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UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA

CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY


LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
Test 1: (50%) Multiple Choices: Select the best answer economic benefits when the capital asset is
available for use
to each of the following questions. Mark only one d) In capital budgeting, planning is important
answer per question by encircling the letter because of possible changes in inflation, the
money supply and the interest rates.
corresponding to your chosen answer.
1) Capital budgeting is the process 6) The capital budget is a (an)
a) Used in a sell or process further decisions a) Plan that coordinates and communications a
b) Of determining how much capital stock to issue company’s plan for the coming year to all the
c) Of making capital expenditures decisions segments of the organization.
d) Of eliminating unprofitable product line b) Plan that assesses the firm’s expenditures
for long-lived assets
c) Plan to insure that there is enough working
2) A capital investment decision is essentially a decision
capital for the company’s need
to exchange current
d) A plan that establishes the firm’s long-term goals
a) Assets for current liabilities
in the context of relevant factors in the firm’s
b) Cash outflows for the promise of receiving environment.
future cash inflows
c) Cash flows from operating activities for future 7) Capital budgeting techniques are least likely to be
cash inflows from investing activities used in the evaluating
d) Cash inflows for future cash outflows a) A disinvestment decision, such as a sale of
unprofitable business segment
3) The primary capital budgeting method that uses b) The acquisition of a new ship by a shipping line
discounted cash flow technique is the c) The adoption of the ABC system in
a) Net present value method allocating costs to product lines
b) Cash payback technique d) The implementation of a major advertising
c) Annual rate of return method program that will have long-term effects on the
d) Profitability index method company.

4) Cost of capital is the 8) The following items are included in the computation
of the net cost of investment, except:
a) Amount the company must pay for its plan
a) The initial cash outlay covering all expenditures
assets
on the investment project up to the time when it
b) Dividends a company must pay on its equity
is ready for use or operation
securities b) Working capital requirement to operate the
c) Cost the company must incur to obtain its capital investment project
capital resources c) Avoidable cost of immediate repairs on old asset
d) Cost the company is charged by investment to be replaced, net of tax
bankers who handle the issuance of equity or d) The book value of the old asset to be
long-term debt securities replaced

5) Which of the following about capital budgeting and 9) In evaluating capital investment proposals, the
capital budget is incorrect? projects expected rate of return is compared with a
a) Capital budgeting is the process of planning hurdle rate, or a desired rate of return. The standard
expenditures for assets, the return on rate may be the weighted-average rate of return the
which are expected to be realized within company must pay to its long-term creditors and
one year. shareholders for the use of their funds. It is the cost
b) Once capital decisions are made, they tend to be of using funds and is more commonly called as
relatively inflexible because the commitments a) Discount rate
extend will into the future. b) Capital
c) In capital budgeting, accurate forecasting is c) Capital expense
needed to anticipate changes in the demand for d) Cost of capital
the product so that the firm may realize full
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
10) Which of the following statements about cash flow b) Mutually-exclusive projects
determination for capital budgeting purposes is c) Mutually-inclusive projects
incorrect? d) Independent projects
a) Relevant opportunity costs are included in the
cash flow forecast 16) A project that when accepted or rejected will not
b) Tax savings due to depreciation expense must be affect the cash flows of another projects refers to as:
considered a) Independent projects
c) Depreciation is relevant because it affects b) Dependent projects
net income c) Mutually exclusive projects
d) Changes in net working capital should be d) Sustaining projects
included in the cash flow forecast
17) A capital investment decision is essentially a decision
11) The discounted cash flow model is ordinarily to exchange current:
considered the best model for long-range decision- a) Assets for current liabilities
making. It may be characterized as follows, except: b) Cash outflows for the promise of receiving
a) The discounted cash flow model considers the future cash inflows
time value of money c) Cash inflows from operating activities for future
b) The discounted cash flow model involves interest cash inflows from investing activities
factors and risk d) Cash inflows for future cash outflows
c) The accounting rate of return and net
present value methods are among the 18) The higher the risk element in a project, the
methods used in the discounted cash flow a) More attractive the investment is
model b) Higher the net present value is
d) The model involves the use of the present value c) Higher the cost of capital is
factors to discount the future cash flows to d) Higher the discount rate required is
present values
19) The normal methods of analyzing investments
12) What does the term capital budgeting means in the a) Cannot be used by not-for-profit entities
context of making capital expenditures decisions? b) Do not apply if the project will not produce
a) The process of choosing assets revenues
b) The process of allocating the funds among assets c) Cannot be used if the company plans to finance
c) The process of acquiring the funds to finance the the project with funds already available
business. internally
d) None of the given choices d) Require forecasts of cash flows expected
from the project
13) The long-term planning process for making and
financing investments that affects a company’s 20) Deciding whether or not an investment meets a
financial result over a number of years is referred to predetermined company standard is called a
as: a) Screening decision
a) Capital budgeting b) Payback decision
b) Strategic planning c) Profitability decision
c) Master budgeting d) Preference decision
d) Long-range planning 21) The primary capital budgeting method that uses
discounted cash flow technique is the:
14) Capital budgeting is the process a) Net present value method
a) Used in a sell or process further decision b) Cash payback technique
b) Of determining how much capital stock to issue c) Annual rate of return method
c) Of making capital expenditures decisions d) Profitability index method
d) Of eliminating unprofitable product line
22) Cost of capital is the:
15) Competing investment projects where accepting one a) Amount the company must pay for its plant
project eliminates the possibility of taking the assets
remaining projects is referred to as: b) Dividends a company must pay on its equity
a) Common projects securities
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
c) Cost the company must incur to obtain its d) Risk analysis
capital requirements
d) Cost the company is charged by investment 29) A major difference between an investment in working
bankers who handle the issuance of equity or capital and one in depreciable assets is that
long-term debt securities. a) An investment in working capital is never
returned, while most depreciable assets have
23) The only future costs that are relevant to deciding some residual value
whether to accept an investment are those that will b) An investment in working capital is returned in
a) Be different if the project is accepted rather full at the end of a project’s life, while an
than rejected investment in depreciable assets has no residual
b) Be saved if the project is accepted rather than value
rejected c) An investment in working capital is not tax-
c) Be deductible for tax purposes deductible when made, nor taxable when
d) Affect net income in the period that they are returned, while an investment in
incurred depreciable asses does not allow tax
deductions
24) In capital budgeting, sensitivity analysis is used to: d) Because an investment in working capital is
a) Determine whether an investment is profitable usually returned in full at the end-of the project’s
b) See how a decision would be affected by life, it is ignored in computing the amount of the
changes in variables investment required for the project.
c) Test the relationship of the IRR and NPV
d) Evaluate mutually exclusive investments 30) Which of the following would not be included as part
of the periodic cash inflows associated with an
25) How should the following projects be listed in their investment project?
order of increasing risk? a) Savings for fixed and variable production costs
a) New venture, replacement, expansion b) Savings in selling, general and administrative
b) Replacement, new venture, expansion costs
c) Replacement, expansion, new venture c) Receipts from sales
d) Expansion, replacement, new venture d) Opportunity costs of undertaking the
projects
26) An approach that uses a number of outcome
estimates to get a sense of the variability among 31) The periodic cash flows associated with an
potential return is investment project include which of the following?
a) The discounted cash flow technique a) Savings in taxes caused by deductibility of
b) The net present value method depreciation on tax return
c) Risk analysis b) Income tax effect of gain (loss) on disposal of
d) Sensitivity analysis existing assets in an assets replacement decision
c) Purchase of assets and freight cost
27) Post-audit of capital projects: d) All of these are periodic cash flows in an
a) Is usually done conclusive investment project
b) Is done using different evaluation technique that
what were used in making the original capital 32) The NPV and IRR methods give
budgeting decisions a) The same decision (accept or reject) for
c) Provide a formal mechanism by which the single investment
company can determine whether existing b) The same choice from among mutually exclusive
projects should be supported or terminated investments
d) All of the given choices c) Different rankings of projects with unequal lives
d) The same rankings of projects with different
28) A thorough evaluation of how well a project’s actual required investments
performance matches the projections made when the
project was proposed is called as 33) The net present value (NPV) model can be used to
a) Pre-audit evaluated and rank two or more proposed projects.
b) Post-audit The approach that computes the total impact on cash
c) Sensitivity analysis
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
flows for each option and then converts these total 39) The relationship between the payback period and IRR
cash flows to their present values is called the is that
a) Differential approach a) Have been higher than the IRR
b) Incremental approach b) A payback period of less than one-half the
c) Contribution approach life of a project will yield an IRR lower than
d) Total project approach the target rate
c) The payback period is the present value factor
34) Which statement is most correct concerning for the IRR
depreciation in capital budgeting analysis? d) A project whose payback period does not meet
a) Depreciation is not a cash flow and does not the company’s cutoff rate for payback will not
affect the tax cash flow meet the company’s criteria for IRR
b) Depreciation is not a cash flow but does
affect the tax cash flow 40) In choosing from among mutually exclusive
c) Depreciation is a cash flow but does not affect investments, the manager should normally select the
the tax cash flow one with the highest
d) Depreciation is a cash flow and does affect the a) Net present value
tax cash flow b) Internal rate return
c) Profitability index
35) If there were no income taxes d) Book rate of return
a) Depreciation would be ignored in capital
budgeting 41) The proper treatment of an investment and inventory
b) The NPV method would not work is to
c) Income would be discounted instead of cash flow a) Ignore it
d) All potential investments would be desirable b) Add it to the required investment in fixed assets
c) Add it to the required investment in fixed assets
36) All other things being equal, as cost of capital and subtract if from the annual cash flows
increases d) Add it to the investment in fixed assets and
a) More capital projects will probably be acceptable add the present value of the recovery to the
b) Fewer capital projects will probably be present value of the annual cash flows
acceptable
c) The number of capital projects that are 42) Which of the following is not a defect of the payback
acceptable will change, but the direction of the method?
change is not determinable just by knowing the a) It ignores cash flows because it uses net
direction of the change in cost of capital income
d) The company will probably want to borrow b) It ignores profitability
money rather than issue stock c) It ignores the present values of cash flows
d) It ignores the pattern of cash flows beyond the
37) Which of the following is true of an investment? payback period
a) The higher the cost of capital, the lower the
net present value 43) The technique which if most concerned with liquidity
b) The lower the cost of capital, the higher the IRR is the
c) The longer the project’s life, the shorter its a) Payback period
payback period b) Net present value technique
d) The higher the project’s net present value, the c) Internal rate of return
shorter its life d) Book rate of return

38) if the present value of the future cash flows for an 44) The profitability index
investment equals the required investment, the IRR a) Does not take into account the discounted cash
a) Equals the cutoff rate flows
b) Equals the cost of borrowed capital b) Is calculated by dividing total cash flows by the
c) Equals zero initial investments
d) Is lower than the company’s cutoff rate return c) Allows comparison of the relative
desirability of projects that require varying
initial investments
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
d) Will never be greater than 1.0. Solution A
Annual savings on expenses P50,000
===================================== Less: additional depreciation
Test 2: (50%) Multiple Choices: Select the best answer (40,000 – 25,000) 15,000
Additional taxable income 35,000
to each of the following problems. Mark only one x Tax rate 40%
answer per problem by encircling the letter Additional tax P14,00
0
corresponding to your chosen answer. Submit
necessary computation to support your answer. 3) If an asset costs P35, 000 and is expected to have a
P5, 000 salvage value at the end of its ten year life.
Failure to support your answer is tantamount to a And generates annual net cash inflows of P5, 000
wrong answer. each year the cash payback period is
a. 8 years
1) Bravado Company is considering to replace its old
b. 7 years
equipment with a new one. The old equipment has a
c. 6 years
net book value of P100, 000 and 4 remaining useful
d. 5 years
years with P25,000 depreciation each year. The old
equipment can be sold at P80, 000. The new
Solution B
equipment costs, P160,000 have a 4 year life. Cash
Initial amount of investment s P35,000
savings on operating expenses before 40% taxes
÷ Annual after tax cash flow 5,000
amount to P50, 000 per year. What is the amount of
Payback period 7 years
investment in the new equipment?
a. P160,000 4) Umali Corporation is considering an investment in a
b. P 72,000 new cheese cutting machine to replace its existing
c. P 80,000 cheese cutter. Information on the existing machine
d. P 68,000 and replacement machine follow:

Solution B Cost of the new machine P400,00


Initial amount of investment 160,000
0
Less Cash inflow
MV of old equipment 80,00
0 Net annual savings in operating costs 90,000
Tax benefits on loss on sales
(20,000 x .4) 8,000 88,000
Salvage value now of the old machine 60,000
Net investment 72,000

Salvage value of the old machine in 8


2) Myrid Company is considering replacing its old
years 0
machine with a new and more efficient one. The old
machine has a book value of P100, 000, a remaining
Salvage value of the new machine in 8
useful life of 4 years, and annual straight line
years 50,000
depreciation of P25, 000. The existing machine has a
current market value of P80, 000. The replacement
Estimated life of the new machine 8 years
machine would cost P160, 000 have a 4 year life, and
will save P50, 000 per year in cash operating costs. If
the replacement machine would be depreciated using
What is the expected payback period for the new
the straight line method and tax rate is 40%, what
machine?
should be the increase in annual income tax?
a. 4.44 years
a. P14,000
b. 8.50 years
b. P28,000
c. 2.67 years
c. P40,000
d. 3.78 years
d. P 4,000
Solution D
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
Cost of the new machine P400,00 First year 900,000 (3,600,000)
0
Less Salvage value 60,000 Second year 1,200,000 (2,400,000)
Net investment P340,00
0 Third year 1,500,000 900,000
÷ Annual savings 90,000
Payback period 3.78 Fourth year 900,000 0

5) For P4, 500, 000, Siren Corporation purchased a new


machine with an estimated useful life of five years Hence, the Payback period is at the end of 4
with no salvage value at its retirement. The machine periods, wherein, the initial outflows are fully
recovered
is expected to produce cash flow from operations, net
of income taxes as follows;
6) Consider a project that requires cash outflow of P50,
000 with a life of eight years and a salvage value of
First year P900,000
P5, 000. Annual before tax cash inflows amounts to
P10,000. Salvage valued is ignored in computing
Second year 1,200,000
depreciation. Assuming a tax rate of 30% and a
required rate return of 8% what is the payback
Third year 1,500,000
period for the project?
Fourth year 900,000 a. 5.0 years
b. 5.6 years
Fifth year 800,000 c. 6.0 years
d. 6.6 years

Siren will use the sum of the year’s digits method to Solution B
depreciate the new machine as follows; Initial investment P50,00
0
÷ Annual after tax cash
First year P1,500,000
inflow
Cash inflow after tax
Second year 1,200,000 (P10,000 ÷ 70%) 7,000
Add Tax shield on
Third year 900,000 Depreciation
(50,000 ÷ 8 years)
Fourth year 600,000 * 30% 1,875 8,875
Payback period 5.6 years
Fifth year 300,000
7) Machine Manufacturing Company considers a projects
that will require an initial investment of P500,000 and
What is the payback period for the machine? is expected to generate future cash flows of P200,
a. 3 years 000 for year 1 through 3 and P100,000 for year 4
b. 4 years through 7. The project’s payback period is
c. 5 years a. 2.50 years
d. 2 years b. 3.50 years
c. 1.67 years
Solution B d. 3.33 years
Cash inflow Unrecovered
out flow Solution A
Cash inflow Cash outflow
Initial investment (4,500,000) Outflows (500,000)
Cash Inflows
Year 1 200,000 (300,000)
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
Year 2 200,000 (100,000) Solution A
Year 3 200,000 100,000 Outflows (120,000)
Inflows and salvage
Payback period; 2+ (100,000/200,000) 2.50 value
years Year 1 40,000 (80,000)
Year 2 36,000 (44,000)
8) Vinson Industries Inc. requires all its capital Salvage value 28,000 (16,000)
investment projects to have a payback period of 5
years or shorter. Vinson is currently considering an Bailout period: 2 + (16,000/32,000) 2.50
equipment purchase that has an initial cost of P900, years
000. The equipment is expected to have a ten year
10) Consider a project that requires an initial cash
life and a salvage value of P50, 000. Assuming cash
outflows of P500,000 with a life of eight years and
flows are equal, how much annual cash inflows are
salvage value of P20,000 upon its retirement. Annual
necessary in order to meet the payback period
cash inflow before tax amounts to P100,000 and a
requirement?
tax rate of 30 percent will be applicable. The required
a. P180,000
minimum rate of return for this type of investment is
b. P170,000
8 percent. The present value of 1 and the annuity of
c. P190,000
1, discounted at 8 percent for 8 periods are 0.54 and
d. P 90,000
5.747 respectively. Salvage value is ignored in
computing deprecation. The net present value
Solution A
amount to
Initial investment P900,000
÷ Payback period 5 years a. P 7,560
Required annual cash inflows P180,000 b. P10,050
c. P17,606
9) The Dwelight Company plans to invest in a d. P20,050
duplicating machine that costs P120,000. The
following are the expected annual cash inflows that Solution C
are evenly received each month and the estimated Computation of Net Present value
salvage value at any point of each year PV of ATCF; 88,750 x 5.747 510,04
6
PV of after tax salvage Value; 20,000 x 7,560
Year Cash Inflows Salvage Value
0.70 x 0.54
Total 517,60
1 P40,000 P50,000 6
Investment 500,00
2 36,000 40,000 0
Net Present value 17,606
3 32,000 28,000
Before tax cash flow 100,00
4 28,000 20,000 0
Less annual depreciation (500,000 ÷ 8) 62,500
5 25,000 5,000 Book income before tax 37,500
Less income tax (37,500 x 0.3) 11,250
Net book income 26,250
Add back depreciation 62,500
What is the bail out period for this project?
Annual after tax cash inflow 88,750
a. 2.50 years Alternative computation for ATCF
b. 2.43 years (100,000 x .70) + (62,500 x .30) 88,750
c. 2.57 years
d. 1.83 years
11) Vendo Company is planning to buy a coin-operated
machine costing P400,000. For book and tax
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
purposes, this machine will be depreciated P80,000 b. P29,510
each year for five years. Vendo estimates that this c. P22,750
machine will yield an annual inflow, net of d. P26,130
depreciation and income taxes, of P120,000. Vendo
desired rate of return on its investments is 12%. At Solution D
the following discount rates, the NVP’s of the Annual cash inflow net of taxes P6,000
investment in this machine are; x PV factor of an ordinary
annuity for 6 periods at 10% 4.355
Discount rate NPV Initial Investment P26,130

12% + P3,258 13) A company is considering putting up P50,000 in a


three year project. The company’s expected rate of
14% +1,197 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
16% -708 three years is 0.712. The cash flows, net of income
taxes are P18,000 (present value of P16, 074) for the
18% - 2,474 first year and P22,000 (Present value of P17, 534) for
the second year. Assuming that the rate of return is
exactly 12%, the cash flow net of income taxes for
Vendo’s expected IRR on its investment in this the third year would be
machine is a. P23,022
a. 3.25% b. P 7,120
b. 12.00% c. P10,000
c. 16.00% d. P16,392
d. 15.30%
Solution A
Solution D Investment (Total of PV @ IRR of 12%) P50,00
By using interpolation: 0
Les PV year 1 & 2 (16,704 + 17,534) 33,608
Discount rate Net Present Value s
0.14 1,197 PV of the 3rd cash flow 16,392
IRR 0 ÷ PV of 1 at 12% for 3 years 0.712
0.16 -708 After tax cash flow on third year 23,022
(0.14 – IRR) ÷ (0.14 – 0.16) =1,197 ÷ (1,197
+708) 14) The Miracle Company is planning to purchase a new
(0.14 – IRR) ÷ -.2 = 1,197 ÷ 1,905
machine which it will depreciate for book purposes,
(0.14 – IRR) ÷ -.02 = 0.628
(0.14 – IRR) = 0.628 x -.02 on a straight-line basis over a ten year period with no
0.14 – IRR = 0.013 salvage value and a full year depreciation taken in
IRR = 0.013+0.14 the year of acquisition. The new machine is expected
IRR = 0.153 OR 15.30% to produce cash flow from operations, net of income
taxes of P66,000 a year in each of the next ten
12) Camel Company invests in a machine with a useful years. The accounting (book value) rate of return on
life of six years and no salvage value. The machine the initial investment is expected to be 12 percent.
will be depreciated using the straight-line method. It How much will the new machine cost?
is expected to produce annual cash inflow from a. P300,000
operations, net of income taxes of P6,000. The b. P660,000
present value of an ordinary annuity of P1 for six c. P550,000
periods at 10% is 4.355. The present value of P1 for d. P792,000
six periods at 10% is o.564. Assuming that Camel
uses a time adjusted rate of return of 10% how much Solution A
is the original investment? Annual cash inflow P66,000
a. P10,640
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
÷ Accounting Rate of return 12% Total of present value of depreciation 287,920
Ad Depreciation rate 10% 22% Tax rate 40%
d Present value of net advantage 115,16
8
Initial investment P300,00
0
16) ACR Company, Which operates a school canteen, is
planning to buy a doughnut-making machine for
15) Prime Consulting Inc. operates consulting offices in
P300,000. The machine is expected to produce
Manila, Olongapo and Cebu. The firm is presently
36,000 units of doughnuts per year which can be sold
considering an investment in a mainframe computer for P10 each. Variable cost to produce and sell the
and communication software. The computer would doughnut is P4 per unit. Incremental fixed costs
cost P6 million and have an expected life of 8 years. exclusive of depreciation, is estimated at P56,000 per
For tax purposes the computer can be depreciated year. The doughnut-making machine will be
using either straight line method or Sum of the Years depreciated on a straight-line basis for 5 years to a
Digits (SYD) method over five years. No salvage zero salvage value. The company pays income tax a
value is recognized in computing depreciation rate of 32%.
expense and no salvage value is expected at the end What is the expected annual return (Accounting net
of the life of the equipment. The company’s cost of income) to be earned from the doughnut making
capital is 10 percent and it tax rate is 40 percent. machine?
The present value of annuity of 1 for 5 years is 3.791
a) P108,800
and for 8 periods is 5.335. The present value of 1 b) P128,000
end of each period are: c) P100,000
d) P 68,000
Perio PV Factor Perio PV Factor
d d Solution: D

1 0.9091 5 0.6209 Sales (36,000 x 10) P360,00


0
2 0.8264 6 0.5645
Less Variable costs
(36,000 x P4) 144,000
3 0.7513 7 0.5132
Contribution margin 216,000
4 0.6830 8 0.4665
Less FC

The present value of the net advantage of using SYD Cash FC P56,00
method of depreciation with a 5-year life instead of 0
straight line method of depreciating the equipment is
Depreciation
a) P 86,224 (P300,000 ÷ 5 years 60,000 116,000
b) P115,168
c) P215,560 Income b4 tax P100,00
d) P287,893 0

Solution B Less Tax 32%


year SYD Straight Difference PV
line
Accounting net income P68,000
1 2,000,000 1,200,000 800,000 727,280
2 1,600,000 1,200,000 400,000 330,560
3 1,200,000 1,200,000 0 0
4 800,000 1,200,000 (400,000) (273,200 17) In relation to problem #16, what is the annual net
) cash inflow from the doughnut-making machine?
5 400,000 1,200,000 (800,000) (496,720 a) P108,800
) b) P128,000
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
c) P100,000
d) P 68,000 Solution: B

Solution: B Incremental annual income P69,700


Accounting net income P68,000
Incremental depr 17,500
Add Depreciation (non-cash expense) 60,000
Net cash inflow P128,00 Net cash inflows P87,200
0

18) Fermin printers, Inc. is planning to replace its present


printing equipment with a more efficient unit. The 20) What is the net income cost of investment in the new
new equipment will cost P400,000, with a five-year equipment for decision-making purposes?
useful life, no salvage value. The old unit was a) P232,000
acquired three years ago for P500,000. The company b) P400,000
uses the straight-line method in depreciable assets. c) P300,000
The old unit is being depreciated at P62,500 per d) P368,000
year. If the new equipment is acquired, the old one
will be sold for P100,000. Otherwise, the company Solution: A
will just continue using it for 5 years. Cash operating Cost of new equipment P400,00
costs are P100,000 and P220,000 for new and old 0
equipment, respectively. Income tax is at the rate of Les Proceed from sales of old
s equipment:
32% of income before tax The increase in annual net
Proceed from sales P100,00
income as a result of acquiring the new equipment is
0
a) P27,200 Tax savings
b) P39,100 (P100,000 – (500,000-
c) P69,700 187,500) * 32% 68,000 168,000
d) P87,200 Net cost of Investment P232,00
0
Solution: C
21) Vhong Corporation has determined that if a new
Savings in cash operating equipment costing P120,000 is purchased, the
cost (P220,000-P100,000) P120,000 company’s net income will increase by P10,000 per
year. If the new equipment will be depreciated using
Les Incremental dep’r.
the straight-line method over a period of six years to
s
a zero salvage value, the payback period is
a) 6.00 years
New equip P80,000
b) 12.00 years
Old equip 62,500 17,500 c) 0.25 years
d) 4.00 years
Savings or income b4 tax P102,500
Solution: D
Les Tax (102,500x32%) 32,800
s Initial investment P120,00
0
Incremental annual income P69,700
÷ Annual net cash inflow

19) In relation to problem #18, what is the expected Net income P10,000
increase in annual net cash inflows if the new
equipment is acquired? Add: Depr 20,000 30,000
a) P 52,200
Payback period 4 years
b) P 87,200
c) P 69,700
d) P149,700
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
22) A new machine is expected to produce the following Required annual net cash inflows P600,000
after-tax cash inflows over a period of 5 years:
After-tax cash inflows Less Depreciation
Year Per Year Cumulative (1,800,000÷10yrs) 180,000
1 P 16,000 P 16,000
Required net income after tax P420,000
2 12,000 28,000
3 20,000 48,000
÷ Tax rate 60%
4 8,000 56,000
5 6,000 62,000 Income b4 tax P700,000

If the machine will cost P40,000, its payback period Add Depreciation 180,000
is
a) 5.00 years Required annual cash savings P880,00
b) 3.00years 0
c) 2.60 years
d) 3.23 years
24) NPC Company paid a cash dividend to its common
Solution: C shareholders over the past 12 months of P2,20 per
Cost of the machine P40,00 share. The current market value of the common
0 stock is P40 per share, and investors are anticipating
Less Cumulative cash flow for 2 years 28,000 the common dividend to grow at a rate of 6%
Amount to be recorded in year 3 12,000 annually. The cost to issue new common stock will
÷ Cash flow in year 3 20,000 be 5% of the market value. The cost of a new
Fraction of year r .6 year common stock will be
a) 11.50%
Hence, the payback period is 2 years + 0.6 years = b) 11.79%
2.6 years. c) 11.83%
d) 12.14%
23) For new equipment acquisition, Melba C Corporation
has set a payback goal of 3 years and a desired rate Solution: D
of return of 25% based on initial investment. An
Unit cost of cash dividend P2.200
equipment to be used in Melba C. Corporation’s x Dividend grow rate 1.060
Forming Department is being evaluated. Data New cost of dividend P2.332
pertaining to the equipment are as follows: ÷ Stock price P40
Cost of the equipment P 1,800,000 x one minus floatation
Useful life 10 years cost (1-.05) .95 38
Salvage value at the end of the 0 .0614
useful life Add Growth rate .0600
Cost of the new stock 0.1214
12.14
Melba C Corporation is subject to 40% income tax
rate. It uses the straight-line method in computing
25) ERC Corporation’s current capital structure is shown
depreciation.
below. This structure is optimal, and the company
To meet Melba C. Corporation’s payback goal, the wishes to maintain it
new equipment must generate savings in annual cash
operating costs of Debt 25%
a) P600,000
b) P880,000 Preferred equity 5%
c) P700,000
d) P420,000 Common equity 70%

Solution: B
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
ERC’s management is planning to build a P75M Debt 5.4% P5,600,000 P302,000
facility that will be financed according to this desired Preferred 6.0% 1,000,000 60,000
capital structure. Currently, P15M of cash is Common 13 8,000,000 1,040,000
available for capital expansion. The percentage of Total P14,600,00 1,402,000
the P75M that will come from a new issue of common 0
Weighted average cost of capital
stock is
(P1,402,000 ÷ P14,600,000) 9.6%
a) 52.50%
b) 50.00%
Dividend pay P1.20
c) 56.25% ÷ Market price of common stock P40
d) 56.00% Dividend yield 3%
Add Growth rate 10%
Solution: D Cost of common stock 13%
Required fund to build the facility P75M
Less Cash already available 15M Current yield of debt .090%
Fund is still needed P60M One minus – tax rate (1-.40) .6%
x Common stock % 70% Cost of debt .054%
Funds to be financed by common stock P42M
÷ Required fund P75M 27) BTO Corporation is planning to buy a vending
Percentage coming from common 56% machine costing P50,000. This machine will be
stock
depreciated over a 5-year period, using the straight
line method. It is estimated that the machine will
26) GTI’s new financing will be in proportion to the
yield an annual cash inflow, net of depreciation and
market value of its present financing is shown below:
income taxes, of P14,000. At the following discount
rates, the net present values of the investment in
Book Value
this machine are:

Long-term debt P7,000,000


Discount rate Net present value
Preferred stock (100,000 shares) 1,000,000
10% P3,074
Common stock (200,000 shares) 7,000,000
12% 470

14% -1,938
The firm’s bond are currently selling at 80% of par
generating a current market yield of 9%, and the
16% 4,164
corporation has a 40% tax rate. The preferred stock
is selling at its par value and pays a 6% dividend.
The common stock has a current market value of P40
BTO’s desired rate of return on this investment is
and is expected to pay a P1.20 per share dividend
10%. The accounting rate of return on BTO
this fiscal year. Dividend growth is expected to be
Corporation’s initial investment in this machine is
10% per year. GTI’s weighted average cost of capital
a) 8%
is (round your calculations to tenths of a percent).
b) 10%
a) 13.0%
c) 48%
b) 8.3%
d) 28%
c) 9.6%
d) 9.0%
Solution: A
Net cash inflows P14,000
Solution: C Les Depreciation 10,000
s
Market Net income 4,000
Cost of value of Total cost ÷ Cost of investment 50,000
capital Equity of capital Accounting rate of return 8%
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
Using the normal rate of return of 14 percent the net
28) In relation to problem #27, what is the expected present value for this machine is
payback period of the investment project? (round it a) P12,239
off to the nearest tenth) b) P19,670
a) 5.00 years c) P13,419
b) 0.28 years d) P27,936
c) 12.50 years
d) 3.60 years Solution: B
Period
Solution: D 1 32,000 x 0.87790 28,070.0
8
Investment P50,000 2 32,000x1.05 33,600 x 0.76947 25,854.1
÷ Net cash inflow 14,000 9
Payback period 3.571 or 3 32,000x1.05 35,280 x 0.67497 23,812.9
3.6 ² 4
4 32,000x1.05 37.044 x 0.59208 21,933.0
³ 1
29) Still in relation to problem #27, what is the internal Total 99,670.2
rate of return of the investment project? 2
a) More than 14% Less: Investment 80,000.0
0
b) Less than 12%
Net Present Value 19,670.2
c) More than 12% but less than 10% 2
d) More than 12% but less than 14%
31) Zambales Mines Inc. is contemplating the purchase of
Solution: D a piece of equipment to exploit a mineral deposit that
The present value factor of 3.571 is between 3.605 is located on land to which the company has minerals
for 12% and 3.433 for 14% for 5 periods. Hence, rights. Based on an engineering and cost analysis,
the IRR is between 12% and 14%. the following cash flows associated with operating a
mine in the area are expected
30) By the end of December 31, 2005, Alay Foundation is Cost of new equipment and timbers 2,750,00
considering the purchase of a copying machine for 0
P80, 000. The expected annual cash savings are
expected to be P32, 000 in the next four years. At Working capital acquired 1,000,00
the end of the four years the machine will be 0
discarded without any salvage value. All the cash
savings are state in number of pesos at December Net annual cash receipts* 1,200,00
31, 2006. The company expected that the inflation 0
rate is constantly 5 percent each year. Hence, the
first year’s cash inflow was adjusted for 5 inflation. Cost of construct new road in three 400,000
For simplicity all cash inflows are assumed to be at years
year end.
The present value at 14% of 1 of 4 period is 2.91371. Salvage value of equipment in 4 years 650,000
The present value of 1 at end of each period are;

Period 1 0.87719 *receipts from sales of ore, less out of pocket costs
for salaries, utilities, insurance etc.
Period 2 0.76947
It is estimated that the mineral deposit would be
Period 3 0.67497 exhausted after four years of mining. *At that point
the working capital would be released for
Period 4 0.59208 reinvestment elsewhere. The company’s discount rate
is 20%. The net present value for the project is
a) P454,620
UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA
CALAMBA CAMPUS, BRGY. PACIANO RIZAL, CALAMBA CITY
LAGUNA, PHILIPPINES

Capital budgeting
Edmund E. Hilario, CPA, MBA
Management Accounting 2
1st
Semester 2017-2018
b) P(79,303)
c) P(561,553)
d) P(204,688)

Solution: B
PV of annual cash receipts (1,200,000 x
2.58872 3,106,463
Add/(Deduct):
PV of salvage value (650,000 x
0.48225) 313,462
PV of return of working capital 482,250
(1,000,000 x 0.48225)
Cost of new equipment & timbers -2,750,000
Working capital -1,000,000
PV of cost of construction of road
(400,000 x 0.5787) -231,480
Negative Net Present Value -79,303

32) A piece of labor saving equipment that Marubeni


Electronics Company could use to reduce costs in one
of its plants in Angeles City has just come onto the
market. Relevant data relating to the equipment
follows;
Purchase coat of the equipment P432,00
0

Annual cost savings that will be 90,000


provided by the equipment

Life of the equipment 12 years

What is the simple rate of return to be provided by


the equipment?
a) Between 15%and 18%
b) 25.00%
c) 20.83%
d) 12.50%

Solution: D
Annual cash savings P90,000
Les Depreciation (432,000 ÷ 12) 36,000
s
Annual income 54,000
÷ Initial investment 432,000
Simple rate of return 12.5%