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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES COLLEGE OF ACCOUNTANCY ACCO 4053 - Synthesis 4, Integrated Course in Management Advisory Services February9, 2013 CAPITAL BUDGETING THEORY 1. 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. 2. The “inflation element” refers to the A. Impact that future price increases will have on the original cost of a capital expenditure. B. Fact that the real purchasing power of a monetary unit usually increases over time. C. Future deterioration of the general purchasing power of the monetary unit. D. Future increases in the general purchasing power of the monetary unit. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient. This equipment has an estimated useful life of six years. As part of this acquisition, a P150,000 investment in working capital is required. In a discounted cash flow analysis, this investment in working capital should be A. Amortized over the useful life of the equipment. B. Disregarded because no cash is involved. C. Treated as a recurring annual cash flow that is recovered at the end of six years. D. Treated as an immediate cash outflow that is recovered at the end of six years. To approximate annual cash inflow, depreciation is A. Added back to net income because it is an inflow of cash. B. Subtracted from net income because it is an outflow of cash. C. Subtracted from net income because it is an expense. D. Added back to net income because it is not an outflow of cash. In capital expenditures decisions, the following are relevant in estimating operating costs except A. Future costs. B. Cash costs. C. Differential costs. D. Historical costs. Which of the following best identifies the reason for using probabilities in capital budgeting is A. Different life of projects. C. Uncertainty. B. Cost of capital. D. Time value of money. In capital budgeting decisions, the following items are considered among others: 1. Cash outflow for the investment. 2. Increase in working capital requirements. 3. Profit on sale of old asset 4. Loss on write-off of old asset. For which of the above items would taxes be relevant? A. Items 1 and 3 only. C. All items. B. 8. Items 3 and 4 only. D. Items 1, 3 and 4 only. Your company is purchasing a transport equipment as part of its territorial expansion strategy. The technical services department indicated that this equipment needs overhauling in year 4 or year 5 of its useful life. The overhauling cost will be expected during the year the overhauling is done. The finance officer insists that the overhauling be done in year 4, not in year 5. The most likely reason is A. There is lower tax rate in year 5. B. There is higher tax rate in year 5 C. The time value of money is considered. D. Due statements A and C above. An optimal capital budget is determined by the point where the marginal cost of capital is A. Minimized. B. Equal to the average cost of capital. C. Equal to the rate of return on total assets. D. Equal to the marginal rate of return on investment. 9. 3. 10. The following statements refer to the accounting rate of return (ARR) 1. The ARR is based on the accrual basis, not cash basis. 2. The ARR does not consider the time value of money. 3. The profitability of the project is considered. From the above statements, which are considered limitations of the ARR concept? A. Statements 2 and 3 only. B. Statements 3 and 1 only. C. All the 3 statements. D. Statements 1 and 2 only. 11. The payback method assumes that all cash inflows are reinvested to yield a return equal to A. the discount rate. B. the hurdle rate. C. the internal rate of return.D. zero. 12. As a capital budgeting technique, the payback period considers depreciation expenses (DE) and time value of money (TVM) as follows: A. B. C. D. DE Relevant irrelevant Irrelevant relevant TVM Relevant irrelevant Relevant irrelevant 13. The bailout payback period is A. The payback period used by firms with government insured loans. B. The length of time for payback using cash flows plus the salvage value to recover the original investment C. (a) and (b) D. None of the above. 14. Which of the following methods measures the cash flows and outflows of a project as if they occurred at a single point in time? A. Cash flow based payback period. C. Payback method. B. Capital budgeting. D. Discounted cash flow. 15. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital 4. 5. 6. 7. 1|Page Risk-free rate. B. Residual sales value of project Exclude Include Exclude Include Depreciation expense Include Include Exclude Exclude 27. Less than the amount of investment C. Discount rate. B. Equal to the amount of investment B. Uses a discount rate that equates the discounted cash inflows with the outflows. D. C. Which of the following combinations is NOT possible? Profitability Index NPV IRR 2|Page . The cash flows are extended over a longer period of time. The amount of cash flows relating to the project. C. Cutoff rate. I only. 26. 29. Cost of capital. that is. D. C. Cannot be determined 18. Polo Co. Uses discounted cash flows whereas the internal rate of return model does not. B. B. C. Which of the following would cause the project to look less appealing.budgeting project. C. D. List A Greater than Greater than Equal to Equal to List B Increase Decrease Increase Decrease 21. The cost of equity financing. II Emphasis on cash flows. C. Net present value B. Payback period. A company had made the decision to finance next year’s capital projects through debt rather than additional equity. Internal Rate of Return Net Present Value Yes No No Yes No No Yes Yes 30. More than the amount of investment D. is normally affected by the A. C. B. III Recognition of the time value of money. Computes a desired rate of return for capital projects. D. which of the following factors generally is not important? A. I and II. The discount rate that equates the present value of the expected cash flows with the cost of the investment is the A. B. The timing of cash flows relating to the project. D. must at least be A. 25. You have determined the profitability of a planned project by finding the present value of all the cash flows from that project. 16. 19. The method of financing the project under consideration. The excess present value method is anchored on the theory that the future returns. D. Proceeds from the sale of the asset to be replaced. The weighted-average cost of capital. Accounting rate of return D. expressed in terms of present value. Results in higher estimate for the IRR on the investment. The cash flows are accelerated and the project life is correspondingly shortened. Net present value B. Projects extending beyond 5 years must earn a higher specified rate of return. The benchmark cost of capital for these projects should be A. 28. When using the net present value method for capital budgeting analysis. D. Which of the following capital budgeting techniques can readily accommodate this requirement? A. Which of the following characteristics represent an advantage of the internal rate of return techniques over the accounting rate of return technique in evaluating a project? I Recognition of the project’s salvage value. A project’s net present value. Amount of annual depreciation on the asset to be replaced. II.D. B. II and III. Required rate of return. D. Opportunity cost. The before-tax cost of new-debt financing. Hurdle rate. Will result in inconsistent errors being made on estimating NPVs such that project cannot be evaluated reliably. Amount of annual depreciation on fixed assets used directly on the project. C. Payback C. Is done because present value tables for continuous flows cannot be constructed. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost. C. requires higher rates of return for projects with a life span greater than 5 years. the value of the firm and the price of its common stock will <List B> A. A. Carrying amount of the asset to be replaced by the project. The investment cost decreases without affecting the expected income and life of the project. B. D. and III. The common assumption in capital budgeting analysis is that cash inflows occur in lump sums at the end of individual years during the life of an investment project when in fact they flow more or less continuously during those years A. B. 23. C. I. 24. Cost of capital 17. B. ignoring income tax considerations. C. The discount rate increases. D. Results in understated estimates of NPV. In an investment in plant the return that should keep the market price of the firm stock unchanged is A. A. The impact of the project on income taxes to be paid. Opportunity cost of capital. The after-tax cost of new-debt financing. 20. Internal Rate of Return C. All of the following refer to the discount rate used by a firm in capital budgeting except A. Discounted rate of return D. D. An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the net present value method A. B. B. have a lower present value? A. Can be used when there is no constant rate of return required for each year of the project. How are the following used in the calculation of the internal rate of return of a proposed project? Ignore income tax considerations. the required rate of return is called all of the following except the A. C. 22. an increase in investment cost. it would also be acceptable under the payback approach. A ranking procedure on the basis of quantitative criteria may be established by specifying a minimum desired rate of return.000.000. 38. B. the net present value method will provide a ranking of the projects that is superior to the ranking obtained using the internal rate of return method. Which mutually exclusive project would you select. increasing. That generates cash flows for the longer period of time. D. The NPV and payback approaches will always rank projects in the same order. C. $25. D.000. C. a remaining useful life of 5 years. which rate is used in calculating the net present value of each project. 32. 34. hence you are indifferent. $92. an increase in investment cost. a decrease in investment cost. The NPVs are equal. C. a decrease in investment cost. In ranking these projects.A. D. Which one of the following is considered a ranking method rather than a screening method? A. C. D. Above. B. $100. What is the effect of changes in cash inflows. with 3 years of zero cash flow followed by 3 years of $1. The lower the index. D.000. B. Above. investment cost and cash outflows on profitability (present value) index (PI) A. PI will increase with an increase in cash inflows. profitability index (PI). or an increase in cash outflows. B. A. the higher the rate. C. Project A with three annual cash flows of $1. C. D. Information relating to the company and the investments follow: Fisher rate for the three projects 7% Cost of capital 8% Based on this information. $80. That has the greater accounting rate of return. C. none of the projects are acceptable. Project B. net present value. increasing. If the net present value method is used.000 B. Whose net after-tax flows equal the initial investment. B. B. D. The machine has a current market value of $100. In selecting the required rate of return.500 annually? A. When ranking two mutually exclusive investments with different initial amounts. 39. and simple accounting rate of return (SARR) are some of the capital budgeting techniques. B. The IRRs are equal. A. D. The existing machine has a current market value of $400. Which of the following would decrease the net present value? A.000. What is the cash flow from selling the machine if the tax rate 40%. That has the greater profitability index. D. C. C. D. Payback period (PP). Which of the following is always true with regard to the net present value (NPV) approach? A.0 million. have a 5-year 3|Page . 37.000 2 Hatchet Company is considering replacing a machine with a book value of $400. it would also be acceptable under the internal rate of return (IRR) approach. The company uses a discount rate of 12%. the least pertinent is this statement. Below.000 D. If the internal rate of return method is used in the capital rationing problem. B. D.000 C. If a project is found to be acceptable under the NPV approach. B. Net present value. the capital budgeting evaluation techniques profitability index. C. hence you are indifferent. decreasing. if both are priced at $1. Greater than 1 Equals 1 Less than 1 Less than 1 Positive Zero Negative Positive More than cost of capital Equals cost of capital Less than cost of capital Less than cost of capital A. Acme is considering the sale of a machine with a book value of $80. Increase discount rate to 15%. or Project B. Time-adjusted rate of return.000 and 3 years remaining in its useful life. PROBLEMS 1. 36. The project has a life of 7 years with salvage value of P200. Project A. the profitability index is calculated to rank the projects.000 and your discount rate is 15%. The NPV and the IRR approaches will always rank projects in the same order. and internal rate of return will provide a consistent ranking of the projects.000. It should consider each project whose internal rate of return is _____ its marginal cost of capital and accept those projects in _____ order of their internal rate of return. What is the effect of an increase in the cost of capital on these techniques? A. Accounting rate of return. Below. C. Straight-line depreciation of $25. or a decrease in cash outflows. If a project is found to be acceptable under the NPV approach. or a decrease in cash outflows. Decrease the initial investment amount to P9. 40. A company is evaluating three possible investments. Profitability index. PI will decrease with an increase in cash outflows. Velasquez & Co. the better the project. PI will increase with an increase in cash inflows. decreasing.000. and annual straight-line depreciation of $80. 31.000. the better the project. B. we know that A. B. PP Increase No change No change Decrease PI Decrease Decrease Increase No change SARR Increase No change Decrease No change 35. Extend the project life and associated cash inflows. PI will decrease with an increase in cash inflows. is considering an investment proposal for P10 million yielding a net present value of P450.000 annually is available. Increase the salvage value. all three projects are acceptable. one may either calculate the organization’s cost of capital or use a rate generally acceptable in the industry. Capital budgeting methods are often divided into two classifications: project screening and project ranking. The replacement machine would cost $550. or an increase in cash inflows. each of which has its own internal rate of return. management should give first priority to the project A. Several proposed capital projects which are economically acceptable may have to be ranked due to constraints in financial resources. A company has analyzed seven new projects. 33. for two years is The cost of capital is 12%.000. 4. but it would be zero after 5 years. P52.130 6. 24.000 per year.000 six years ago with a new one that would cost P2. P7.250. 5% B.000. Its disposal value now is $5.000 which will reduce income taxes of P400.250. for the third 4|Page .600.534) for the second year. Outflow of P6. what is the present value of the working capital cash flow expected to be received in year 10? A. the trade-in transaction will not have any implication but the cost to repair is tax-deductible. 3. it needs to repair the old one at a cost of P200. is considering replacing an old press that cost P800. 10.000 (after-tax). 40.500.000 (present 14% is 3. Maxwell Company has an opportunity to acquire a new machine to replace one of its present machines.120 8. Lyben Inc.000 B.4331. The net present value factor for five (5) years at 12% is 3.200 B. D.000 per year in cash operating costs.6048 and at 0.000. $23. The internal rate of return for this investment is value of P16. The cash flow. Additional gross working capital of P12.000 Expected economic life in years 5 Net income P 20.000 will be needed to support operation planned with the new equipment. The cash inflows A company is considering putting up P50. The applicable tax rate is 35%. The loss on retirement of these other assets is P1.000 increase 11.00 at 12% for one year is 0.000 C.000 with freight and installation costs amounting to P1. the cash flow. repair of the old unit will have to be made at an estimated cost of P4. To do this. The effective corporate tax rate is 35% of net income subject to tax.375 9.8% D. P16.000 C. B.392 D. The estimated income and costs based on expected sales of P10.00 per unit 80. Acquisition cost is P450. 2.000. $35.000. $9.000.000. 15% D. net of income taxes will be P18. 13. $23.48% Assuming that the rate of return is exactly 12%.000 Costs @ P8. The working capital would be liquidated at the end of the project's 10-year life.000 the equipment are as follows: units per year are: Original investment $30. have a 5-year life.600 C.356 C.000 per year for five years with no equipment salvage value. If White Corp. The net investment assigned to the new machine for decision analysis is A.000 Sales @ P10.181 B. $150. 20% A. plans to replace a production machine that was acquired several years ago.074) for the first year and P22. 22. faces a marginal tax rate of 35 percent. At the end of the ten years. The machine being considered is worth P800.425. For purposes of capital budgeting.life. and for three years is 0. One project that is currently under evaluation has a cash flow in the fourth year of its life that has a present value of $10. What will be the accounting rate of return based on initial investment of P100. P10. the machinery must be disposed of with a zero net book value but with a scrap salvage value of P20.000 D.000. would require a working capital investment of $200. A project under consideration by the White Corp.100 C.000.000 and the supplier is willing to accept the old machine at a trade-in value of P60.868 B. C Corp.893. Variable operating costs would be $100. P610.000 to remove the machinery. $330. decrease its selling price of the new product by 10%? assuming no taxes are paid? A. A. MLF Corporation is evaluating the purchase of a P500. 12.000. Other assets that are to be retired as a result of the acquisition of the new machine can be salvaged and sold for P3.000 C. If the new equipment is not purchased.868 D.000 Great Value Company is planning to purchase a new machine costing P50. and save $75. 20. Considering the 5 years in total.0% B.500.000 (present value of P17. The increased production of the new press would increase inventories by P40. B. the net investment in the new machine is A. Data on years with no salvage value. This cost can be avoided by purchasing the new equipment. $53.797.04% C.Outflow of P10. $40.45% B.600 D. 15.000.000 C.000 Salvage value at the end of five years $3. has an after-tax cost of capital of 10 percent and a marginal tax rate of 30 percent.712. and no estimated salvage value. Shipping and installation would cost an additional P200. The estimated life of the new equipment is five Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. 5. P2. If the replacement machine would be depreciated using the straight-line method and the tax rate is 40%. Inc. P540. What is the pre-tax amount of the cash flow in year 4? (Round to the nearest dollar.00 per unit P100.000 The accounting rate of return based on initial investment is 20% The company uses the straight-line method of depreciation with no mid-year convention. C Corp. is planning to produce a new product. net of income taxes.000.000.000 Net annual cash inflow $12.000 and could be sold currently for P50. Tax-wise.000. The new machine would cost $90. $90.000 per year.000. accounts receivable by P160.000 decrease B.000 in a three-year project. Inflow of P30. what would be the net investment required to replace the existing machine? A.000 and a remaining life of 5 years. Diliman Republic’s net initial investment for analyzing the acquisition of the new press assuming a 35% income tax rate would be A.000.000 and accounts payable by P140. Outflow of P17.0% D. 10% C.600 year would be A.000 Key Corp.450.000 D. Diliman Republic Publishers. $550. It will require some P30.000 D.000 decrease C. P2.970 D. The appropriate “end -of-life” cash flow based on the foregoing information is A. $15. The old press has a book value of P150. P57. The company’s expected expected from the investment is P145.000.0% 13. P2. Ignore income taxes. B. P50. $15. P660.000 increase D. it is necessary to acquire a new equipment that will cost the company P100. P2.000 B. what would be the difference in profit before income taxes by acquiring the new machine as opposed to retaining the present one? A. The present value of P1. $77. $36.000 with salvage value of P50.0% C. P800. C.000.000 die attach machine.000 if management What is the accounting rate of return on original investment rounded off to the nearest percent.500. rate of return is 12%. 7. The old unit is to be traded-in will be given a trade-in allowance of P7. P23. $10. The present machine has a book value of $50. $43.000. assumes that all cash flows occur at the end of the year and the company uses 11 percent as its discount rate.) A. P53.022 Lor Industries is analyzing a capital investment proposal for new machinery to produce a new product over the next ten years. Variable operating costs would be $125.000 3. Should the company decide not to acquire the new machine. 019. The variable cost is $7.000 in annual cash flows for a period of four years. 2. $21.550. $147.000 24. is considering an investment in a project that generates a profitability index of 1. with an estimated useful life of 5 years and a salvage value of $10. Assume Drillers employs straight-line depreciation on all depreciable assets. Savings are expected from the use of machine estimated at P170.'s cost of capital is 12 percent. of $36. The investment is expected to generate $350. The McNally Co. no C. and assume that they are taxed at a rate of 36%. The Salvage Co.000. $88.0000 in years 3 and 4. excluding depreciation. No. B. What is the net present value of this project? A. since the payback period is 3.000 B. since the payback period is 4 years and still shorter than the useful life of the project. since the payback period extends beyond the life of the project.862 2 0.500 a year of the last three years of the payback period. Etc.2 years. 1. It uses 16% as hurdle rate in evaluating capital projects.200 C. $0 C. The present value of the cash inflows on the project is $44. D.14. plans to replace its old sing-along equipment.225. $55. the firm is uncertain as to whether it has determined a reasonable estimate of the salvage value of the truck. P24. What is the present value of all the relevant cash flows at time zero? A. How much shall the machine cost? A. The new machine’s salvage value is $20.246 5|Page .000 Annual operating costs 56. The firm's discount rate is 8 percent. between 6 and 7 years D. B. Sweets. the ship will have no value and will be sunk in some already polluted harbor.000) D. It has an estimated useful life of 3 years. between 5 and 6 years C. However. 16.000. If the ship produces equal annual labor cost savings over its 10-year life. Below are the projected after-tax cash inflow for the five year period covering the useful life. The company’s tax rate is 35%. $57. Cramden Armored Car Co. 3.000. $69.743 1.000 at the end of its economic life.000 D.000 units a year for 5 years.000 Current salvage value 10. The device will be sold for a price of $12.000) C.000. (P124. (P54. what is the approximate NPV of the project? A. $42. $26. Tropez Co. The project would generate annual cash inflows of $75. Assume that 30% of the depreciable base will be depreciated in the first year. Should the company proceed with the P320. The machine is expected to have zero value at the end of the four-year period.154 C. net of income taxes.700) 18. D. Womark Company purchased a new machine on January 1 of this year for $90.000 and would have no salvage value. Drillers Inc. yes D.000 B.117. since the payback period is 4 years or 80% of the useful life of the project. $56. The old machine can be sold for $50. $114. How many years must the annual cash flows be generated for the project to generate a net present value of $0? A. The new machine is expected to produce cash flow from operations.300 Estimated useful life 10 years 10 years The company’s income tax rate is 35% and its cost of capital is 12%. is evaluating a project to produce a high-tech deep-sea oil exploration device.780. A. C. P36.492 B.. $33. is considering the acquisition of a new armored truck. is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.000. $1. and its marginal tax rate is 40 percent. $119.022. Year 1 2 3 4 5 P’000 600 700 480 400 400 The founder and president of the candy company believes that the best gauge for capital expenditure is cash payback period and that the recovery period should not be more than 75% of the useful life of the project or the asset.55 years or 71% of the useful life of the project. the company assumed that the truck would be salvaged at the end of the fifth year for $60. Should the company undertake the project? A.000 and would be fully depreciated by the straight-line method over 10 years.) A.000 a year in each of the next 5 years.000 a year shall be charged to income of the six years of the payback period. $30. is planning to purchase a new machine that will take six years to recover the cost.500 a year for the first three years of the payback period and P3. no 23.000 Accumulated depreciation 55.000 P120.000 38. $68. Yes. Depreciation of P3. and $15. Salvage Co. Inc. $10.000 16. It is the start of the year and St. The new ship would cost $500. P18. P12.750. yes B.846 22. (P110.000 D.200 D.000) B. $326. In computing the net present value. What will be the bailout period (rounded) for the new machine? A. APJ. The machine will be depreciated using the straight-line method.000 Salvage value.4 years.000 C.000 in years 1 and 2.978 19.000 capital investment? Year Present Value of P1 Present Value of an Ordinary Annuity of P1 1 0.492 D. The truck is expected to cost $300. $13. The investment required is $80 million for a plant with a capacity of 15. are $25 million per year.000 per unit. Yes.550. plans to undertake a capital expenditure requiring P2 million cash outlay.3.154 B. C. The company's discount rate is 12 percent.550. Booker Steel Inc.278 D. It has a resale value of P20. The firm has determined that the truck generates a positive net present value of $17. At the end of 10 years. net of income taxes. If the required rate of return is 12%. and 30% in the third year.4 years.605 3 0.000. end of useful life 2. $17.487 21. The company has an effective tax rate of 40%.641 2.9 years. The machine is expected to produce cash flow from operations. how much do the annual savings in labor costs need to be to generate a net present value of $0 on the project? (Round to the nearest dollar. 17.000.862 0. What is the net present value of the investment? Would the company want to purchase the new machine? Income taxes are not considered. JJ Corp. of P4. Inc. 40% in the second year.511. Sales are expected to be 12. between 7 and 8 years B. 1.000.000 annually. The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $950.000 C. (P120.000. What expected salvage value for the truck would cause the investment to generate a net present value of $0? Ignore taxes. The required rate of return is 14%. A.000 units per year. These information are available: Old New Equipment cost P70. is considering an investment that would require an initial cash outlay of $400. is considering the purchase of a new machine that will cost P320.000 B. between 8 and 9 years 20. No.000 and fixed costs.000 15. P5. The company's cost of capital is 11 percent for average projects.000 Market share.801 34. due to NPV of P11.57 What would be the annual savings needed to make the investment realize a 12% yield? A.and low-risk projects.000 C. such as Baton Rouge and Gainesville.. The investment is expected to generate $250.000 6|Page .85498.000 more cash flow in year one and a P110. The machine is expected to provide 15% internal rate of return. and will produce cash flows of $28.000 10. 16% C. If Rohan Transport's cost of capital is 17 percent. The copier machine will be expected to be economically productive for 4 years. $12. Inflation is not expected to affect either costs or revenues during the next 8 years. A.000 140. millions $7 $4 $3. which is of average risk. The company is subject to 40% income tax rate.350 B. -$17. Disposal value after 8 years – nil. The present value of an ordinary annuity of 1 for 4 $50.000 10. $8. The Zeron Corporation recently purchased a new machine for its factory operations at a cost of $921. $5.109 D. 14. 17% D. 15.33% C.000 10.344 D. P15.000 per year for 4 years.60 Present value of 1 due in 5 years at 12% 0. The required rate of return is 14%.000.5% thereafter. MCC increases . P6.000 90. $1.61% 31. due to NPV of P61. $8.000 13.505 C.000 D. P17. 15% B.5% E $400. Rohan Transport is considering two alternative buses to transport people between cities that are in the Southeastern U.000.0% What should the company's capital budget be? A. B. $1.000 in annual cash flows for a period of six years.0 years.54% D. The company must provide bus service for 8 years. whose management is planning to purchase an automated tanning equipment. due to NPV of P6. has an initial cost of $10 million. D. Yes. The following data pertain to Sunlight Corp.000 C. $1. 16. P35. The new machine is expected to have zero value at the end of the six-year period. $2.85734. Find the required increase in annual cash inflows in order to have the time-adjusted rate of return approximately equal the cost of capital. P4.5 Assume that Oxford employs straight-line depreciation. the first machine has P155. The present value of 1 at 8% end of period 1 is 0. 1. is reviewing the following data relating to an energy saving investment proposal: Cost Residual value at the end of 5 years Present value of an annuity of 1 at 12% for 5 years 3. 4. 18. The following forecasts have been prepared for a new investment by Oxford Industries of $20 million with an 8-year life: Pessimistic Expected Optimistic Market size 60. $10. has an initial cost of $5 million. and its operating cost will be $1 million per year for its 10-year life.000 per year for 8 years.050. at 16% = 4. The first machine costs P50.136 periods is 2.000. and that rate is normally adjusted up or down by 2 percentage points for high.000 D. which is a high-risk project. Economic life of equipment – 8 years.700 29.500.000 14.820. due to negative NPV of P1. Time-adjusted internal rate of return – 14% 5. 9% B.0% C $450. Assuming an opportunity cost of capital of 14%. 12% 32. Smoot Automotive has implemented a new project that has an initial cost. 10% C.639.684. 18% 33. based on expected outcomes? A.A. and then generates inflows of $10.563. % 25 30 35 Unit price $750 $800 $875 Unit variable cost $500 $400 $350 Fixed cost. how much is the estimated before-tax cash inflow to be provided by the machine? A. Clean-Up Plan A. Yes. The present value of 1 at 15% end of 1 period and 2 periods are 0.055. No.701 D.8% D $350. The salvage value at the end of 4 years is negligible. P5.000 26.970 annually. All cash flows occur at year-end. C. The old machine has a remaining life of six years.250. What is the internal rate of return? A.189 B.000 12. Depreciation is approximately P46. and its annual operating cost over Years 1 to 10 will be $2 million. Union Electric Company must clean up the water released from its generating plant.501 B. The table of present values of P1 received annually for 8 years has these factors: at 14% = 4.92593 and period 2 is 0. respectively.722 27.000 more than the second machine. Several proposed capital projects are under consideration.306 D. A new electric bus will cost $90.556. A gas-powered bus has a cost of $55. The project has a payback period of 4.626. $6.860 B.441 C. and will produce end-of-year net cash flows of $22. with projected cost and internal rates of return (IRR) as follows: Project Cost IRR A $100. During the two-year life of these two alternatives. 11% D. A company's marginal cost of new capital (MCC) is 10% up to $600. after which it plans to give up its franchise and to cease operating the route. Plan B. $27.86957 and 0.600.S. What is the project's internal rate of return (IRR)? A. $13. What is the approximate PV of costs for the better project? (VD) 25. Berry Products is considering two pieces of machinery. Yes.871 28. $4. At what discount rate would Machine 1 equally acceptable as machine 2? A.501 C. Cost of capital of Sunlight Corp – 16% 6.. Estimated net annual cash inflows for each of the 8 years – P81.722. $11.415 B.75614.344 7. 2. what is the NPV of this project. 3. $0 B.000 less cash flow in year two than the second machine.000.000 a year for the next seven (7) years. P25.000 and another . The disposal value of the old machine at the time of replacement is zero.79% B. Payback Company is considering the purchase of a copier machine for P42. and that they are taxed at 35%. by what amount will the better project increase the company's value? A.111 C.889 30. In order to realize the IRR of 15%.5% B $300.5% for the next $400. Para Co.825. 000 8. A B.000 22.000 B. What is the net present value of the proposed investment. Information on three (3) investment projects is given below: Project Investment Required Net Present Value X P150.35% B 500. C. Questions 43 and 44 are based on the following information.30 Your advice is A. The construction of a waste treatment plant was arrived at after a careful cost-benefit analysis. Proposal 1 because it has the highest profitability index.000.750. 41. while the present value of an ordinary annuity of P1 is P5. The flotation costs associated with issuing new equity are $2 per share. P69. assuming Daneche uses a 12% discount rate? A. B. and the current stock price is $40 per share.50. 2nd G.8 million.602 Rank the projects in terms of preference: A. is considering the following five independent projects: Project Required Amount of Capital IRR A $300. The new machine will cost P200. D.000 10% 39.550 4.000) 4. Daneche’s. Mulva's earnings are expected to continue to grow at 5 percent per year. What proposal(s) should be accepted? A. To proceed due to an estimated IRR of less than 14% but not more than 12%.980 C. B B $(200) 8% C. To facilitate computations. Daneche's cost of capital is 12%. 25% D.000 and is expected to generate cash savings of P60.000 25. B.000 2 1.60 3. PI B Either Either B NPV A B A B 38. 42.08 150. Mulva Inc. What is the size of Mulva's capital budget? A. 3rd X. C.10% D 550. The ranking is the same.52 0.40 3. 2nd G. P185. -$15.000 D.200.000 per year in operating costs. Problem 41 and 42 are based on the following information. 3rd W. Proposals 1 and 2 because their total net present values are the highest among all possible proposal combinations. None of the above.640 B.450 11. 1st X. C.15 P200. the accounting rate of return is A. D. Not to proceed due to an estimated IRR of less than 12%. None of the above. -$5. $2.670 W 60.000 36. The foundation estimates that the annual savings from the project will amount to P325. With the company’s initial investment on the new machine. Next year's dividend (D1) is forecasted to be $2.11 175. 2nd W.3220. To proceed due to an estimated IRR of more than 16%. During the construction period a status report was presented for your review: Which of the projects will be selected using the profitability index (PI) approach and the NPV approach? A. 35. The P1 million asset is depreciable over five (5) years on a straight-line basis.650. To proceed due to an estimated IRR of less than 16% but not more than 14%. D.005 G 100. A tax-exempt foundation. Proposals 2 and 3 because their total net present values are the highest among all possible proposal combinations.48 Present value of an annuity of P1 3. 20% C.000 3 1. Proposal 4 because it has the lowest profitability index.50% The company has a target capital structure which is 40 percent debt and 60 percent equity. The company can issue bonds with a yield to maturity of 10 percent.000) 13.000 C.A. $1. Five mutually exclusive projects had the following information: 7|Page .000 13.650 12.000 9. C.57 0. B.22% C 400. Inc. The foundation’s hurdle rate is 12% and as a consultant of the foundation. C D C $200 13% D $1.400. -$16. The company has $900. $800. -$17.000 P34.000 4 1.9 million. intends to invest P1 million in a five-year project. D. D. 15% B. P139. below are present value factors: N=5 12% 14% 16% Present value of P1 0. $1. The following data relate to two capital-budgeting projects of equal risk: Present Value of Cash Flows Period 0 1 2 3 Project A $(10. B. 1st W.000.000 19.000 D. Sincerely Foundation. a tax-exempt entity.750 Project B $(30.250 A NPV $500 IRR 12% Which project is preferred? A. 1st G.9 million. The firm faces a 40 percent tax rate. 40.13 125.25% E 650.150 3.8 million. For ten periods at 12%. B. you are asked to determine the internal rate of return and advise if the project should be pursued.000 23. C.000 The firm has a budget constraint of P300. the present value of P1 is P0. D. 37. The Nativity Corporation has the following investment opportunities: Proposal Profitability Index Initial Cash Outlay 1 1. plans to purchase a new machine which they project to depreciate over a ten-year period without salvage value. 3rd X.000 in retained earnings. 17 years C. The old car has a book value of P15. 4 years.25 54.250 D. The firm’s tax rate is 25% and requires a return of 10%.25 C. 5. Payback results only D. net cash flow are listed below.000 P30.000 P40.850 B.14 P(15. B.7% Excess present value index 1.000 46.683 48.98 C. 65% actual cost to date. D. Income tax rate is 25%. The acquisition of the new car will yield annual cash savings of P20. Projects L & N. P5 million plus a cost overrun of about P769. Recommend immediate review with the project implementation team to determine the cause of overrun and the corrective actions to be taken. D.11 years D. Projects M & N. 1. The present value of year two’s cash flow is A.75 D. P25.5 years D.747. how much will the completion cost be most likely? A. completed cost as originally estimated. P35. 1. C. It has a life of four years and will be depreciated on a straight-line basis (no salvage value). The net investment of the new car is A.856.000. The company’s desired after-tax opportunity costs is 12%.450 49.654 17. Accounting rate of return and profitability index results. a and b combined 8|Page .000 and can be sold at P12. The net cash flow for year 1 is A. Assuming cost is evenly distributed throughout the construction period.666 17. 5. C.6% 0. P500.750 C. and O. P34.02 D.000 and its estimated useful life is five years without scrap value. About P100. What would be an appropriate action to take considering the situation in number 28? A. The profitability index of the project (rounded to the nearest hundredth) is A. P36.05 55.250 D.75 D.6% 1. 3 years B. P30. B.850 B. The payback period of the investment is (M) A.14 years B. P101.18 years C.150 D. 3. P59. 0. is contemplating four projects: L. M. N. D.000 B.000 less than the original cost at completion. 5. Projects M. 9% C. 3. P98. P28. P104.000 The present value factors for P1 at 10% is Year 1 2 3 4 Present Value Factor 0. In Thousand Pesos O L M N Initial cost 400 470 380 420 Annual cash flows Year 1 113 180 90 80 2 113 170 110 100 3 113 150 130 120 4 113 110 140 130 5 113 100 150 150 Net present value P7.863.02 The company will choose A.13 P54.000 capital budget for the year. The project would be accepted on the basis of the A.750. P108. P5 million % of actual completion to date. P29. P95. It has P900. Wait for the next quarterly status report on the project.750. It requires an immediate cash outlay of P100. Immediately stop further work on the project. 5. P107. The capital costs for the initiation of each mutually-exclusive project and its estimated after-tax. 7% B.751 0. P35.75 million 43.96 Questions 48 through 55 are based on the following information. The original cost estimate of P5 million.750 C. P23.100.15 B. P26. Idle funds cannot be reinvested at greater than 12%. B. Income before depreciation is projected to be: YEAR 1 2 3 4 Income before depreciation P30.826 0.50 B.909 0. 15% 52.75 53. The payback period for the project is A. Projects L & M.000 above the original cost at completion.095 years 47.540 Internal rate of return 12. P108.96 B. The present value of the project’s net cash flow is A.000 before income tax. 0. C. Telephone Corp. The accounting rate of return of the project is A. (M) 45. 51. B. P3.950 C. 12% D.000. P31.000 C.250 50. The Burgos Corporation is considering investing in a project.000 P40. No need to take any action. P25. The new car costs P120. Payback and present value results.2% 1.151. The net cash flow for year 4 is A. P107. 44.650. Questions 45 and 46 are based on the following information.708) 10.25 C. Beta Company plans to replace its company car with a new one. N & O.