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FLEXIBLE BUDGET

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

Month Machine Hours Utility Cost


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

The company’s earnings per common share (EPS) is P12. The


common shares’ current market price is P60, while that of preferred
shares is P250. The income tax is 30%.

Compute the following


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

A. COD (7%);CPS (8%); COCE (20%)


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

Kyle Corporation’s common stock is currently selling at par. The


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

Compute the Payback Period of the projects

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

The working capital needed for Project B will be


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:

Project Investment NPV Life of the project IRR


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:

a. Discounted Payback period


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:

a. Discounted payback period


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%.

Requirements: PBP – 2.34 YEARS


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%