CPA REVIEW SCHOOL OF THE PHILIPPINES 11.

The payback method assumes that all cash inflows are

Manila reinvested to yield a return equal to
MANAGEMENT ADVISORY SERVICES D. zero.
CAPITAL BUDGETING 12. As a capital budgeting technique, the payback period
THEORY considers depreciation expenses (DE) and time value of
1. Capital budgeting techniques are least likely to be used money (TVM) as follows:
in evaluating the B. Irrelevant; irrelevant
D. Adoption of a new method of allocating non-traceable 13. The bailout payback period is
costs to product lines. B. The length of time for payback using cash flows plus the
2. The “inflation element” refers to the salvage value to recover the original investment
C. Future deterioration of the general purchasing power of 14. Which of the following methods measures the cash
the monetary unit. flows and outflows of a project as if they occurred at a
3. Mahlin Movers, Inc. is planning to purchase equipment single point in time?
to make its operations more efficient. D. Discounted cash flow.
This equipment has an estimated useful life of six years. 15. When using one of the discounted-cash-flow methods
As part of this acquisition, a to evaluate the feasibility of a capital budgeting project,
P150, 000 investments in working capital is required. In a which of the following factors generally is not important?
discounted cash flow analysis, this investment in working
A. The method of financing the project under
capital should be
consideration.
D. Treated as an immediate cash outflow that is recovered
16. In an investment in plant the return that should keep
at the end of six years.
the market price of the firm stock unchanged is
4. To approximate annual cash inflow, depreciation is
D. Cost of capital
D. Added back to net income because it is not an outflow of
17. The excess present value method is anchored on the
cash.
theory that the future returns, expressed in terms of
5. In capital expenditures decisions, the following are present value, must at least be
relevant in estimating operating costs except
A. Equal to the amount of investment
D. Historical costs.
18. A company had made the decision to finance next
6. Which of the following best identifies the reason for year’s capital projects through debt rather than additional
using probabilities in capital budgeting is equity. The benchmark cost of capital for these projects
C. Uncertainty. should be
7. In capital budgeting decisions, the following items are D. The weighted-average cost of capital.
considered among others: 19. All of the following refer to the discount rate used by a
1. Cash outflow for the investment. firm in capital budgeting except
2. Increase in working capital requirements.
C. Opportunity cost.
3. Profit on sale of old asset
4. Loss on write-off of old asset. 20. If a firm identifies (or creates) an investment
For which of the above items would taxes be relevant? opportunity with a present value <List A> its cost, the
value of the firm and the price of its common stock will
B. Items 3 and 4 only.
<List B>
8. Your company is purchasing transport equipment as
A. List A Greater; List B Increase
part of its territorial expansion strategy. The technical
services department indicated that this equipment needs 21. The common assumption in capital budgeting analysis
overhauling in year 4 or year 5 of its useful life. The is that cash inflows occur in lump sums at the end of
overhauling cost will be expected during the year the individual years during the life of an investment project
overhauling is done. The finance officer insists that the when in fact they flow more or less continuously during
overhauling be done in year 4, not in year 5. The most those years
likely reason is A. Results in understated estimates of NPV.
A. There is lower tax rate in year 5. 22. An advantage of the net present value method over the
9. An optimal capital budget is determined by the point internal rate of return model in discounted cash flow
where the marginal cost of capital is analysis is that the net present value method
D. Equal to the marginal rate of return on investment. B. Can be used when there is no constant rate of return
required for each year of the project.
10. The following statements refer to the accounting rate
of return (ARR) 23. When using the net present value method for capital
1. The ARR is based on the accrual basis, not cash basis. budgeting analysis, the required rate of return is called all
2. The ARR does not consider the time value of money. of the following except the
3. The profitability of the project is considered. A. Risk-free rate.
From the above statements, which are considered 24. A project’s net present value, ignoring income tax
limitations of the ARR concept? considerations, is normally affected by the
D. Statements 1 and 2 only. A. Proceeds from the sale of the asset to be replaced.
25. You have determined the profitability of a planned C. the capital budgeting evaluation techniques profitability
project by finding the present value of all the cash flows index, net present value, and internal rate of return will
from that project. Which of the following would cause the provide a consistent ranking of the projects.
project to look less appealing, that is, have a lower present 36. Several proposed capital projects which are
value? economically acceptable may have to be ranked due to
A. The discount rate increases. constraints in financial resources. In ranking these
26. How are the following used in the calculation of the projects, the least pertinent is this statement.
internal rate of return of a proposed project? Ignore D. If the net present value method is used, the profitability
income tax considerations. index is calculated to rank the projects. The lower the
D. Residual sales value of project - Include; Depreciation index, the better the project.
expense - Exclude 37. Capital budgeting methods are often divided into two
27. The discount rate that equates the present value of the classifications: project screening and project ranking.
expected cash flows with the cost of the investment is the Which one of the following is considered a ranking method
B. Internal rate of return rather than a screening method?
28. Which of the following characteristics represent an C. Profitability index.
advantage of the internal rate of return techniques over 38. A company has analyzed seven new projects, each of
the accounting rate of return technique in evaluating a which has its own internal rate of return. It should
project? consider each project whose internal rate of return is _____
I. Recognition of the project’s salvage value. its marginal cost of capital and accept those projects in
II. Emphasis on cash flows. _____ order of their internal rate of return.
III. Recognition of the time value of money. B. Above; decreasing
C. II and III. 39. Velasquez & Co. is considering an investment proposal
29. Polo Co. requires higher rates of return for projects for P10 million yielding a net present value of P450,000.
with a life span greater than 5 years. Projects extending The project has a life of 7 years with salvage value of
beyond 5 years must earn a higher specified rate of return. P200,000. The company uses a discount rate of 12%.
Which of the following capital budgeting techniques can Which of the following would decrease the net present
readily accommodate this requirement? value?
D. Internal Rate of Return Yes; Net Present Value Yes B. Increase discount rate to 15%.
30. Which of the following combinations is NOT possible? 40. What is the effect of changes in cash inflows,
Profitability Index NPV IRR investment cost and cash outflows on profitability
D. Less than 1 Positive Less than cost of capital (present value) index (PI)
31. Which of the following is always true with regard to the A. PI will increase with an increase in cash inflows, a
net present value (NPV) approach? decrease in investment cost, or a decrease in cash
A. If a project is found to be acceptable under the outflows.
NPV approach, it would also be acceptable under the PROBLEMS
internal rate of return (IRR) approach. 1. Acme is considering the sale of a machine with a
32. When ranking two mutually exclusive book value of $80,000 and 3 years remaining in its
investments with different initial amounts, useful life. Straight-line depreciation of $25,000 annually
management should give first priority to the project is available. The machine has a current market value of
D. That has the greater profitability index. $100,000. What is the cash flow from selling the machine
33. Which mutually exclusive project would you select, if if the tax rate 40%.
both are priced at $1,000 and your discount rate is 15%; C. $92,000
Project A with three annual cash flows of $1,000, or Project 2. Hatchet Company is considering replacing a machine
B, with 3 years of zero cash flow followed by 3 years of with a book value of $400,000, a
$1,500 annually? remaining useful life of 5 years, and annual straight-
A. Project A. line depreciation of $80,000. The existing machine has a
34. Payback period (PP), profitability index (PI), and current market value of $400,000. The replacement
simple accounting rate of return (SARR) are some of the machine would cost $550,000, have a 5-year life, and save
capital budgeting techniques. What is the effect of an $75,000 per year in cash operating costs. If the
increase in the cost of capital on these techniques? replacement machine would be depreciated using the
B. PP-No change; PI-Decrease; SARR-No change straight-line method and the tax rate is 40%, what would
be the net investment required to replace the existing
35. A company is evaluating three possible investments.
machine?
Information relating to the company and the investments
follow: B. $150,000
Fisher rate for the three projects 7% 3. Diliman Republic Publishers, Inc. is considering
Cost of capital 8% replacing an old press that cost P800,000 six years ago
Based on this information, we know that with a new one that would cost P2,250,000. Shipping and
installation would cost an additional P200,000. The old
press has a book value of P150,000 and could be sold
currently for P50,000. The increased production of the 8. Lor Industries is analyzing a capital investment proposal
new press would increase inventories by P40,000, for new machinery to produce a new product over the next
accounts receivable by P160,000 and accounts payable by ten years. At the end of the ten years, the machinery must
P140,000. Diliman Republic’s net initial investment for be disposed of with a zero net book value but with a scrap
analyzing the acquisition of the new press assuming a 35% salvage value of P20,000. It will require some P30,000
income tax rate would be to remove the machinery. The applicable tax rate is
B. P2,425,000 35%. The appropriate “end-of-life” cash flow based on
4. Key Corp. plans to replace a production machine the foregoing information is
that was acquired several years ago. B. Outflow of P6,500.
Acquisition cost is P450,000 with salvage value of P50,000. 9. C Corp. faces a marginal tax rate of 35 percent. One
The machine being considered is worth P800,000 and the project that is currently under evaluation has a cash flow
supplier is willing to accept the old machine at a trade-in in the fourth year of its life that has a present value of
value of P60,000. Should the company decide not to $10,000 (after-tax). C Corp. assumes that all cash flows
acquire the new machine, it needs to repair the old one occur at the end of the year and the company uses 11
at a cost of P200,000. Tax-wise, the trade-in percent as its discount rate. What is the pre-tax amount of
transaction will not have any implication but the cost the cash flow in year 4? (Round to the nearest dollar.)
to repair is tax-deductible. The effective corporate tax rate B. $23,356
is 35% of net income subject to tax. For purposes of 10. Maxwell Company has an opportunity to acquire a new
capital budgeting, the net investment in the new machine machine to replace one of its present machines. The new
is machine would cost $90,000, have a 5-year life, and no
B. P610,000 estimated salvage value. Variable operating costs would
5. Great Value Company is planning to purchase a new be $100,000 per year. The present machine has a book
machine costing P50,000 with freight and installation costs value of $50,000 and a remaining life of 5 years. Its
amounting to P1,500. The old unit is to be traded-in will disposal value now is $5,000, but it would be zero after 5
be given a trade-in allowance of P7,500. Other assets that years. Variable operating costs would be $125,000 per
are to be retired as a result of the acquisition of the new year. Ignore income taxes. Considering the 5 years in
machine can be salvaged and sold for P3,000. The loss on total, what would be the difference in profit before income
retirement of these other assets is P1,000 which will taxes by acquiring the new machine as opposed to
reduce income taxes of P400. If the new equipment is not retaining the present one?
purchased, repair of the old unit will have to be made at an D. $40,000 increase
estimated cost of P4,000. This cost can be avoided by 11. A project under consideration by the White Corp.
purchasing the new equipment. Additional gross working would require a working capital investment of $200,000.
capital of P12,000 will be needed to support operation The working capital would be liquidated at the end of the
planned with the new equipment. The net investment project's 10-year life.
assigned to the new machine for decision analysis is If White Corp. has an after-tax cost of capital of 10 percent
A. P50,200 and a marginal tax rate of 30 percent, what is the present
6. Hooker Oak Furniture Company is considering the value of the working capital cash flow expected to be
purchase of wood cutting equipment. received in year 10?
Data on the equipment are as follows: B. $77,100
Original investment $30,000 12. Lyben Inc. is planning to produce a new product. To do
Net annual cash inflow $12,000 this, it is necessary to acquire a new equipment that will
Expected economic life in years 5 cost the company P100,000. The estimated life of the new
Salvage value at the end of five years $3,000 equipment is five years with no salvage value. The
The company uses the straight-line method of depreciation estimated income and costs based on expected sales of
with no mid-year convention. P10,000 units per year are:
What is the accounting rate of return on original Sales @ P10.00 per unit P100,000
investment rounded off to the nearest percent, Costs @ P8.00 per unit 80,000
assuming no taxes are paid? Net income P 20,000
D. 22.0% The accounting rate of return based on initial investment
7. A company is considering putting up P50,000 in a is 20%
three-year project. The company’s expected rate of What will be the accounting rate of return based
return is 12%. The present value of P1.00 at 12% for one on initial investment of P100,000 if management
year is 0.893, for two years is 0.797, and for three years is decrease its selling price of the new product by 10%?
0.712. The cash flow, net of income taxes will be P18,000 B. 10%
(present value of P16,074) for the first year and P22,000 13. MLF Corporation is evaluating the purchase of a
(present value of P17,534) for the second year. Assuming P500,000 die attach machine. The cash inflows expected
that the rate of return is exactly 12%, the cash flow, net of from the investment is P145,000 per year for five years
income taxes, for the third year would be with no equipment salvage value. The cost of capital is
D. P23,022 12%. The net present value factor for five (5) years at
12% is 3.6048 and at 14% is 3.4331. The internal rate of would be salvaged at the end of the fifth year for $60,000.
return for this investment is What expected salvage value for the truck would cause the
C. 13.8% investment to generate a net present value of $0? Ignore
14. APJ, Inc. is planning to purchase a new machine that taxes.
will take six years to recover the cost. A. $30,000
The new machine is expected to produce cash flow from 19. Booker Steel Inc. is considering an investment that
operations, net of income taxes, of P4,500 a year for the would require an initial cash outlay of
first three years of the payback period and P3,500 a year of $400,000 and would have no salvage value. The project
the last three years of the payback period. Depreciation of would generate annual cash inflows of $75,000. The firm's
P3,000 a year shall be charged to income of the six years of discount rate is 8 percent. How many years must the
the payback period. How much shall the machine cost? annual cash flows be generated for the project to generate
C. P24,000 a net present value of $0?
15. Sweets, Etc., Inc. plans to undertake a capital C. between 7 and 8 years
expenditure requiring P2 million cash outlay. 20. Salvage Co. is considering the purchase of a new ocean-
Below are the projected after-tax cash inflows for the five going vessel that could potentially reduce labor costs of
year period covering the useful life? its operation by a considerable margin. The new ship
The company’s tax rate is 35%. would cost
Year 1 2 3 4 5 $500,000 and would be fully depreciated by the straight-
P’000 600 700 480 400 400 line method over 10 years. At the end of 10 years, the ship
The founder and president of the candy company believes will have no value and will be sunk in some already
that the best gauge for capital expenditure is cash payback polluted harbor. The Salvage Co.'s cost of capital is 12
period and that the recovery period should not be more percent, and its marginal tax rate is 40 percent. If the ship
than 75% of the useful life of the project or the asset. produces equal annual labor cost savings over its 10-year
Should the company undertake the project? life, how much do the annual savings in labor costs need to
B. Yes, since the payback period is 3.55 years or 71% of the be to generate a net present value of $0 on the project?
useful life of the project. (Round to the nearest dollar.)
16. Womark Company purchased a new machine on B. $114,154
January 1 of this year for $90,000, with an estimated useful 21. The McNally Co. is considering an investment in a
life of 5 years and a salvage value of $10,000. The project that generates a profitability index of 1.3. The
machine will be depreciated using the straight-line present value of the cash inflows on the project is $44,000.
method. The machine is expected to produce cash flow What is the net present value of this project?
from operations, net of income taxes, of $36,000 a year in A. $10,154
each of the next 5 years. The new machine’s salvage value 22. The Zeron Corporation wants to purchase a new
is $20,000 in years 1 and 2, and $15,0000 in years 3 and 4. machine for its factory operations at a cost of $950,000.
What will be the bailout period (rounded) for the new The investment is expected to generate $350,000 in annual
machine? cash flows for a period of four years. The required rate of
C. 1.9 years. return is 14%. The old machine can be sold for $50,000.
17. It is the start of the year and St. Tropez Co. plans to The machine is expected to have zero value at the end of
replace its old sing-along equipment. the four-year period. What is the net present value of the
These information are available: investment? Would the company want to purchase the
Old New new machine? Income taxes are not considered.
Equipment cost P70,000 A. $119,550; yes
P120,000 23. Drillers Inc. is evaluating a project to produce a high-
Current salvage value 10,000 - tech deep-sea oil exploration device.
Salvage value, end of useful life 2,000 16,000 The investment required is $80 million for a plant with a
Annual operating costs 56,000 38,000 capacity of 15,000 units a year for 5 years. The device will
Accumulated depreciation 55,300 - be sold for a price of $12,000 per unit. Sales are expected
Estimated useful life 10 years 10 years to be 12,000 units per year. The variable cost is $7,000 and
The company’s income tax rate is 35% and its cost of fixed costs, excluding depreciation, are $25 million per
capital is 12%. What is the present value of all the relevant year. Assume Drillers employs straight-line
cash flows at time zero? depreciation on all depreciable assets, and assume that
B. (P110,000) they are taxed at a rate of 36%. If the required rate of
18. Cramden Armored Car Co. is considering the return is 12%, what is the approximate NPV of the project?
acquisition of a new armored truck. The truck is expected B. $21,511,000
to cost $300,000. The company’s discount rate is 12 24. JJ Corp. is considering the purchase of a new machine
percent. The firm has determined that the truck generates that will cost P320,000. It has an estimated useful life of 3
a positive net present value of $17,022. However, the firm years. Assume that 30% of the depreciable base will be
is uncertain as to whether it has determined a reasonable depreciated in the first year, 40% in the second year, and
estimate of the salvage value of the truck. In computing the 30% in the third year. It has a resale value of P20,000 at
net present value, the company assumed that the truck
the end of its economic life. Savings are expected from the return. The company is subject to 40% income tax rate.
use of machine estimated at P170,000 annually. The The present value of an ordinary annuity of 1 for 4 periods
company has an effective tax rate of 40%. It uses 16% as is 2.85498. In order to realize the IRR of 15%, how much
hurdle rate in evaluating capital projects. Should the is the estimated before-tax cash inflow to be provided by
company proceed with the P320,000 capital investment? the machine?
Year Present Value of P1 Present Value of an Ordinary A. P17,860
Annuity of P1 29. Para Co. is reviewing the following data relating to an
1 0.862 0.862 energy saving investment proposal:
2 0.743 1.605 Cost $50,000
3 0.641 2.246 Residual value at the end of 5 years 10,000
B. Yes, due to NPV of P11,684. Present value of an annuity of 1 at 12% for 5 years 3.60
25. A company's marginal cost of new capital (MCC) Present value of 1 due in 5 years at 12% 0.57
is 10% up to $600,000. MCC increases .5% for the What would be the annual savings needed to make the
next $400,000 and another .5% thereafter. Several investment realize a 12% yield?
proposed capital projects are under consideration, with C. $12,306
projected cost and internal rates of return (IRR) as follows: 30. Smoot Automotive has implemented a new project that
Project Cost IRR has an initial cost, and then generates inflows of $10,000 a
A $100,000 10.5% year for the next seven (7) years. The project has a
B $300,000 14.0% payback period of
C $450,000 10.8% 4.0 years. What is the project's internal rate of return
D $350,000 13.5% (IRR)?
E $400,000 12.0% B. 16.33%
What should the company's capital budget be?
31. Berry Products is considering two pieces of machinery.
B. $1,050,000 The first machine costs P50,000 more than the second
26. The following forecasts have been prepared for a new machine. During the two-year life of these two
investment by Oxford Industries of alternatives, the first machine has P155,000 more cash
$20 million with an 8-year life: flow in year one and a P110,000 less cash flow in year two
Pessimistic Expected Optimistic than the second machine. All cash flows occur at year-end.
Market size 60,000 90,000 140,000 The present value of 1 at 15% end of 1 period and 2
Market share, % 25 30 35 periods are 0.86957 and 0.75614, respectively. The
Unit price $750 $800 $875 present value of 1 at 8% end of period 1 is 0.92593 and
Unit variable cost $500 $400 $350 period 2 is 0.85734. At what discount rate would Machine
Fixed cost, millions $7 $4 $3.5 1 equally acceptable as machine 2?
Assume that Oxford employs straight-line depreciation, B. 10%
and that they are taxed at 35%.
32. The Zeron Corporation recently purchased a new
Assuming an opportunity cost of capital of 14%, what is
machine for its factory operations at a cost of $921,250.
the NPV of this project, based on expected outcomes?
The investment is expected to generate $250,000 in annual
B. $4,563,505 cash flows for a period of six years. The required rate of
27. The following data pertain to Sunlight Corp., whose return is 14%. The old machine has a remaining life of six
management is planning to purchase an automated years. The new machine is expected to have zero value at
tanning equipment. the end of the six-year period. The disposal value of the old
1. Economic life of equipment – 8 years. machine at the time of replacement is zero. What is the
2. Disposal value after 8 years – nil. internal rate of return?
3. Estimated net annual cash inflows for each of the 8 years B. 16%
– P81,000.
33. Rohan Transport is considering two alternative buses
4. Time-adjusted internal rate of return – 14%
to transport people between cities that are in the
5. Cost of capital of Sunlight Corp – 16%
Southeastern U.S., such as Baton Rouge and Gainesville. A
6. The table of present values of P1 received annually for 8
gas-powered bus has a cost of $55,000, and will produce
years has these factors: at
end-of-year net cash flows of $22,000 per year for 4 years.
14% = 4.639, at 16% = 4.344
A new electric bus will cost $90,000, and will produce cash
7. Depreciation is approximately P46,970 annually.
flows of $28,000 per year for 8 years. The company must
Find the required increase in annual cash inflows in order
provide bus service for 8 years, after which it plans to give
to have the time-adjusted rate of return approximately
up its franchise and to cease operating the route. Inflation
equal the cost of capital.
is not expected to affect either costs or revenues during
A. P5,501 the next 8 years. If Rohan Transport's cost of capital is 17
28. Payback Company is considering the purchase of a percent, by what amount will the better project increase
copier machine for P42,825. The copier machine will be the company's value?
expected to be economically productive for 4 years. The D. $27,801
salvage value at the end of 4 years is negligible. The
machine is expected to provide 15% internal rate of
34. Union Electric Company must clean up the water NPV $500 $(200) $200 $1,000
released from its generating plant. The company's cost of IRR 12% 8% 13% 10%
capital is 11 percent for average projects, and that rate is Which project is preferred?
normally adjusted up or down by 2 percentage points for D. D
high- and low-risk projects. Clean-Up Plan A, which is of 39. The Nativity Corporation has the following investment
average risk, has an initial cost of $10 million, and its opportunities:
operating cost will be $1 million per year for its 10-year Proposal Profitability Index Initial Cash Outlay
life. Plan B, which is a high-risk project, has an initial cost 1 1.15 P200,000
of $5 million, and its annual operating cost over Years 1 to 2 1.13 125,000
10 will be $2 million. What is the approximate PV of costs 3 1.11 175,000
for the better project? (VD) 4 1.08 150,000
B. -$15.9 million. The firm has a budget constraint of P300,000.
35. Mulva Inc. is considering the following five What proposal(s) should be accepted?
independent projects: C. Proposals 2 and 3 because their total net present values
Project Required Amount of Capital IRR are the highest among all possible proposal combinations.
A $300,000 25.35% 40. Information on three (3) investment projects is given
B 500,000 23.22% below:
C 400,000 19.10% Project Investment Required Net Present Value
D 550,000 9.25% X P150,000 P34,005
E 650,000 8.50% G 100,000 22,670
The company has a target capital structure which is 40 W 60,000 13,602
percent debt and 60 percent equity. The company can Rank the projects in terms of preference:
issue bonds with a yield to maturity of 10 percent. The D. The ranking is the same.
company has $900,000 in retained earnings, and the
Problem 41 and 42 are based on the following information.
current stock price is $40 per share. The flotation costs
Daneche’s, a tax-exempt entity, plans to purchase a
associated with issuing new equity are $2 per share.
new machine which they project to depreciate over a
Mulva's earnings are expected to continue to grow at 5
ten-year period without salvage value. The new machine
percent per year. Next year's dividend (D1) is forecasted to
will cost P200,000 and is expected to generate cash
be $2.50. The firm faces a 40 percent tax rate. What is the
savings of P60,000 per year in operating costs. Daneche's
size of Mulva's capital budget?
cost of capital is 12%.
B. $1,750,000 For ten periods at 12%, the present value of P1 is P0.3220,
36. A tax-exempt foundation, Sincerely Foundation, Inc. while the present value of an ordinary
intends to invest P1 million in a five-year project. The annuity of P1 is P5.650.
foundation estimates that the annual savings from the 41. What is the net present value of the proposed
project will amount to P325,000. The P1 million asset is investment, assuming Daneche uses a 12% discount rate?
depreciable over five (5) years on a straight-line basis. C. P139,000
The foundation’s hurdle rate is 12% and as a consultant of
42. With the company’s initial investment on the new
the foundation, you are asked to determine the internal
machine, the accounting rate of return is
rate of return and advise if the project should be pursued.
To facilitate computations, below are present value B. 20%
factors: Questions 43 and 44 are based on the following
N=5 12% 14% 16% information.
Present value of P1 0.57 0.52 0.48 The construction of a waste treatment plant was arrived at
Present value of an annuity of P1 3.60 3.40 3.30 after a careful cost-benefit analysis.
Your advice is During the construction period a status report was
D. To proceed due to an estimated IRR of more than 16% presented for your review:
 completed cost as originally estimated, P5 million
37. The following data relate to two capital-budgeting
projects of equal risk:  % of actual completion to date, 65%
Present Value of Cash Flows  actual cost to date, P3.75 million
Period Project A Project B 43. Assuming cost is evenly distributed throughout the
0 $(10,000) $(30,000) construction period, how much will the completion cost be
1 4,550 13,650 most likely?
2 4,150 12,450 B. P5 million plus a cost overrun of about P769,000
3 3,750 11,250 44. What would be an appropriate action to take
Which of the projects will be selected using the considering the situation in number 28?
profitability index (PI) approach and the NPV approach? C. Recommend immediate review with the project
B. PI-Either; NPV-B implementation team to determine the cause of overrun
38. Five mutually exclusive projects had the following and the corrective actions to be taken.
information:
A B C D
 C. P101,863.75
Questions 45 and 46 are based on the following 54. The profitability index of the project (rounded to the
information. nearest hundredth) is
Beta Company plans to replace its company car with a new C. 1.02
one. The new car costs P120,000 and its estimated useful
55. The project would be accepted on the basis of the
life is five years without scrap value. The old car has a
book value of P15,000 and can be sold at P12,000. The D. a and b combined
acquisition of the new car will yield annual cash savings of 14. APJ, Inc. is planning to purchase a new machine that
P20,000 before income tax. Income tax rate is 25%. (M) will take six years to recover the cost.
45. The net investment of the new car is The new machine is expected to produce cash flow from
C. P107,250 operations, net of income taxes, of
P4,500 a year for the first three years of the payback
46. The payback period of the investment is (M)
period and P3,500 a year of the last
C. 5.11 years three years of the payback period. Depreciation of P3,000
47. Telephone Corp. is contemplating four projects: L, M, a year shall be charged to income
N, and O. The capital costs for the initiation of each of the six years of the payback period. How much shall the
mutually-exclusive project and its estimated after-tax, net machine cost?
cash flow are listed below. The company’s desired after- A. P12,000 B. P18,000 C. P24,000 D. P36,000
tax opportunity costs is 12%. It has P900,000 capital 15. Sweets, Etc., Inc. plans to undertake a capital
budget for the year. Idle funds cannot be reinvested at expenditure requiring P2 million cash outlay.
greater than 12%. Below are the projected after-tax cash inflow for the five
In Thousand Pesos year period covering the useful life.
LMNO The company’s tax rate is 35%.
Initial cost 400 470 380 420 Year 1 2 3 4 5
Annual cash flows P’000 600 700 480 400 400
Year 1 113 180 90 80 The founder and president of the candy company believes
2 113 170 110 100 that the best gauge for capital
3 113 150 130 120 expenditure is cash payback period and that the recovery
4 113 110 140 130 period should not be more than
5 113 100 150 150 75% of the useful life of the project or the asset. Should
Net present value P7,540 P59,654 P54,666 P(15,708) the company undertake the project?
Internal rate of return 12.7% 17.6% 17.2% 10.6% A. No, since the payback period is 4 years or 80% of the
Excess present value index 1.02 1.13 1.14 0.96 useful life of the project.
The company will choose B. Yes, since the payback period is 3.55 years or 71% of the
A. Projects M & N. useful life of the project.
Questions 48 through 55 are based on the following C. No, since the payback period extends beyond the life of
information. the project.
The Burgos Corporation is considering investing in a D. Yes, since the payback period is 4 years and still
project. It requires an immediate cash outlay of P100,000. shorter than the useful life of the
It has a life of four years and will be depreciated on a project.
straight-line basis (no salvage value). The firm’s tax rate 16. Womark Company purchased a new machine on
is 25% and requires a return of 10%. Income before January 1 of this year for $90,000, with an
depreciation is projected to be: estimated useful life of 5 years and a salvage value of
YEAR 1 2 3 4 $10,000. The machine will be
Income before depreciation P30,000 P30,000 P40,000 depreciated using the straight-line method. The machine
P40,000 is expected to produce cash flow
The present value factors for P1 at 10% is from operations, net of income taxes, of $36,000 a year in
Year 1 2 3 4 each of the next 5 years. The new
Present Value Factor 0.909 0.826 0.751 0.683 machine’s salvage value is $20,000 in years 1 and 2, and
48. The net cash flow for year 1 is $15,0000 in years 3 and 4. What
B. P28,750 will be the bailout period (rounded) for the new machine?
49. The net cash flow for year 4 is A. 1.4 years. B. 2.2 years. C. 1.9 years. D. 3.4 years.
D. P36,250 17. It is the start of the year and St. Tropez Co. plans to
50. The payback period for the project is replace its old sing-along equipment.
These information are available:
B. 3.17 years
Old New
51. The accounting rate of return of the project is Equipment cost P70,000 P120,000
D. 15% Current salvage value 10,000 -
52. The present value of year two’s cash flow is Salvage value, end of useful life 2,000 16,000
A. P23,747.50 Annual operating costs 56,000 38,000
53. The present value of the project’s net cash flow is Accumulated depreciation 55,300 -
Estimated useful life 10 years 10 years of each project.
The company’s income tax rate is 35% and its cost of D. If the net present value method is used, the profitability
capital is 12%. What is the present index is calculated to rank the
value of all the relevant cash flows at time zero? projects. The lower the index, the better the project.
A. (P54,000) B. (P110,000) C. (P120,000) D. (P124,700) 37. Capital budgeting methods are often divided into two
18. Cramden Armored Car Co. is considering the classifications: project screening and
acquisition of a new armored truck. The truck project ranking. Which one of the following is considered a
is expected to cost $300,000. The company's discount ranking method rather than a
rate is 12 percent. The firm has screening method?
determined that the truck generates a positive net present A. Net present value. C. Profitability index.
value of $17,022. However, the B. Time-adjusted rate of return. D. Accounting rate of
firm is uncertain as to whether it has determined a return.
reasonable estimate of the salvage value of 38. A company has analyzed seven new projects, each of
the truck. In computing the net present value, the company which has its own internal rate of
assumed that the truck would be return. It should consider each project whose internal rate
salvaged at the end of the fifth year for $60,000. What of return is _____ its marginal cost
expected salvage value for the truck of capital and accept those projects in _____ order of their
would cause the investment to generate a net present internal rate of return.
value of $0? Ignore taxes. A. Below; decreasing. C. Above; increasing.
A. $30,000 B. $0 C. $55,278 D. $42,978 B. Above; decreasing. D. Below; increasing.
19. Booker Steel Inc. is considering an investment that 39. Velasquez & Co. is considering an investment proposal
would require an initial cash outlay of for P10 million yielding a net present
$400,000 and would have no salvage value. The project value of P450,000. The project has a life of 7 years with
would generate annual cash inflows salvage value of P200,000. The
of $75,000. The firm's discount rate is 8 percent. How company uses a discount rate of 12%. Which of the
many years must the annual cash following would decrease the net
flows be generated for the project to generate a net present value?
present value of $0? A. Extend the project life and associated cash inflows.
A. between 5 and 6 years C. between 7 and 8 years B. Increase discount rate to 15%.
B. between 6 and 7 years D. between 8 and 9 years C. Decrease the initial investment amount to P9.0 million.
MSQ- D. Increase the salvage value.
35. A company is evaluating three possible investments. 40. What is the effect of changes in cash inflows,
Information relating to the company and the investments investment cost and cash outflows on
follow: profitability (present value) index (PI)
Fisher rate for the three projects 7% A. PI will increase with an increase in cash inflows, a
Cost of capital 8% decrease in investment cost, or a
Based on this information, we know that decrease in cash outflows.
A. all three projects are acceptable. B. PI will increase with an increase in cash inflows, an
B. none of the projects are acceptable. increase in investment cost, or an
C. the capital budgeting evaluation techniques profitability increase in cash outflows.
index, net present value, and C. PI will decrease with an increase in cash inflows, a
internal rate of return will provide a consistent ranking of decrease in investment cost, or a
the projects. decrease in cash outflows.
D. the net present value method will provide a ranking of D. PI will decrease with an increase in cash outflows, an
the projects that is superior to the increase in investment cost, or an
ranking obtained using the internal rate of return method. increase in cash inflows.
36. Several proposed capital projects which are MSQ-06
economically acceptable may have to be ranked Pag
due to constraints in financial resources. In ranking these
projects, the least pertinent is this
statement.
A. If the internal rate of return method is used in the
capital rationing problem, the higher
the rate, the better the project.
B. In selecting the required rate of return, one may either
calculate the organization’s cost of
capital or use a rate generally acceptable in the industry.
C. A ranking procedure on the basis of quantitative criteria
may be established by specifying
a minimum desired rate of return, which rate is used in
calculating the net present value