,000
(800,000)
Total present value of difference in depreciation
Tax Rate
Present value of net advantage
X
X
X
X
X
0.9091
0.8264
0.6513
0.6830
0.6209
Present Value
727,280
330,560
0
(273,200)
(496,720)
287,920
40%
115,168
3. 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 operations, net
of 40 percent income taxes, as follows:
First year
Second year
Third year
Fourth year
Fifth year
P160,000
140,000
180,000
120,000
100,000
Maleen will use the sum-of-the-years-digits’ method to depreciate the new machine as follows:
First year
Second year
Third year
Fourth year
Fifth year
P150,000
120,000
90,000
60,000
30,000
The present value of 1 for 5 periods at 12 percent is 3.60478. The present values of 1 at 12 percent at
end of each period are:
End of:
Period 1
0.89280
Period 2
0.79719
Period 3
0.71178
Period 4
0.63552
Period 5
0.56743
Had Maleen used straight-line method of depreciation instead of declining method, what is the
difference in net present value provided by the machine at a discount rate of 12 percent?
a. Increase of P 9,750
b. Decrease of P 9,750
c. Decrease of P24,376
d. Increase of P24,376
Answer: B
SYD
SL
1 150,000
90,000
2 120,000
90,000
3
90,000
90,000
4
60,000
90,000
5
30,000
90,000
Total of present values of depreciation
Tax rate
Present value of net advantage
Difference
60,000
30,000
(30,000)
(60,000)
X 0.89280
X 0.79719
X 0.71178
X 0.63552
X 0.56743
Present Value
53,568
23,916
0
(19,066)
(34,046)
24,372
40%
9,749
4. Show Company is negotiating to purchase an equipment that would cost P200,000, with the expectation
that P40,000 per year could be saved in after-tax cash operating costs if the equipment were acquired.
The equipment’s estimated useful life is 10 years, with no salvage value, and would be depreciated by the
straight-line method. Show Company’s minimum desired rate of return is 12 percent. The present value
of an annuity of 1 at 12 percent for 10 periods is 5.65. The present value of 1 due in 10 periods, at 12
percent, is 0.322.
The average accrual accounting rate of return (ARR) during the first year of asset’s use is:
a. 20.0 percent
b. 10.5 percent
c. 10.0 percent
d. 40.0 percent
Answer: B
ARR = Average annual net income ÷ Average Investment
Annual after-tax cash flow
Less Depreciation (200,000 / 10 years)
Net Income
Divide by Average Investment (200,000 + 180,000)/2
ARR:
40,000
20,000
20,000
190,000
10.5%
The problem asked for the average accounting rate of return for the first year of asset’s life.
5. The Makabayan Company 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 produce 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 12 percent. How much will the new
machine cost?
a. P300,000
b. P660,000
c. P550,000
d. P792,000
Answer: A
ATCF = after tax cash flow
(ATCF – Depreciation) ÷ Initial investment = Accounting Rate of Return
Let X = Initial investment
(66,000 – 0.10X) ÷ X = 0.12
Net income ÷ Investment = ARR
66,000 - .10X = .12X
.22X = 66,000
X = 300,000
6. The Fields Company 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 produce cash flow 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 12%. How much will the new machine cost?
a. P300,000
b. P550,000
c. P660,000
d. P792,000
Answer: A
Net Income: = 66,000 - .10X
AAR = NI/ Investment
.12 = (66,000 - .10X) / X
.12X = 66,000 - .10X
.22 X = 66,000
X = 300,000
7. Orlando Corporation is considering an investment in a new cheese-cutting machine to replace its existing
cheese cutter. Information on the existing machine and the replacement machine follow:
Cost of the new machine
P400,000
Net annual savings in operating costs
90,000
Salvage value now of the old machine
60,000
Salvage value of the old machine in 8 years
0
Salvage value of the new machine in 8 years
50,000
Estimated life of the new machine
8 years
What is the expected payback period for the new machine?
a. 4.44 years
b. 8.50 years
c. 2.67 years
d. 3.78 years
Answer: D
Cost of the new machine
Salvage value of old machine at period zero
Net investment (Outflows)
Divide by cash flow after tax
Payback period
400,000
( 60,000)
340,000
90,000
3.78 years
8. For P4,500,000, Siniloan Corporation purchased a new machine with an estimated useful life of five years
with no salvage value at its retirement. The machine is expected to produce cash flow from operations,
net of income taxes, as follows:
First year
P 900,000
Second year
1,200,000
Third year
1,500,000
Fourth year
900,000
Fifth year
800,000
Siniloan will use the sum-of-the-years-digits’ method to depreciate the new machine as follows:
First year
P1,500,000
Second year
1,200,000
Third year
900,000
Fourth year
600,000
Fifth year
300,000
What is the payback period for the machine?
a. 3 years
b. 4 years
c. 5 years
d. 2 years
Answer: B
Cash Inflow
Outflows
First year
Second year
Third year
Fourth year
900,000
1,200,000
1,500,000
900,000
Unrecovered Outflow
(4,500,000)
(3,600,000)
(2,400,000)
( 900,000)
0
Payback Period: At the end of 4 periods, the initial outflows are fully recovered.
Note to the CPA Candidates: A modified question for this problem is to compute the Present Value of the net advantage of using
sum-of-the-years’ digits of depreciation instead of straight-line method.
9. Paz Insurance Company’s management is considering an advertising program that would require an initial
expenditure of P165,500 and bring in additional sales over the next five years. The cost 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 expenses from the advertising
program are projected to increase by 10 percent each year. Paz Insurance Company’s tax rate is 40
percent.
The present value of 1 at 10 percent, end of each period:
Period
Present value of 1
1.
0.90909
2.
0.82645
3.
0.75131
4.
0.68301
5.
0.62092
The net present value of the advertising program would be
a. P 37,064
b. P(37,064)
c. P 29,136
d. P(29,136)
Answer: A
Additional Sales 75,000 – expenses 25,000 = 50,000 income before tax – tax 20,000 = PAT 30,000
Present value of cash returns: (30,000 x 0.90909) x 5 periods
136,364
Net investment (165,500 x 60%)
99,300
Net present value
37,064
Note: Because the constant growth rate and the discount rate are both 10%, the present value for each period is constant.
10. Zambales Mines, Inc. is contemplating the purchase of equipment to exploit a mineral deposit that is
located 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 would be associated with opening and operating a
mine in the area.
Cost of new equipment and timbers
2,750,000
Working capital required
1,000,000
Net annual cash receipts*
1,200,000
Cost to construct new road in three years
400,000
Salvage value of equipment in 4 years
650,000
*Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, etc.
It is estimated that 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 discount rate is 20%.
The net present value for the project is:
a. P 454,620.
b. P (79,303).
c. P(561,553)
d. P(204,688).
Answer: B
PV of annual cash receipts
PV of salvage value
PV of return of working capital
Cost of new equipment and timbers
Working capital
PV of cost of construction of road
Negative net present value
1,200,000 x 2.58872
650,000 x 0.48225
1,000,000 x 0.48225
3,106,463
313,462
482,250
(2,750,000)
(1,000,000)
( 231,480)
(79,303)
400,000 x .5787
11. The Pambansang Kamao Corporation has to replace its completely damaged boiler machine with a new
one. The old machine has a net book value of P100,000 with zero market value; therefore it 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 an internal rate of return of 12 percent.
The present values at 10% and 12%, respectively, are:
Annuity of 1, 6 periods
1 end of 6 periods
10%
4.35526
0.56447
12%
4.11141
0.50663
If the machine were to be depreciated using straight-line method for 6 years without any salvage value, the
estimated profitability index is:
a. 1.20
b. 1.06
c. 1.07
d. Cannot be determined from the information
Answer: B
The purpose of profitability index is to compare two projects’ profitability by reducing the present value per 1 peso of investment.
Therefore, the ratio of 4.35526 @ 10% to 4.11141 @ 12% indicated the profitability index.
Profitability index: 4.35526/4.11141 = 1.06
12. The Mejicano Company is planning to purchase a piece of equipment that will reduce annual cash
expenses over its 5-year useful life by equal amounts. The company will depreciate the equipment using
straight-line method of depreciation based on estimated life of 5 years without any salvage value. The
company is subject to 40 percent tax. The marginal cost of capital for this acquisition is 11.055 percent.
The management accountant calculated that the internal rate of return based on the estimated after-tax
cash flows is 12.386 percent and a net present value of P10,000. The president, however, wants to know
the profitability index before he finally decides.
What is the profitability index for this investment?
a. 1.011
b. 1.034
c. 1.022
d. 1.044
Answer: B
PV of annuity of 1 at IRR ∑(1 ÷ 1.12386)5
PV of annuity of 1 at MCC ∑(1 ÷ 1.11055)5
After-tax cash flows
Investment:
Profitability index
10,000 ÷ (3.69079 – 3.57057)
83,180.84 x 3.57057
(297,000 + 10,000) ÷ 297,000
3.57057
3.69079
83,180.84
297,000
1.034
A shorter calculation of the Profitability Index can be made by:
3.69079 ÷ 3.57057 = 1.034
13. Kipling Company has invested in a project that has an eight-year life. It is expected that the 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 present value of annuity of 1 for 8 periods is 4.968 and
the present value of 1 is 0.404?
a. P160,000
b. P 99,360
c. P 80,800
d. P 64,640
Answer: B
The payback period that corresponds to the project’s internal rate of return of 12 percent is 4.968. Therefore, the amount of
investment must equal the product of the payback period and the net cash flows:
Investment: (4.968 x 20,000) = P99,360
14. Katol Company invested in a machine with a useful life of six years and no salvage value. The machine
was depreciated using the straight-line method. It was expected to produce annual cash inflow from
operations, net of income taxes, of P6,000. The present value of an 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 Katol used a
time- adjusted rate of return of 10%, what was the amount of the original investment?
a. P10,640
b. P29,510
c. P22,750
d. P26,130
Answer: D
The amount of investment: the PV of annuity at IRR
4.355 x 6,000 = 26,130
Items 15 to 17 are based on the following:
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 freight charges will be P24,200 and
P800, respectively. Newman uses straight-line depreciation.
The medical center estimates that the machine will be used five times a week with the average charges to the
patient for ultrasound of P800. There are P10 in medical supplies and P40 of 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
15. The cash payback period is:
a. 3.0 years
b. 4.5 years
c. 5.0 years
d. 6.0 years
Answer: C
Cost of Investment:
Invoice price
Installation cost
Freight charge
Total investment
950,000
24,200
800
975,000
Annual Cash Flow:
Number of procedures:
Contribution margin per procedures:
Total annual cash flow:
Cash payback period:
(52 weeks per year x 5)
(P800 – P10 – P40)
(260 x P750)
(975,000 ÷ 195,000)
260
P750
P195,000
5 years
16. The project is expected to generate net present value of:
a. P276,510
b. P299,743
c. P331,510
d. P253,277
Answer: B
Present value of cash flow
(195,000 x 6.418)
Present value of salvage value (55,000 x 0.42241)
Total
Capital investment
Net present value
P1,251,510
23,233
P1,274,743
975,000
P 299,743
17. What is the accounting rate of return provided by the project?
a. 20.0 percent
b. 10.6 percent
c. 11.2 percent
d. 38.0 percent
Answer: A
Average investment:
Annual depreciation:
Annual net income:
(975,000 + 55,000 salvage value) ÷ 2
(975,000 – 55,000) ÷ 10
195,000 – 92,000
515,000
92,000
103,000
Average annual Rate of Return:
P103,000  P515,000
20%
Items 18 to 23 are based on the following:
Pinewood Craft Company is considering the purchase of two different items of equipment, as described below:
Machine A. A compacting machine has just come onto the market that would permit Pinewood 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:
a. The machine would cost P420,000 and would have a 10% salvage value at the end of its 12-year
useful life. The company uses straight-line depreciation and considers salvage value in computing
depreciation deductions.
b. The shelving products manufactured from use of the machine would generate revenues of P300,000
per year. Variable manufacturing costs would be 20% of sales.
c. Fixed expenses associated with the new shelving products would be (per year): advertising, P40,000;
salaries, P110,000; utilities, P5,200; and insurance, P800.
Machine B. A second machine has come onto the market that would allow Pinewood Craft Company to
automate a sanding process that is now done largely by hand. The following information is available:
a. The new sanding machine would cost P234,000 and would have no salvage value at the end of its 13year useful life. The company would use straight-line depreciation on the new machine.
b. Several old pieces of sanding equipment that are fully depreciated would be disposed of at a scrap
value of P9,000.
c. The new sanding machine would provide substantial annual savings in cash operating costs. It would
require an operator at an annual salary of P16,350 and P5,400 in annual maintenance costs. The
current, hand-operated sanding procedure costs the company P78,000 per year in total.
Pinewood Craft Company requires a simple rate of return of 15% on all equipment purchases. Also, the
company will not purchase equipment unless the equipment has a payback period of 4.0 years or less.
(In all the following questions, please ignore income tax effect)
18. The expected income each year from the new shelving products (Machine A) is:
a. P 52,500
b. P240,000
c. P 84,000
d. P 92,500
Answer: A
Annual revenues
Variable expenses (300,000 x 20%)
Contribution margin
Fixed expenses
Advertising
Salaries
Utilities
Insurance
Annual cash income
Less Depreciation
420,000 x 0.90 ÷ 12
Annual Income
300,000
(60,000)
240,000
40,000
110,000
5,200
800
(156,000)
84,000
(31,500)
52,500
19. The annual savings in cost if Machine B is purchased is
a. P56,250
b. P43,250
c. P38,250
d. P21,750
Answer: A
Current operating costs – old machine
Deduct Operating costs – Machine B
Annual salary of operator
Annual maintenance cost
78,000
16,350
5,400
21,750
Annual cash savings
56,250
20. The simple rate (%) of return for Machine A is:
a. 12.5 percent
b. 20.0 percent
c. 25.0 percent
d. 18.0 percent
Answer: A
Simple Rate of Return = Net Income ÷ Initial Investment
52,500 ÷ 420,000 = 12.50 %
21. The simple rate of return for Machine B is:
a. 16.3 percent
b. 17.0 percent
c. 25.0 percent
d. 34.0 percent
Answer: B
Savings
Less Depreciation
Annual income
Simple Annual Return
234,000 ÷ 13 years
38,250 ÷ 225,000
56,250
(18,000)
38,250
17 %
22. The payback period for Machine A is:
a. 3.0 years
b. 4.5 years
c. 5.0 years
d. 7.5 years
Answer: C
Payback period = Initial Investment ÷ Annual Cash Inflow
420,000 ÷ 84,000 = 5 years
23. The payback period for Machine B is:
a. 4.0 years.
b. 4.2 years.
c. 6.1 years.
d. 5.9 years.
Answer: A
225,000 ÷ 56,250 = 4 years
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