Day 1- Capital Budgeting

1. Three potential investment projects (A, B, and C) at Stay at Home Corporation all require the
same initial investment, have the same useful life (3 years), and have no expected salvage
value. Expected net cash inflows from these three projects each year is as follows:
ABC
Year 1 P 1,000 P 2,000 P 3,000
Year 2 P 2,000 P 2,000 P 2,000
Year 3 P 3,000 P 2,000 P 1,000
What can be determined from the information provided above?
A.the net present value of project C will be the highest.
B. the internal rate of return of projects A and C cannot be computed.
C. the net present value and the internal rate of return will be the same for all three projects.
D. both A and B above.
2. The payback method assumes that all cash inflows are reinvested to yield a return equal to
A.zero
B. the Discount Rate
C. the Time-Adjusted-Rate-of-Return
D. the Cost-of-Capital
3. When the cash flows are the same every period after the initial investment in a project, the
payback period is equal to:
A.the net present value.
B. the simple rate of return.
C. the factor of the internal rate of return.
D. the payback rate of return.
4. Capital budgeting techniques are least likely to be used in evaluating the
A.Acquisition of new aircraft by a cargo company.
B. Design and implementation of a major advertising program.
C. Trade for a star quarterback by a football team.
D. Adoption of a new method of allocating non-traceable costs to product lines.
5. Which of the following is always true with regard to the net present value (NPV) approach?
A.If a project is found to be acceptable under the NPV approach, it would also be acceptable
under the internal rate of return (IRR) approach.
B. The NPV and the IRR approaches will always rank projects in the same order.
C. If a project is found to be acceptable under the NPV approach, it would also be
acceptable under the payback approach.
D. The NPV and payback approaches will always rank projects in the same order.
6. Which of the following would decrease the net present value of a project?
A decrease in the income tax rate
B. A decrease in the initial investment
C. An increase in the useful life of the project
D. An increase in the discount rate
7. A project’s net present value, ignoring income tax considerations, is normally affected by the
A.Proceeds from the sale of the asset to be replaced.
B. Carrying amount of the asset to be replaced by the project.
 C. Amount of annual depreciation on the asset to be replaced.
D. Amount of annual depreciation on fixed assets used directly on the project.
8. Sensitivity analysis, if used with capital projects,
A.Is used extensively when cash flows are known with certainty
B. Measures the change in the discounted cash flows when using the discounted payback
method rather than the net present value method.
C. Is a “what-if” technique that asks how a given outcome will change if the original estimates
of the capital budgeting model are changed.
D. Is a technique used to rank capital expenditure requests.
9. S1: If a company is operating at a profit, the cash inflow resulting from the depreciation tax
shield is computed by multiplying the depreciation deduction by one minus the tax rate.
S2: In calculating the “investment required” for the project profitability index, the amount
invested should be reduced by any salvage recovered from the sale of old equipment.
S3: Depreciation is included as a cash flow in capital budgeting decisions to ensure that the
original cost of the asset is fully recovered.
A.Only one statement is correct
B. Only one statement is incorrect
C. All statements are correct
D. All statements are incorrect
10. Which of the following combinations is possible?
Profitability Index NPV IRR
A. greater than 1 Positive equals cost of capital
B. greater than 1 Negative less than cost of capital
C. less than 1 Negative less than cost of capital
D. less than 1 Positive less than cost of capita
11. Which of the following is NOT a defect of the payback method?
A.It ignores cash flows because it uses net income.
B. It ignores profitability.
C. It ignores the present values of cash flows.
D. It ignores the pattern of cash flows beyond the payback period.
12. Joy Boy. uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four projects for the upcoming year.
Project 1 Project 2 Project 3 Project 4

Initial cash outlay P200,000 P298,000 P248,000 P272,000

Annual net cash inflows
Year 1 P 65,000 P100,000 P 80,000 P 95,000
Year 2 70,000 135,000 95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present value ( 3,798) 4,276 14,064 14,662
Profitability index 98% 101% 106% 105%
Internal rate of return 11% 13% 14% 15%
No Budget Restriction P600,000 Available Funds P300,000Available Funds
A. Projects 2, 3 & 4 Projects 3 & 4 Project 3
B. Projects 1, 2 & 3 Projects 2, 3 & 4 Projects 3 & 4
C. Projects 1, 3 & 4 Projects 2 & 3 Project 2
D. Projects 3 & 4 Projects 2 & 4 Projects 2 &
13. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are
some of the capital budgeting techniques. What is the effect of an increase in the cost of
capital on these techniques?
A. B. C. D.
PP Increase No change No change Decrease
PI Decrease Decrease Increase No change
SARR Increase No change Decrease No change
14.  Front Liners Co. considering the purchase of a PPE that could potentially reduce labor costs
of its operation by a considerable margin. The new PPE would cost P 300,000 and would be
fully depreciated by the straight-line method over 5 years. At the end of 5 years, the ship will
have no value and will be junk. The Front Liners Co.'s cost of capital is 10 percent, and its
marginal tax rate is 35 percent. If the ship produces equal annual labor cost savings over its
5-year life, how much do the annual savings in labor costs need to be to generate a net
present value of P 0 on the project?
A. P 79,139
B. P 121,753
C. P 58,139
D. P 89,445
15. Covid Free Corporation is reviewing the following data relating to an energy saving
investment proposal:
 Initial investment P 50,000
Life of the project 5 years
Salvage value P 10,000
Annual cash savings ?
What annual cash savings would be needed in order to satisfy the company's 10% required
rate of return (rounded to the nearest one hundred pesos)?
A. P 13,190
B. P 11,551
C. P 14,829
D. P 15,828

16.
Bayanihan Construction, Inc., has a large crane that cost P 70,000 when purchased ten years
ago. Depreciation taken to date totals P 50,000. The crane can be sold now for P 12,000.
Assuming a tax rate of 30%, if the crane is sold the total after-tax cash inflow for capital
budgeting purposes will be:
A. 12,000
B. 8,400
C. 20,000
D. 14,400

17. Vivi Co. has an antiquated high-capacity printer that needs to be upgraded. The system
either can be overhauled or replaced with a new system. The following data have been
gathered concerning these two alternatives:
Overhaul Present System Purchase New System
Purchase cost when new P 300,000 P 400,000
Accumulated depreciation P 220,000 —
 Overhaul costs needed now P 250,000 —
Annual cash operating costs P 120,000 P 90,000
Salvage value now P 90,000 —
Salvage value in ten years P 30,000 P 80,000
Working capital required — P 50,000
The company uses a 10% discount rate and the total-cost approach to capital budgeting
analysis. The working capital required under the new system would be released for use
elsewhere at the conclusion of the project. Both alternatives are expected to have a useful
life of ten years.
The net present value of the overhaul alternative and new system alternative respectively is
(rounded off factors to three decimal places) is:

18. Middle Class Industries is replacing a grinder purchased 10 years ago for P15,000 with a
new one costing P25,000 cash. The original grinder is being depreciated on a straight-line
basis over 15 years to a zero-salvage value. Middle Class will sell this old equipment for
P6,000 cash. The new equipment will be depreciated on a straight-line basis over 10 years
to a zero-salvage value. Assuming a 40% marginal tax rate, Middle Class’s net cash
investment at the time of purchase is the old grinder is sold and the new one purchased is
A. P19,400
B. P15,000
C. P17,400
D. P25,000

19. Lockdown 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 P40,000
Annual net cash inflow 9,000
Salvage value now of the old machine 6,000
Salvage value of the old machine in 8 years 0
Salvage value of the new machine in 8 years 5,000
Estimated life of the new machine 8 years
What is the expected payback period for the new machine?
20. Heal as One Company has a payback goal of 2 years on new equipment acquisitions. A new
sorter is being evaluated that costs P450,000 and has a 5-year life. Straight-line depreciation
will be used; no salvage value is anticipated. Heal as One Company is subject to a 40%
income tax rate. To meet the company’s payback goal, the sorter must generate reductions
in annual cash operating costs of
A. P216,000
B. P360,000
C. P315,000

D. P190,000
21. Hygiene Products Company is considering generation of a new product that can kill any virus
in an instant. It can be sold for P100 and have a variable cost of P60. Expected volume is
20,000 units. New equipment costing P1,500,000 and having a five-year useful life and no
salvage value is needed, and will be depreciated using the straight-line method. The
machine has cash operating costs of P20,000 per year. The firm is in the 40 percent tax
bracket and has cost of capital of 12 percent. The present value of 1, end of five periods is
0.56743; present value of annuity of 1 for 5 periods is 3.60478.
How many units per year the firm must sell for the investment to earn 12 percent internal rate
of return?
22. Quarantine Inc., is considering investing in automated equipment with a ten-year useful life.
Managers at Quarantine 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 10% discount rate, the net present value of the
cash flows associated with just the tangible costs and benefits is a negative P184,350. How
large would the annual net cash inflows from the intangible benefits have to be to make this
a financially acceptable investment?
A. P18,435
B. P30,000
C. P35,000
D. P37,236

23. Leaves Co. is planning to buy a coin-operated machine costing P40,000. For book and tax
purposes, this machine will be depreciated P8,000 each year for five years. Leaves
estimates that this machine will yield an annual cash inflow of P12,000. Leaves’s desired
rate of return on its investments is 12%. At the following discount rates, the NPVs of the
investment in this machine are:
Discount rate NPV
12% +P3,258
14% + 1,197
16% - 708
18% - 2,474
Leaves’s accounting rate of return on its initial investment in this machine is expected to be?
24.

Young’s Town Co. is expanding its manufacturing plant, which requires an investment of
P4,000,000 in new equipment and plant modifications. Young’s Town sales are expected to
increase by P3,000,000 per year as a result of the expansion. Cash investment in current
assets averages 30% of sales; accounts payable and other current liabilities are 10% sales.
What is the estimated total investment for this expansion?

25. The Mega 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
26. For P450,000, Fresca 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 P160,000
Second year 140,000
Third year 180,000
Fourth year 120,000
Fifth year 100,000
Fresca will use the sum-of-the-years-digits’ method to depreciate the new machine as
follows:
First year P150,000
Second year 120,000
Third year 90,000
Fourth year 60,000
Fifth year 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 – 0.8928, Period 2 - 0.79719, Period 3 - 0.71178, Period 4 - 0.63552,
Period 5 - 0.56743
Had Fresca used straight-line method of depreciation, what is the difference in net present
value provided by the machine at a discount rate of 12 percent?
27. A project has a NPV of P15,000 when the cutoff rate is 10%. The annual cash flows are
P20,505 on an investment of P50,000. the profitability index for this project is
A. 1.367
B. 3.333
C. 2.438
D. 1.300

28. Ligo Company is planning to invest P80,000 in a three-year project. Ligo’s expected rate of
return is 10%. The present value of P1 at 10% for one year is .909, for years is .826, and for
three years is .751. The cash flow, net of income taxes, will be P30,000 for the first year
(present value of P27,270) and P36,000 for the second year (present value of P29,736).
Assuming the rate of return is exactly 10%, what will the cash flow, net of income taxes, be
for the third year?
29.

5Five5 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
30. Iska Morena plans to buy a haymaker. It costs P175,000 and is expected to last for five
years. She presently hires 6 workers at P10,000 per month for each of the three harvesting
months each year. The equipment would eliminate the need for two workers. Morena uses
straight-line depreciation and projects a salvage value of P25,000. Her tax rate is 25% and
opportunity cost of funds is 12.0%. The present value of 1discounted at 12 percent at the
end of 5 periods is 0.56743 and the present value of an annuity of 1 for 5 periods is 3.60478.
Which of the following is true?
A. The present value of cash flows in year 5 is P22,710
B. NPV is P28,436
C. NPV is P15,250
D. NPV is P14,186