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MANAGEMENT ADVISORY SERVICES REVIEW

QUIZ ON CAPITAL BUDGETING- PROBLEMS


NAME: _______________________________________ _____________DATE: _____________________
SCORE: _________________
INSTRUCTIONS: WRITE BEFORE THE NUMBER THE LETTER OF YOUR CHOICE. STRICTLY NO
ERASURE OR ALTERATION IS ALLOWED. NO SOLUTION, NO CREDIT.
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Acme is considering the sale of a machine with a book value of P160,000 and 3 years remaining in its useful
life. Straight-line depreciation of P50,000 annually is available. The machine has a current market value of
P200,000. What is the cash flow from selling the machine if the tax rate is 40%?
a. P50,000
b. P160,000
c. P184,000
d. P200,000
Altoona Company is considering replacing a machine with a book value of P200,000, a remaining useful life
of 4 years, and annual straight-line depreciation of P50,000. The existing machine has a current market value
of P175,000. The replacement machine would cost P320,000, have a 4 year life, and save P100,000 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 increase in annual income taxes if the company replaces the machine?
a. P28,000
b. P40,000
c. P42,000
d. P64,000
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.
b. 1.14.
c. 0.33.
d. 14%.
A project has a NPV of P30,000 when the cutoff rate is 10%. The annual cash flows are P41,010 on an
investment of P100,000. The profitability index for this project is
a. 1.367.
b. 3.333.
c. 2.438.
d. 1.300.
Portage Press Company is considering replacing a machine with a book value of P200,000, a remaining useful
life of 5 years, and annual straight-line depreciation of P40,000. The existing machine has a current market
value of P200,000. The replacement machine would cost P300,000, have a 5-year life, and save P100,000 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 increase in annual net cash flow if the company replaces the
machine?
a. P60,000
b. P68,000
c. P76,000
d. P84,000
Winneconne Company 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
b. P150,000
c. P330,000
d. P550,000
An investment opportunity costing P75,000 is expected to yield net cash flows of P23,000 annually for five
years. The NPV of the investment at a cutoff rate of 14% would be
a. P(3,959).
b. P3,959.
c. P75,000.
d. P78,959.
An investment opportunity costing P55,000 is expected to yield net cash flows of P22,000 annually for five
years. The payback period of the investment is
a. 0.4 years.
b. 2.5 years.
c. P33,000.

d. some other number.


An investment opportunity costing P180,000 is expected to yield net cash flows of P53,000 annually for five
years. The IRR of the investment is between
a. 10 and 12%.
b. 12 and 14%.
c. 14 and 16%.
d. 16 and 18%.
10.
An investment opportunity costing P150,000 is expected to yield net cash flows of P45,000 annually for five
years. The cost of capital is 10%. The book rate of return would be
a. 10%.
b. 20%.
c. 30%.
d. 33.3%.
11.
An investment opportunity costing P150,000 is expected to yield net cash flows of P36,000 annually for six
years. The NPV of the investment at a cutoff rate of 12% would be
a. P(2,004).
b. P2,004.
c. P150,000.
d. P147,996.
Use the following to answer questions 12-13:
(Ignore income taxes in this problem.) Cedar Hill Hospital needs to expand its facilities and desires to obtain a new
building on a piece of property adjacent to its present location. Two options are available to Cedar Hill, as follows:
Option 1: Buy the property, erect the building, and install the fixtures at a total cost of P600,000. This
cost
would be paid off in five installments: an immediate payment of P200,000, and a payment of
P100,000 at
the end of each of the next four years. The annual cash operating costs associated with
the new facilities are
estimated to be P12,000 per year. The new facilities would be occupied for
thirteen years, and would
have a total resale value of P300,000 at the end of the 13-year period.
Option 2: A leasing company would buy the property and construct the new facilities for Cedar Hill which
would then be leased back to Cedar Hill at an annual lease cost of P70,000. The lease period would
run
for 13 years, with each payment being due at the BEGINNING of the year. Additionally, the
company
would require an immediate P10,000 security deposit, which would be returned to Cedar Hill at the end of the
13-year period. Finally, Cedar Hill would have to pay the annual maintenance
cost of the facilities, which is
estimated to be P4,000 per year. There would be no resale value at the end of the 13-year period under this
option.
The hospital uses a discount rate of 14% and the total-cost approach to net present value analysis in evaluating its
investment decisions.
12.
Under option 1, the present value of all cash outflows associated with buying the property, erecting the
building, and installing the fixtures is closest to:
A) P(200,000)
B) P(491,400)
C) P(600,000)
D) P(387,200)
13.
Under option 1, the net present value of all cash flows is closest to:
A) P(456,000)
B) P(600,000)
C) P(300,000)
D) P(507,000)
Use the following to answer questions 14-16:
(Ignore income taxes in this problem.) Perky Food Corporation produces and sells coffee jelly. Perky currently
produces the jelly using a manual operation but is considering the purchase of machinery to automate its operations.
Information related to the two operations is as follows:
Manual
Automated
Operation
Operation
Cost of machinery .....................................

P420,000
Useful life of machinery ............................

12 years
Expected salvage value in 12 years ...........

P0
Expected annual revenue (50,000 jars) ..... P210,000
P210,000
Expected annual variable costs ................. P135,000
P42,000
Expected annual fixed costs ...................... P30,000
P72,000
Perky's discount rate is 12%. Perky uses the straight-line method of depreciation.
14.
What is the net present value of automating operations using the incremental cost approach?
A) P11,940
B) P56,940
C) P(104,106)
D) P112,684
15.
Within what range does the internal rate of return fall?
A) 6% to 8%
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B) 10% to 12%
C) 12% to 14%
D) 18% to 20%
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What is the simple rate of return for automating operations?


A) 3.8%
B) 12.1%
C) 14.5%
D) 22.9%
Use the following to answer questions 17-18:
The Weston Company is analyzing projects A, B, and C as possible investment opportunities. Each of these projects
has a useful life of five years. The following information has been obtained:
Project A
Project B
Project C
Initial investment required ........................ P500,000
P480,000
P630,000
Present value of future cash inflows ......... P675,000
P520,000
P690,000
Internal rate of return ................................ 18%
14%
16%
17.
Which of the following statements is correct?
A) Project B is preferred over Project C according to the project profitability index.
B) Project B is preferred over Project A according to the internal rate of return.
C) Project C is preferred over Project A according to the project profitability index.
D) Project A is preferred over Project C according to a net present value ranking.
18.
Which project has the highest ranking according to the net present value and the project profitability index
criteria?
Net Present Value
Profitability Index
A) Project B
Project B
B) Project A
Project A
C) Project B
Project A
D) Project C
Project C
19.
Sales of the Kotter Company during the past year were all cash sales. Similarly, all expenses were paid in cash.
The tax rate was 30%. If the after-tax net cash inflow from these operations last year was P15,000, and if the
total before-tax cash sales were P60,000, then the total before-tax cash expenses must have been:
A) P21,429
B) P27,000
C) P45,000
D) P38,571
20.
(Ignore income taxes in this problem.) You have deposited $16,700 in a special account that has a guaranteed
interest rate of 11% per year. If you are willing to completely exhaust the account, what is the maximum
amount that you could withdraw at the end of each of the next 6 years? Select the amount below that is closest
to your answer.
A) P3,465
B) P3,089
C) P2,783
D) P3,947
21.
(Ignore income taxes in this problem.) Mercer Corporation is considering replacing a technologically obsolete
machine with a new state-of-the-art numerically controlled machine. The new machine would cost P250,000
and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new
machine would cost P12,000 per year to operate and maintain, but would save P55,000 per year in labor and
other costs. The old machine can be sold now for scrap for P10,000. The simple rate of return on the new
machine is closest to:
A) 17.9%
B) 7.5%
C) 22.0%
D) 7.2%
22.
(Ignore income taxes in this problem.) In an effort to reduce costs, Pontic Manufacturing Corporation is
considering an investment in equipment that will reduce defects. This equipment will cost P420,000, will have
an estimated useful life of 10 years, and will have an estimated salvage value of P50,000 at the end of 10
years. Pontic's discount rate is 22%. What amount of cost savings will this equipment have to generate per year
in each of the 10 years in order for it to be an acceptable project?
A) P50,690 or more
B) P41,315 or more
C) P105,315 or more
D) P94,316 or more
23.
(Ignore income taxes in this problem.) Naomi Corporation has a capital budgeting project that has a negative
net present value of $36,000. The life of this project is 6 years. Naomi's discount rate is 20%. By how much
would the annual cash inflows from this project have to increase in order to have a positive net present value?
A) P1,200 or more
B) P2,412 or more

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C) P6,000 or more
D) P10,824 or more
(Ignore income taxes in this problem.) Highpoint, Inc., is considering investing in automated equipment with a
ten-year useful life. Managers at Highpoint have estimated the cash flows associated with the tangible costs
and benefits of automation, but have been unable to estimate the cash flows associated with the intangible
benefits. Using the company's 12% required rate of return, the net present value of the cash flows associated
with just the tangible costs and benefits is a negative P282,500. How large would the annual net cash inflows
from the intangible benefits have to be to make this a financially acceptable investment?
A) P20,000
B) P28,250
C) P35,000
D) P50,000
(Ignore income taxes in this problem.) Stratford Company purchased a machine with an estimated useful life
of seven years. The machine will generate cash inflows of P9,000 each year over the next seven years. If the
machine has no salvage value at the end of seven years, and assuming the company's discount rate is 10%,
what is the purchase price of the machine if the net present value of the investment is P17,000?
A) P43,812
B) P26,812
C) P17,000
D) P22,195
(Ignore income taxes in this problem.) Anthony operates a part time auto repair service. He estimates that a
new diagnostic computer system will result in increased cash inflows of P1,500 in Year 1, P2,100 in Year 2,
and P3,200 in Year 3. If Anthony's required rate of return is 10%, then the most he would be willing to pay for
the new computer system would be:
A) P4,599
B) P5,501
C) P5,638
D) P5,107
(Ignore income taxes in this problem.) Fossa Road Paving Company is considering an investment in a curbforming machine. The machine will cost P240,000, will last 10 years, and will have a P40,000 salvage value at
the end of 10 years. The machine is expected to generate net cash inflows of P60,000 per year in each of the 10
years.Fossa's discount rate is 18%. What is the net present value of this machine?
A) P5,840
B) P37,280
C) P(48,780)
D) P69,640
A company is considering the purchase of a machine that promises to reduce operating costs by the same
amount for every year of its 6-year useful life. The machine will cost P83,150 and has no salvage value. The
machine has a 20% internal rate of return. Ignore income taxes. The annual cost savings promised by the
machine is
a. P25,000
b. P50,000
c. P35,000
d. P20,000
Whogoat Inc. is considering replacing an old machine that cost P900,000sixyears ago with a new one that
would cost P2,150,000. Shipping and installation would cost an additional P150,000. The old machine has a
book value of P300,000 and could be currently sold for P40,000. The increased production of the new
machine would increase inventories by P60,000, accounts receivable by P180,000 and accounts payable by
P125,000. Whogoats net initial investment for analyzing the acquisition of the new machine assuming a 35%
income tax rate would be
a. P2425,000
b. 2,276,000
c. 2,449,000
d. 2,415,000
A company considers a project that will generate cash sales of P45,000 per year. Fixed costs will be P12,000
per year, variable costs will be 35% of sales and depreciation of the equipment in the project will be P6,500
per year. Taxes are 30%. The expected annual cash flow to the company resulting from the project is
a. P 14,025
b. 7,525
c. 14,000
d. 17,250

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iCPA

Prepared by:
JADE BALLADO-TAN, CPA, MBA
Subject Instructor