Chapter 9

Capital Budgeting - Key

I TRUE OR FALSE

1 TRUE 21 TRUE 41 TRUE

2 FALSE 22 FALSE 42 TRUE
3 TRUE 23 FALSE 43 TRUE
4 FALSE 24 FALSE 44 FALSE
5 TRUE 25 TRUE 45 TRUE
6 TRUE 26 TRUE 46 FALSE
7 TRUE 27 FALSE 47 TRUE
8 FALSE 28 TRUE 48 FALSE
9 FALSE 29 TRUE 49 FALSE
10 TRUE 30 FALSE 50 FALSE
11 FALSE 31 FALSE 51 TRUE
12 TRUE 32 TRUE 52 FALSE
13 FALSE 33 FALSE
14 TRUE 34 TRUE
15 FALSE 35 FALSE
16 TRUE 36 TRUE
17 TRUE 37 FALSE
18 TRUE 38 TRUE
19 TRUE 39 FALSE
20 FALSE 40 FALSE

II MULTIPLE CHOICE QUESTIONS

1 A 16 B 31 B
2 B 17 D 32 C
3 D 18 C 33 D
4 C 19 D 34 C
5 B 20 D 35 C
6 A 21 B 36 C
7 C 22 D 37 A
8 A 23 D 38 D
9 C 24 C 39 B
10 B 25 B 40 A
11 D 26 D 41 B
12 D 27 D 42 A
13 C 28 A 43 D
14 C 29 D 44 C
15 B 30 B 45 C
MULTIPLE CHOICE PROBLEMS
1 C 13 C 25 C
2 B 14 B 26 D
3 B 15 C 27 B
4 D 16 B 28 C
5 C 17 C 29 B
6 B 18 C 30 C
7 B 19 B 31 B
8 D 20 C 32 A
9 D 21 D 33 B
10 B 22 B 34 C
11 B 23 C 35 B
12 C 24 A 36 A

SOLUTIONS TO MULTIPLE CHOICE PROBLEMS

#1 investment years
year recovered unrecovered recovered
at y-0 105,000.00 -
1 50,000.00 55,000.00 1
2 45,000.00 10,000.00 1
3 10,000.00 - 0.25 (P10,000 / P40,000) = .25
2.25 payback
or
2 years + (P105,000 - P95,000) = 2.25 years
P 40,000

#2 Average Net income = P95,000 / 5 years = P19,000

ARR = P19,000 / P105,000 = 18.095 or 18.10%

#3 Total present values of cash inflows

year PV CASH PRESENT
FACTOR FLOWS VALUES
1 0.81 50,000.00 40,500.00
2 0.65 45,000.00 29,250.00
3 0.52 40,000.00 20,800.00
4 0.42 35,000.00 14,700.00
5 0.34 30,000.00 10,200.00
Total present values of cash inflows 115,450.00
Initial investment cost 105,000.00
Net present value 10,450.00

#4 Present value = P56,000 x 2.531 = 141,736.00

Initial investment cost 140,000.00
Net present value 1,736.00
#5 Present value 20,000.00 x 2.531 50,620.00
Initial investment 50,000.00
Profitability index P50,620 / P50,000 1.01

#6 PV Factor = Investment / Annual cash flows = P68,337 / P27,000 = 2.531

2.531 is at 9%

#7 Present value = P30,000 x 2.487 = 74,610.00

#8 Payback period = P400,000 / P100,000 = 4 years

#9 Present values = P142,000 x 4.355 = 618,410.00

Initial investment = 600,000.00
Net present value 18,410.00

#10 Accounting Rate of Return (ARR) = P20,000 / (410,000 / 2) = P20000 / P200,000 = 10%

#11 PV Factor = P600,000 / P142,000 = 0.42254

between 4.1111 and 4.3555 approximately 11%

#12 Revenues 90,000.00

Operating costs 38,000.00
Depreciation P320,000 / 8 years 40,000.00 78,000.00
Annual net income 12,000.00
ARR = P12,000 / (P320,000 / 2) = 0.0750

#13 Net income 12,000.00

Depreciation expense 40,000.00
Annual cash flows 52,000.00
Payback P320,000 / P52,000 = 0.6154
or 6.2 years

#14 ARR = Net income / Average investments = P60,000 = 30%

(P300,000 + P100,000) / 2

#15 Average investment = (P80,000 + P4,000 ) / 2 = 42,000.00

#16 year PV Factor at 15% Cash Flows Present Values

1 0.8700 x 100,000.00 = 87,000.00
2 0.7560 x 160,000.00 120,960.00
Total PV of cash inflows 207,960.00

#17 year PV Factor at 14% Cash Flows Present Values

1 0.8800 x 15,000.00 = 13,200.00
2 0.7700 x 15,000.00 11,550.00
3 0.6700 x 10,000.00 6,700.00
Total PV of cash inflows 31,450.00

#18 Payback = P200,000 / P40,000 = 5.00 years

#19 PV of P1 at 12% = P24,600 x 3.605 = 88,683.00

#20 Payback = P600,000 / P225,000 = 2.6667 years

#21 Present value factor = P30,000 / P7,300 = 4.1095

4.231 and 4.111 in between is 4.1095 is at 12%
4.2310 0.12150
4.1095 in between
4.1110 (0.0015)

#22 Present value = P7,300 x 4.355 at 10% 31,791.50

Initial investment 30,000.00
Net present value 1,791.50 1,792.00

#23 Profitability index = P31,792 / P30,000 = 1.0597 1.06

Savings on labor 8,000.00

less, increased in power costs (1,000.00)
net savings 7,000.00
PV of 12% for 10yrs x 5.65
#24 PV of savings = 39,550.00
Less ,Investment costs 30,000.00
#25 Net present value = 9,550.00

#26 Investment / annual cash flow = Factor of Time Adjusted Rate Of Return

P84,900 / P15,000 = 5.660 this is in Table 4 14% 12 years 14%

#27 Return in five (5) years 10,000.00

factor for 12% for 5 yrs at Table 3 0.5670
PV and the maximum amount that the company would be willing to invest. 5,670.00

#28 factor at present

years amount 18% value
a b c d
(b x c)
Working capital now (30,000.00) 1.00 (30,000.00)
cash inflow 1 - 6 years 10,000.00 3.50 34,980.00
working capital released 6 30,000.00 0.37 11,100.00
net present value 16,080.00

#29 P100,000 / P25,000 = 4 years

#30 investment outflow inflows balance

year 1 (50,000.00) (50,000.00)
2 20,000.00 (30,000.00)
3 20,000.00 (10,000.00)
4 (50,000.00) 20,000.00 (20,000.00)
5 20,000.00 -
payback is 5 years or at year 5
#31 Net income = (P30,000 - {P100,000 - P10,000}) = P30,000 - P18,000 = 12,000.00
5 years
AROR = P12,000 / { (P100,000 + P10,000)/ 2 } = 21.81% or 22%

#32 P50,000 x 30% = P15,000

#33 Profitability Index (PI) = PV of cash inflow P50,000 = 1.25

Investment P40,000

#34 Payback = P30,000 / P6,000 = 5 years

#35 Cash flows 6,000.00

Less, depreciation (P30,000 / 5 years) 2,000.00
Net savings 4,000.00 P4,000 / P30,000 = 13.30%

#36 Working capital is an investment not an expense, so no tax adjustment is needed

PROBLEMS

9.1 Cost 475,000.00

Delivery and set up costs 12,500.00
Total investment costs 487,500.00
Average income per year 5 days x 52 weeks x P400 = 104,000.00
Less, Average operating costs per year 5 days x 52 weeks x P25 6,500.00
Cash net income 97,500.00
Less, Depreciation costs (P487,500 - P27,500) / 10 years = 46,000.00
Net income 51,500.00

a Cash payback P487,500 / P97,500 = 5.00 years

b Present values of annual inflows P97,500 x 6.418 10years at 9% 625,755.00

Present values of salvage value P27,500 x .422 11,605.00
Total Present values 637,360.00
Initial cost of investment 487,500.00
Net present value 149,860.00

c Annual Rate of Return P51,500 / [ (487,500 + P27,500 ) / 2 ] =

P51,500 / P257,500 = 20%
9.2 Annual net income 30,000.00
Annual cash flows 78,000.00
Cost of investment 240,000.00
a Payback P240,000 / P78,000 = 3.08 years

b Total Present values P78,000 x 3.791 295,698.00

Initial cost of investment 240,000.00
Net present value 55,698.00

c Annual Rate of Return P30,000 / [ (240,000 + P0 ) / 2 ] =

P30,000 / P120,000 = 25%

9.3 Red Blue

Annual net income 30,000.00 50,000.00
Add, back depreciation Red: P400,000 / 8 yrs = P50,000 50,000.00
Blue : P560,000 / 8 yrs = P70,000 70,000.00
Annual cash flows 80,000.00 120,000.00

a Payback, in years Red: P400,000 / P80,000 5

Blue : P560,000 / P120,000 4.67

b Total present values Red P80,000 x 5.747 459,760.00

Blue P120,000 x 5.747 689,640.00
Initial investment cost 400,000.00 560,000.00
Net present values 59,760.00 129,640.00

c Annual rate of return Net income 1 30,000.00 50,000.00

Average investments (Cost / 2) 2 200,000.00 280,000.00
ARR (1 /2 ) 0.15 0.18

9.4 Net income 64,000.00

Depreciation 52,500.00
Net cash inflows per year 116,500.00
Present value factor at 13% for 12 years 5.9176
Total present values 689,400.40
Initial cost of investment 630,000.00
a Net present values 59,400.40

c Payback P630,000 / P116,500 = 5.408 years

b Internal rate of return

PV Factor = P630,000 / P116,500 = 5.4077
Scanning at 12 year line , 5.4077 is approximately 15%
True rate or exact rate using interpolation is computed as follows
At 14% 5.660 5.660
PV Factor = 5.408
at 16% 5.197
0.463 0.252
Exact rate = 14% + [{.2523 / .463} x 2% ] =
14% + .01089 = 0.15089 15.089%
9.5 Cash flows
year PVF at 12% Cool Hot
Cash flows PV of cash flows Cash flows PV of cash flows
1 0.893 38,000.00 33,934.00 42,000.00 37,506.00
2 0.797 42,000.00 33,474.00 42,000.00 33,474.00
3 0.712 48,000.00 34,176.00 42,000.00 29,904.00
128,000.00 101,584.00 126,000.00 100,884.00
Cost of investments 90,000.00 90,000.00
a Net present values 11,584.00 10,884.00
PV of Hot can be computed at P42,000 x 2.402 = P100,884 also

b Profitability index = PV / Cost 1.13 1.12

c Both are acceptable, however, Cool is preferred as it has higher NPV ang PI

9.6
a Machine 1
Present values (P50,000 - P15,000) x 4.486 = 157,010.00
Cost 152,000.00
Net present values 5,010.00

Machine 2
Present values (P60,000 - P20,000) x 4.486 = 179,440.00
Cost 170,000.00
Net present values 9,440.00

b Machine 1 P157,010 / P152,000 = 1.03

Machine 2 P179,440 / P170,000 = 1.06

c IRR
Machine 1 PV Factor = P152,000 / P35,000 = 4.34 PV Factor at 6 years of 4.355 is at 10%

Machine 2 PV Factor = P170,000 / P40,000 = 4.25 PV Factor at 6 years of 4.231 is at 11%

d Both machines are acceptable

NPV both are positive
PI both are more than 1
IRR both are greater than the minimum required rate of return of 9%

9.7 a 1 Cash payback = P320,000 / P62,000 = 5.16 years

2 Present values P62.000 x 5.535 343,170.00

Cost of investment 320,000.00
Net Present value 23,170.00

3 Profitability index = P343,170 / P320,000 = 1.07

4 Internal rate of return (IRR) = P320,000 / 62,000 = 5.16

5.16 for 8 years is at 11%

5 Annual rate of return (ARR) = P22,000 / [(P320,000 + 0) / 2] = 13.75%

 9.8 a Based on estimates:
Present values P70,000 x 4.355 = 304,850.00
Initial costs 300,000.00
Net present value 4,850.00
accept
b Based on actual:
Present values P58,000 x 5.759 = 334,022.00
Initial costs 340,000.00
Net present value (5,978.00)
reject

9.9 a Present value of annual cash flows = P4,300 x 5.335 22,940.50

Present value of salvage value = P3,000 x .467 1,401.00
Total present values 24,341.50
Cost 25,000.00
Net present value negative - reject (658.50)

b Present value of annual cash flows = (P4,300 + P500) x 5.335 25,608.00

Present value of salvage value = P3,000 x .467 1,401.00
Total present values 27,009.00
Cost 25,000.00
Net present value positive - accept 2,009.00

c Additional benefits would need to have a total present value of at least P658 in order for the van to be purchased.

9.10 a Present value of net cash flows

(P2,520,000 - P2,250,000) = P270,000 x 8.514 = 2,298,780.00
Present value of salvage value = P3,900,000 x .149 = 581,100.00
Total present values 2,879,880.00
Investment costs 2,700,000.00
Net present value 179,880.00

b Present value of net cash flows

(P2,085,000 - P1,875,000) = P210,000 x 8.514 = 1,787,940.00
Present value of salvage value = P3,900,000 x .149 = 581,100.00
Total present values 2,369,040.00
Investment costs 2,700,000.00
Net present value (330,960.00)

c Present value of net cash flows

(P2,520,000 - P2,250,000) = P270,000 x 7.469 = 2,016,630.00
Present value of salvage value = P3,900,000 x .104 = 405,600.00
Total present values 2,422,230.00
Investment costs 2,700,000.00
Net present value (277,770.00)

If # of campers attending each week is only 80, NPV decreases by P510,840, that is from positive P179,880 to a
negative P330,960. Investment should not be made unless attedees is closer to 100.
9.11 a Old loss (2,000.00)
New Net income (loss) Receipts P20,000 x 5% = 1,000.00
Depreciation P12,000 / 10 years = 1,200.00
Net income (Loss) (200.00)
Net difference (1,800.00)

b Payback on the vending machine only P12,000. / P 1,000 = 12 years

relevant payback:
Payback Change in cash flow is P3,000 = salary of employee terminated
P12,000 / P3,000 = 4.00

c
1 Present value of inflows P3,000 x 4.195 = 12,577.50
Cost of investment 12,000.00
Net present value 577.50

2 IRR is approximately 23%

d Present value P3,000 - (P14,000 x 5%) = 11,319.75

Cost 12,000.00
Net present value (680.25)

e Cost P12,000 / 4.1925 = P2,862.25

Receipts = (P2,862.25 - P2,000) / 5% = 17,245.00

9.12 a Revenue 100,000.00

Cash expense 60,000.00
Annual cash inflow 40,000.00

b Present value P40,000 x 4.4941 179,764.00

Cost 160,000.00
Net present value 19,764.00

c IRR factor P160,000 / P40,000 = 4.00 approximately 23%

d Payback = P160,000 / P40,000 = 4 years 4 years

e Profitability index P179,764 / P160,000 = 1.1235

f IRR > than required

PB < than required
depends on which one will be given more weight.
9.13 a Cash payback P262,000 / P42,400 = 6.1792

b IRR at 12 years 6.1793 is approximately 12% 12%

c Present value P42,400 x 6.8137 = 288,900.88

Cost 262,000.00
Net present value 26,900.88

d yes, acceptable

9.14
1 Use table PV of Ordinary Annuity of P1
P200,000 = Annual Payments x the factor at interest rate at 30 years
a AP = P200,000 / 11.2578 17,765.46
b AP = P200,000 / 9.4269 21,215.88
c AP = P200,000 / 8.0552 24,828.68

2 P200,000 = Annual Payments x the factor at interest rate at 15 years

a AP = P200,000 / 8.5595 23,365.85
b AP = P200,000 / 7.6061 26,294.68
c AP = P200,000 / 6.8109 29,364.69

3 a Total payments = 30 x P21,216 = 636,480.00

Total interest paid P636,480-200,000 436,480.00

b Total payments = 15 x P26295 = 394,425.00

Total interest paid P394,425 - 200,000 194,425.00

9.15 a Use table PV of P1

PV of P1 at 12% for 5 years is .5674 The P500 million is the future amount
PV = P500,000,000 x .5674 = 283,700,000.00

b Use table PV of Ordinary annuity of P1. The P100 million is a uniform periodic payment at the
end of series of years. Therefore it is an annuity.
PV of Annuity = P100,000,000 x 3.6048 = 360,480,000.00
In particular, note that Prudential is willing to lend more than in No. 1 even though the interest rate
is the same. Because the company will get its money back more quickly.
9.16 a PV = P30,000 x .6302 18,906.00
b PV = P30,000 x ..4104 12,312.00
c Halves the rates and double the number of periods. Present values decline:
PV = P30,000 x .6246 18,738.00

9.17
a P80,000 = Future amount x .3050 FA = P80,000 / .3050 262,295.08
b P80,000 = Future annual amount x 4.3436 FAA = P80,000 / 4.3436 18,417.90

9.18 List price 42,000.00

Less, Trade in allowance (9,000.00)
Initial cash outlay 33,000.00
Present value of cash operating savings, from 12 year,
PV of ordinary annuity at 12% = P5,000 x 6.1944 30,972.00
Net present value - NPV is negative, do not buy (2,028.00)

The trade-allowance really consists of a P3,000 adjustment of the selling price and a bonafide
P6,000 cash allowance for the old equipment. The relevant amount is the incremental cash outlay
of P33,000. The book value is irrelevant.

9.19 The quickest solution is to get the "net" inflows for each year:
1 End of year Inflows Outflows net flows
1 200,000.00 150,000.00 50,000.00
2 250,000.00 200,000.00 50,000.00
3 300,000.00 250,000.00 50,000.00
4 400,000.00 300,000.00 100,000.00
5 450,000.00 350,000.00 100,000.00

3 payments P50,000 x 2.3216 116,080.00

2 payments P100,000 x 1.6467 x .6750 111,152.25
Total present values 227,232.25
less, initial investment 210,000.00
Net present value 17,232.25
2 The IRR is more than 14%, because the NPV is positive.

9.20 a initial net cash inflows

year investments each year cumulative
0 60,000.00 - (60,000.00)
1 28,000.00 (32,000.00)
2 26,000.00 (6,000.00)
3 24,000.00 18,000.00

Payback period = 2 + ( P6,000 / P 24,000) = 2 + .25 = 2.25 years

 b Net present value
net cash inflows PV Factor
year each year at 12% Present value
0 - - (60,000.00)
1 28,000.00 0.8929 25,001.20
2 26,000.00 0.7972 20,727.20
3 24,000.00 0.7118 17,083.20
net present value 2,811.60

c at a 12% rate, NPV is positive, Therefore, to get an exact IRR, try a higher rate then interpolate.

inflow 14% factor PV at 16% factor PV

28,000.00 0.8772 24,561.60 0.8621 24,138.80
26,000.00 0.7695 20,007.00 0.7432 19,323.20
24,000.00 0.6750 16,200.00 0.6407 15,376.80
60,768.60 58,838.80
initial investment 60,000.00 60,000.00
net present value 768.60 (1,161.20)

at 14% 60,769.00 60,769.00

true rate 60,000.00
at 16% 58,839.00
1,930.00 769.00
True rate = 14% + (769 / 1,930) x 2% = 14% + .8% = 14.8%

d Depreciation per year P60,000 / 3 years = P20,000

Expected Savings in annual operating costs (average)
(P28,000 + P26,000 + P24,000) / 3 = P26,000

(a) ARR on initial investment = (P26,000 - P20,000 ) / P60,000 = 10.00%

(b) ARR on average investment = (P26,000 - P20,000 ) / P30,000 = 20.00%

9.21
Old machine:
Operating cash outflows P50,000 x 3.00 (150,000.00)
Investment in inventories - outflows P200,000 x 1 (200,000.00)
Liquidation value of inventories at terminal date P200,000 x .40 80,000.00
Disposal value of machine * P4,000 x .40 1,600.00
(268,400.00)

New machine
Net cash outlay (P62,000-P15,000) P47,000 x 1.00 (47,000.00)
Operating cash outflows P40,000 x 3 (120,000.00)
Investment in inventories - outflows P160,000 x 1 (160,000.00)
Liquidation value of inventories at terminal date P160,000 x .40 64,000.00
Disposal value of machine * P4,000 x .40 1,600.00
(261,400.00)
PV in favor of new machine - minimizes the PV of future costs 7,000.00
* could be excluded from both alternatives as they have the same amounts - irrelevant cost
 Using the incremental cost analysis approach:
Net cash outlay (P62,000 - P15,000) P47,000 x 1 (47,000.00)
Liquidation value of inventory at time zero P40,000 x 1 40,000.00
Difference in recovery of cash from inventory
liquidation value at terminal date P40,000 x .40 (16,000.00)
Operating savings (P50,000 - P40,000) P10,000 x 3 30,000.00
Net present value in favor of new machine 7,000.00

9.22 Alternative 1 Alternative 2

1 Amount invested 10,000.00 10,000.00
Total increase in cash flows:
Year 0 - 5 P2,000 x 5; P1,500 x 5 10,000.00 7,500.00
Years 6 - 10 P1,000 x 5; P1,500 x 5 5,000.00 7,500.00
totals 15,000.00 15,000.00
Average annual cash flow 1,500.00 1,500.00
Less, Depreciation or amortizations P10,000 / 10 years 1,000.00 1,000.00
Average annual net income 500.00 500.00
ARR on original investments 0.05 0.05

2 IRR Alternative 1 could also be interpreted at cash inflows received at P1,000 for the next 10 years
plus P1,000 for the first 5 years.
P10,000 = PV pf P1,000 at X% for 10 years + PV of P1,000 at X% for the first 5 years.
Let F1 = be the value of X% for 10 years and F2 be the value of X% for 5 years
P10,000 = P1,000 (F1) + P1,000(F2)
P10,000 = P1,000 ( F1 + F2)
F1 + F2 = P10,000 / P1,000 = 10
F1 at 8% for 10 years = 6.7101 F2 at 8% for 5 years = 3.9927
F1 at 10% for 10 years = 6.1446 F2 at 10% for 5 years = 3.7908
at 8% (P1,000 x 6.7101) + (P1,000 x 3.9927) = P10,703
at 10% (P1,000 x 6.1446) + (P1,000 x 3.7908) = P9,935

in rate (F1 + F2) in pesos in rate (F1 + F2) in peso

at 8% 10.7028 10,703.00 10.7028 10,703.00
true rate - - 10.0000 10,000.00
at 10% 9.9354 9,935.00 - -
0.7674 768.00 0.7028 703.00
Exact rate = 8% + (.7028 /.7674) x 2% = 8% +1.83% = 9.83%

Alternative 2
P10,000 = PV pf P1,500 at X% for 10 years
P10,000 = P1,500 (F)
F = P10,000 / P1,500 = 6.6667
 At 8% F = 6.7101 6.7101 6.7101
true rate 6.6667
At 10%, F = 6.1446 6.1446
0.5655 0.0434
True rate = 8% + (.0434 / .5655) x 2% = 8% + .15% = 8.15%
3 The difference between the 9.83% return on Alternative 1 and the 8.15% return on alternative 2 is from the
fact that under Alt. 1, there are greater cash inflows during the first 5 years than under Alt. 2. Under the
Discounted Cash Flow (DCF) method, early cash inflows are weighted more heavily than inflows of later
years since this method considers the time value of money.

9.23
1 PV of annual cash inflows P50,000 x 3.8887 194,435.00
PV of salvage value of machine at end of 6 years P22,000 x .4556 10,023.20
PV of salvage value of parts at end of 6 years P15,000 x .4556 6,834.00
Total present values 211,292.20
Initial investments 202,000.00
Net present value 9,292.20

2 IRR IRR will be greater than 14% because the net present value is positive, try 16%
PV of annual cash inflows P50,000 x 3.6847 184,235.00
PV of salvage value of machine at end of 6 years P22,000 x .4104 9,028.80
PV of salvage value of parts at end of 6 years P15,000 x .4104 6,156.00
Total present values 199,419.80
Initial investments 202,000.00
Net present value negative (2,580.20)
Therefore, the IRR is just below 16%

3 ARR
a Average annual income 50,000.00
Less, Depreciation (P187,000 - P22,000) / 6 years 27,500.00
Net annual income 22,500.00
Initial investment (P187,000 + P15,000) 202,000.00
ARR on initial investment 11.14%

b Average annual income 50,000.00

Less, Depreciation (P187,000 - P22,000) / 6 years 27,500.00
Net annual income 22,500.00
Average investment (P202,000 + P22,000 +P15,000) / 2 = P119,500 119,500.00
ARR on average investment 18.83%

4 The models in requirements 1 and 2 would give a positive decision.

However, the 11.14% ARR based on initial investment might give a negative decision because it is less
than 14%.
9.24 1 Total PV
Cash effects of operation (P150,000 x .60% net of tax) P90,000 x 2.2459 202,131.00
Savings on income taxes on deprn. (P100,000 x .40) P40,000 x 2.2459 89,836.00
Total after tax effect on cash 291,967.00
Investments (300,000.00)
Net present value, negative (8,033.00)
The computers should not be acquired.

2 After tax impact of disposal on cash P.60 (P40,000 - 0) = P24,000

PV is P24,000 x .6407 15,376.80
Net present value in (1) (8,033.00)
New net present value , positive 7,343.80
The computers should be acquired.

3 Applying a 12% discount factor

P150,000 (1 -.40) x 2.4018 = P90,000 x 2.4018 216,162.00
P100,000 x .40 x 2.4018 P40,000 x 2.4018 96,072.00
Total present values 312,234.00
Investments (300,000.00)
Net present value, positive, therefore acquire 12,234.00

9.25
Sales 520.00
less, expenses excluding depreciation 350.00
Depreciation 100.00
Total expenses 450.00
Income before income taxes 70.00
Income taxes at 40% 28.00
Net income 42.00
Cash effects of operations:
Cash inflows from operations less cash expenses P520 -350 170.00
Less, Income tax outflow without depreciation ( P170 x .40) 68.00
102.00
Effect on deprection as savings on income tax
Depreciation P100 x .40% 40.00
Total after tax effect on cash 142.00

Total after tax effect on cash is

Cash inflows from sales 520.00
Cash outflows for expenses (350.00)
Cash outflows for tax (28.00)
Total after tax cash received. 142.00
9.26 Investment (45,000.00)
Cash operating savings
Annual savings 13,500.00
Income taxes at 40% P13,500 x 40% 5,400.00
After tax effect on cash 8,100.00
Present value (P8,100 x 4.5638) 36,966.78
PV of tax savings from depreciation:
Investment x PV Factor x tax rate P45,000 x .7809 x .40 14,056.20
Overhaul requirement:
Total cost 5,000.00
Less, income tax savings at 40% 2,000.00
Total after tax effect 3,000.00
Present value (P3,000 x .6355) (1,906.50)
Residual value
Cash received 4,000.00
Book value -
Gain 4,000.00
Income tax effect on gain at 40% 1,600.00
Total after tax effect 2,400.00
Present value (P2,400 x .4523) 1,085.52
Net present value of all cash flows 5,202.00
The investment is desirable

9.27
1 New machine 120,000.00
Disposal value of old machine (20,000.00)
Incremental tax on gain on disposal (P20,000 - P16,000) x 35% 1,400.00
Net cost of investment 101,400.00

2 Savings before taxes 40,000.00

Less, Income tax
Net cash flow before tax 40,000.00
Less depreciation expense
(P120,000 - 16,000)/10 years (10,400.00)
Net income subject to tax 29,600.00
tax rate 0.35 (10,360.00)
Net cash flows after tax 29,640.00

9.28
1 Net income before depreciation 12,000.00
Less Depreciation expense (P60,000 / 10 years) (6,000.00)
Net income after depreciation 6,000.00
Less Income tax (P6,000 x .35) (2,100.00)
Net income after tax 3,900.00

2 Accounting Rate of Return (ARR) (P3,900 / 60,000) 6.5%

 3 Cash flow before taxes 12,000.00
Less income tax (P6,000 x .35) (2,100.00)
Net cash flow after taxes 9,900.00

4 Payback period P60,000 / 9,900 in years 6.06

5 Payback reciprocal P9,900 /60,000 in percentage 16.50%

or it can be computed by dividing 1 with the payback period
1 / 6.06 16.50%

9.29
Purchase price 100,000.00
Start up costs 3,000.00
Trade in value of fold machine (15,000.00)
Salvage values of other assets (6,000.00)
Tax savings on loss on retirement (800.00)
Repair cost saved (8,000.00)
Additional working capital 24,000.00
Net initial cost of investment 97,200.00

9.30 tax computation cash flows

1 Sales (10,000 x P15) 150,000.00 150,000.00
Variable costs (10,000 x P8) (80,000.00) (80,000.00)
Contribution margin (10,000 x P7) 70,000.00 70,000.00
Fixed operating costs (25,000.00) (25,000.00)
Cash flows before taxes 45,000.00 45,000.00
Depreciation expense (P100,000 / 5 years) (20,000.00) -
Incremental net income before taxes 25,000.00 45,000.00
Income tax at 32% (8,000.00) (8,000.00)
Increase in net income 17,000.00
Add back, depreciation expense 20,000.00
NET CASH INFLOW PER YEAR 37,000.00 37,000.00

2 Net cash inflow per year 37,000.00

Present value factor, 5 years annuity at 14% (Table II) 3.433
Present value of future net cash flows 127,021.00
Less Investment 100,000.00
Net present value 27,021.00

3 Payback period
Net investment cost a 100,000.00
Net annual cash inflows b 37,000.00
Payback period (a / b) 2.7027
4 Internal rate of return IRR
Them IRR is over 24.75%.
The factor is to be determined using the payback period which2.703
Because 2.7027, the closest factor in the five-year row of Table II is 2.745 at 24% and 2.689 at 25%.
(Remember, the higher the rate, the lower the factor.)
Get interest rates where the factor is in between.
To determine the exact or true rate:

At 24% Present value of P1 in annuity 2.745 2.745

Payback factor 2.703
At 25% 2.689
Difference 0.056 0.042
Exact rate [24% + (.042/.056) x 1%] 0.2475
 5 The book rate or accounting rate of return
Net income after tax a 17,000.00
Average investment b 50,000.00
P100,000 / 2
Rate of return (a / b) 0.34

6 The only change required is the determination of the present value of the salvage value
less the tax on the gain.

Salvage value 5,000.00

Tax rate at 32% (P5,000 x 32%) 1,600.00
net cash inflow, end of year 5 3,400.00
Present value factor for single payment 5 years at 14%
in table I 0.519
Present value of salvage value 1,764.60
Add, net present value from number 2 27,021.00
NET PRESENT VALUE 28,785.60

NOTE: We did not have to recompute annual net cash flows. The company still used P20,000 for
Depreciation expense, therefore at end of year 5, the book value is zero and there will be
a gain equal to the salvage value.

9.31
annual net cost of internal rate Net present
Cases cash inflows investments capital of return value

A 120,000.00 503,040.00 14% 20% 122,892.00

B 180,000.00 808,938.00 12% 18% 208,062.00
C 124,141.00 600,000.00 10% 16% 162,880.00
D 200,000.00 900,000.00 12% 18% 230,000.00

CASE A 1 Internal rate of return (IRR)

Investment a 503,040.00
Annual net cash inflows b 120,000.00
Payback factor ( at 10 periods interest of 20%) (a / b) 4.1920

2 Net present value

PV of cash inflows (14% for 10 years) (P120,000 x 5.2162) 625,932.00
PV of investments (503,040.00)
Net present value 122,892.00

CASE B 1 Investment
Annual net cash inflows a 180,000.00
PV factor at 18% for 10 years b 4.4941
Present value of net cash inflows ( a x b) 808,938.00

2 Net present value

Net present value of cash inflows at 12% for 10 years
(P180,000 x 5.65 ) 1,017,000.00
Present value of investments (808,938.00)
Net present value 208,062.00
CASE C 1 Annual net cash inflow
Investment a 600,000.00
PV factor (16% for 10 years) b 4.8332
Annual net cash inflow (a / b) 124,141.36

2 Cost of capital
Investment 600,000.00
Net present value 162,880.00
Total PV of cash inflows a 762,880.00
Annual net cah inflow b 124,141.36
Present value factor (which at 10% for 10 years) (a /b) 6.14525
nearest is 6.1446

CASE D 1 Annual net cash inflow

Investment 900,000.00
Net present value 230,000.00
Total PV of cash inflows a 1,130,000.00
PV factor at 12% for 10 years b 5.65
Annual net cash inflow (a / b ) 200,000.00

9.32
1 Annual profit net of tax
Process 1 Process 2
Sales ( 100,000 @ P50) 5,000,000.00 5,000,000.00
Less, Variable costs at P20 and at P10 (2,000,000.00) (1,000,000.00)
Contribution margin 3,000,000.00 4,000,000.00
Less, Variable
Fixes
costs
costs:
at P20 and at P10
Cash fixed costs 400,000.00 600,000.00
* Depreciation expense on the investment for 4 yrs. 1,000,000.00 1,500,000.00
Total 1,400,000.00 2,100,000.00
Net income before income tax 1,600,000.00 1,900,000.00
Income tax at the rate of 32% (512,000.00) (608,000.00)
Net income after tax 1,088,000.00 1,292,000.00
* Cost of investment / 4 years

2 Accounting rate of return on average investments

Net income after tax a 1,088,000.00 1,292,000.00
Average investments (investment / 2) b 2,000,000.00 3,000,000.00
ARR (a / b) 0.5440 0.4307
OR 54.40% 43.07%
 3 Net income after tax (see solution in no. 1) 1,088,000.00 1,292,000.00
Add back, depreciation expense 1,000,000.00 1,500,000.00
Annual cash inflows after tax a 2,088,000.00 2,792,000.00
PV factor at 16% for 4 years b 2.7980 2.7980
Present value of annual cash inflows c =(a x b) 5,842,224.00 7,812,016.00
PV of investment d 4,000,000.00 6,000,000.00
Net present value (c - d) 1,842,224.00 1,812,016.00

4 Payback period
Investment a 4,000,000.00 6,000,000.00
Annual cash inflow b 2,088,000.00 2,792,000.00
Payback period (a / b) 1.92 2.15

5 Recommendation:
Net income 1,088,000.00 1,292,000.00
ARR 0.544 0.431
Net present value 1,842,224.00 1,812,016.00
Payback 1.92 2.15
Comparing the different measures, it seems that Process I has more advantanges over
Process 2, so most likely it would be Process I. However, the management
must also consider the effects of qualitative issues that could be associated to the
two processes.

9.33
a Cost of new equipment 175,000.00
Cost of removing old equipment 5,000.00
Resale value of old equipment (40,000.00)
Net cost of investment 140,000.00

b Net present value before taxes

Annual operating costs -old equipment (P30,000-+ P48,000) 78,000.00
Annual operating costs -new equipment (P25,000+ P20,000) (45,000.00)
Annual operating cost savings before taxes 33,000.00

Present value of Savings (P33,000 x 5.019) 165,627.00

Net initial cost of investment (140,000.00)
Net Present value 25,627.00

c The investment should be made since the NPV has a positive results.
9.34 Analysis of Cash Flows
PRESENT PROPOSED DIFFERENCE
Revenue 200,000.00 15,000.00 *
Expenses:
Miscellaneous 100,000.00 -
Salaries 110,000.00 13,000.00
210,000.00 13,000.00
Net cash flows (10,000.00) 2,000.00 (12,000.00)
Required Investment:
Equipment - 19,000.00 **
Termination pay - 28,000.00
- 47,000.00 (47,000.00)
* 10% x P150,000 = P15,000 comission
**An acceptable alternative would be to show P3,000 and P22,000 resprectively. The incremental investment
would still be P19,000.

a Present value of P12,000 per year for 10 years at P12,000 x 6.000 72,000.00
Required investment 47,000.00
Net present value 25,000.00

The requirements of the problem focus on the incremental approach. The total project apporach could
view the problem as choosing the alternative that minimizes the net present value of the future costs:

Present:
Operating cash outflows, P10,000 x 6.00 (60,000.00)
Proposed:
Operating cash inflows, P2,000 x 6.00 12,000.00
Termination pay (28,000.00)
Equipment (19,000.00)
Total (35,000.00)
Difference in favor of proposed investment 25,000.00

b The minimum amount of annual revenue that the company would have to receive to justify the
investment would be theat amount yielding an incremental net present value of zero. As the initial
investment is constant, any change in the incremental net present value is due solely to a change in the
amount of revenue. Therefore, the maximum drop in the incremental net present value of P25,000 equals
the maximum drop in the present value of the revenue stream. This implies a maximum drop of
P25,000 / 6 = P4,167 in annual revenue and a minimum amount of annual revenue of P15,000 - P4,167 =
P10,833

Let X = Revenue at point of indifference, where net present value is zero

NPV = PV (New annual cash flows - old annual cash flfows) - Required investment
0 = 6.00[(X - 13,000) - (-10,000)] - 47,000
0 = 6.00(X -13,000 + 10,000) - 47,000
0 = 6.00(X- 3,000) - 47,000
0 = 6.00X - 18,000 - 47,000
6.00X = 65,000
X = 10,833

Part 2 demonstrates sensitivity analysis, where the manager may see the potential impact of the
possible errors in the forecasts of revenue. Such analysis shows how much of a margin of safety is
available. In this case, his "best guess" is revenue of P15,000 ( in part 1). Sensitivity analysis shows
him that a decline of revenue would have to occur from P15,000 to P10,833 before the rate of return on the
project would decline to the minimum acceptable level.
 Another approach to solve requirement 2 could be:

If 10% is the minimum acceptable rate of return, the minimum acceptable net present value must
be zero, using the 10% rate:
NPV = PV if future cash flows - initial investment
Let X = Annual cash inflow
Then 0 = 6.00(X) - 47,000
X = P47,000 / 6.00
X = P7,833
Present value of P7.833 per year for 10 years at 10% P7,833 x 6.00 47,000.00
Required investment 47,000.00
Net present value (0.00)

Note that the requirement asks for the minimum amount of revenue, as distinguished from the difference
in cash flows.

The following analysis shows that revenue can fall toP10,833. Note also that there can be negative
cash flows under both alternatives; the alternative with the least negative cash flow is preferable

Present Proposed Diff. in cash flows

Revenues 200,000.00 10,833.00
Expenses 210,000.00 13,000.00
Net cash flow from operations (10,000.00) (2,167.00) (7,833.00)

9.35
1 Payback period P200,000 / P40,000 5 years

2 Present value of cash inflow at 10% for 8 years P40,000 x 5.335 213,400.00
Investment 200,000.00
Net present value 13,400.00

3 Yes Assuming that the only criteria is the NPV because it has a positive NPV

9.36
a P1,000 is being compounded for 3 years, so your balance on January 1, 2011 is P1,259.71
longway
a b c d e
(bxc) ( b + d)
end of beginning interest interest ending
year balance rate amount balance
2009 1,000.00 0.08 80.00 1,080.00
2010 1,080.00 0.08 86.40 1,166.40
2011 1,166.40 0.08 93.31 1,259.71
shortcut formula
FV = PV(1 + k )4 P1,000(1 + .08)4 = P1,259.71
b The effective annual rate for 8 percent, compunded quarterly
longway
a b c d e
(bxc) ( b + d)
end of beginning interest interest ending
year balance rate amount balance
2009-1st 1,000.00 0.02 20.00 1,020.00
2nd 1,020.00 0.02 20.40 1,040.40
3rd 1,040.40 0.02 20.81 1,061.21
4th 1,061.21 0.02 21.22 1,082.43
2010- 1st 1,082.43 0.02 21.65 1,104.08
2nd 1,104.08 0.02 22.08 1,126.16
3rd 1,126.16 0.02 22.52 1,148.69
4th 1,148.69 0.02 22.97 1,171.66
2011-1st 1,171.66 0.02 23.43 1,195.09
2nd 1,195.09 0.02 23.90 1,218.99
3rd 1,218.99 0.02 24.38 1,243.37
4th 1,243.37 0.02 24.87 1,268.24

shortcut
use FV for % at 12 periods (4 quarters is x 3 years)
FV = P1,000(1.2682) = P1,268.20

c as you solve this problem, keep in mind that the tables assume that payments are made at the end
of each period. Therefore, you may solve this prblem by finding the future value of an annuity of P250
for 4 years at 8 percent.

longway
a b c d e
(bxc) ( b + d)
beginning beginning additional interest interest ending
of year balance investment rate amount balance
2008 250.00 0.08 20.00 270.00
2009 270.00 250.00 0.08 41.60 561.60
2010 561.60 250.00 0.08 64.93 876.53
2011 876.53 250.00 1,126.53
shortcut
FV = P250(4.5061) = P1,126.53
FV of annuity of P250 for 4 years at 8 percent is 4.5061

d An amount is deposited in 4 equal payments in the account at 8% interest rate to obtain balance similar to the amount
equal to requirement letter a (P1,259.71)

longway
a b c d e
(bxc) ( b + d)
beginning beginning additional interest interest ending
of year balance investment rate amount balance
2008 279.56 0.08 22.36 301.92
2009 301.92 279.56 0.08 46.52 628.00
2010 628.00 279.56 0.08 72.61 980.17
2011 980.17 279.56 1,259.73

shortcut formula
P1,259.71 = Amount(4.5061)
Amount = P1,259.71 / 4.5061
= 279.56
9.37
a Alternative a - Investment in the Project
1 2 3 (1 +2 ) 4 5 (3 - 4)
Loan balance Interest at Accumulated Cash for Loan Balance
beginning of 10% per amount at Repayment at end of
Year the year year End of year of loan Year
0 -
1 100,000.00 10,000.00 110,000.00 45,000.00 65,000.00
2 65,000.00 6,500.00 71,500.00 45,000.00 26,500.00
3 26,500.00 2,650.00 29,150.00 45,000.00 (15,850.00)

* Cash of P45,000 is available to pay P29,150 total accumulated loan balance.

b Alternative b - Keep cash and invest in time deposit

1 2 3 (1 +2 )
Investment Interest at Accumulated
balance at 10% per amount at
beginning at
Year of year year End of year
0 - -
1 11,915.00 1,191.50 13,106.50
2 13,106.50 1,310.65 14,417.15
3 14,417.15 1,441.72 15,858.87
* Net present value computation:
PV of annual cash inflows for 3 periods at 10% (P45,000 x 2.487) 111,915.00
Present value of investments 100,000.00
Net present value to be used as the initial investment (see year 1) 11,915.00