UNIVERSITY OF THE EAST 1st SEMESTER,

College of Business Administration – ACLAT Department SY 2024 – 2025

Capital Budgeting Techniques BSA 3102

CLASSROOM-BASED EXERCISES

1. The Chief Financial Officer of UE Corporation has requested an evaluation of a proposed

acquisition of a new machine at a purchase price of P 120,000 and with installation costs of P
20,000. A P 6,000 increase in receivables, inventory, and prepaid expenses will be required. The
company as an old machine that has a book value of P 20,000 and can be sold for P 14,000. The
machine will have a useful life of four years after which it can be sold for P 10,000. The estimated
annual incremental operating revenues and cash operating expenses are P 300,000 and P
200,000, respectively, for each of the four years. Disposal cost at the end of the four year period
is estimated at P 8,000. UE’s effective income tax rate is 30% and the cost of capital is 10%. UE
uses straight-line depreciation for both financial and income tax purposes.
Required: Evaluate the project using NPV techniques

2. UERRMC Corporation is considering automating its factory with the purchase of P 400,000
machine. Shipping and installation would cost P 5,000 and an additional working capital required
will amount to P 10,000. Proceeds on sale of scraps and other old parts of the factory upon
automation will amount to P 15,000. The company calculated that automation would result in
savings of P 45,000 a year due to reduced scrap and P 60,000 a year to reduced labor cost. The
machine has a useful life of 5 years and the company will use the straight-line method for
depreciation purposes. The estimated final salvage value of the machine is P 120,000 but will
require dismantling cost of P 10,000. The company is subject to 30% income tax rate.
Required: Evaluate the project using NPV techniques

3. LT Group Inc. is considering replacing its hand-operated machine with the purchase of a new
fully-automated machine. Data regarding the existing and new machines are presented below:
Existing Machine New Machine
Original Cost P 100,000 P 200,000
Installation Cost P 8,000
Freight and Insurance P 20,000
Depreciation Method straight line straight line
Expected Useful Life 10 years 5 years

The existing machine has been in service for seven years and could be sold currently for P 50,000.
The company expects to realize a before-tax annual reduction in labor costs of P 60,000 if the
new machine is purchased and placed in service. LT Group Inc.’s tax rate is 30% and cost of
capital is 12%.
Required: Evaluate the project using NPV techniques

4. PAL Corporation recently purchased a P 900,000 asset that has three-year service life and no
salvage value. The expected pre-tax annual cash return is P 500,000. The company is subject to
30% income tax rate and employs a 20% after tax hurdle rate of return in capital investment
decisions. Management is studying whether to depreciate the asset using the straight-line
method or sum-of-the-years’ digit method.
Required:
a. How much is the NPV if the company uses straight line method of depreciation?
b. How much is the NPV if the company uses sum-of-the-years’ digit method of depreciation?
c. How much is the total present value of tax shield from depreciation if SYD method is used
instead of a straight-line method?
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5. A new machine is expected to provide over the next six years. It will cost P 600,000, an expected
salvage value of P 30,000, generates annual cash revenues and operating expenses as follows:
Revenues Expenses
Year 1 P 200,000 P 80,000
Year 2 P 180,000 P 50,000
Year 3 P 180,000 P 30,000
Year 4 P 60,000 P 10,000
Year 5 P 90,000 P 30,000
Year 6 P 100,000 P 45,000
This new machine will replace existing equipment with a carrying value of P 50,000 but with a
current market value of P 75,000 and sill has an estimated useful life of 4 years. Assume tax rate
of 30% and cost of capital of 10%.
Required: Evaluate the project using NPV techniques

6. Asia Brewery Company has gathered the following data on a proposal investment project:
Cost of the investment P1,200,000
Additional Working Capital required 50,000
Annual cost savings 240,000
Estimated Salvage value 20,000
Estimated Disposal cost 10,000
Required maintenance cost – end of 3rd year 5,000
Required Maintenance cost – end of 7th year 7,000
Life of the project 10 years
Discount Rate 10%
Tax Rate 40%
Required: What is the net present value of this investment?

7. Tanduay Distillers needs to add a small plant to accommodate a special contract to supply
building materials over five-year period. The required initial cash outlays at time 0 are as follows:
Land P500,000
New building P2,000,000
Equipment P3,000,000
Tanduay uses straight-line depreciation for tax purposes and will depreciate the building over 5
years and equipment over 5 years. Tanduay’s effective tax rate is 40% and the cost of capital is
14%. Revenues from the special contract are estimated at P1.2 million annually, and cash
expenses are estimated at P300,000 annually. At the end of the fifth year, the assumed sales
values of the land and building are P800,000 and P500,000, respectively. It is further assumed the
equipment will removed at a cost of P50,000 and sold for P300,000.
Required:
a. Compute the investment’s net present value
b. Compute the profitability index of the investment

8. Fortune Tobacco Corporation acquired an asset at a cost of P46,000. It had an estimated useful
life of ten years, annual after tax cash benefits are estimated at P10,000 at the end of each year.
The following appear in the interest table for the present value of an annuity of 1 at the yearend
for ten periods:
16% - 4.83 18% - 4.49 20% - 4.19
Required: Determine the internal rate of return.

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9. The following data pertain to an investment in equipment:
Investment cost P20,000
Pre-tax net annual cash inflow 3,200
Life of the project 8 years
Tax rate 40%
Required: Determine the internal rate of return of the investment.

10. The following pertains to Eton Properties Corporation’s investment plan

Investment costs 400,000
annual cash savings 250,000
Required: (disregard the effect of tax)
a. Compute the payback period of the investment in equipment.
b. Compute the payback reciprocal of the investment in equipment.
c. What is the payback period of the equipment if instead of annual cash saving if P240,000, the
following are expected annual cash savings:
Period 1 – P180,000
Period 2 – P140,000
Period 3 – P200,000
d. What is the investment bail-out period if aside from the annual cash saving given in the
previous item, the following is the salvage value for each of the period:
Period 1 – P210,000
Period 2 – P150,000
Period 3 – P 20,000

11. PNB Corporation has an opportunity to acquire a franchise from the Allied B Corporation. PNB
Company has assembled the following information relating to the franchise:
a. Total initial franchising, remodeling and equipment would cost P337,500. Depreciable and
amortizable assets will be depreciated using the straight-line method over a 5 year life and
a P45,000 salvage value.
b. A suitable location in a large shopping mall can be rented for P4,300 per month.
c. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total P375,000
per year and the ingredients would cost 20% of sales.
d. Operating cost would include P87,500 per year for salaries, P5,000 per year for insurance,
and P33,000 per year for utilities. In addition, Mr. Alonzo would have to pay a commission
to Green Tea, Inc., of 5% of sales.
e. Alonzo is subject to income tax rate of 40%.
Required: Compute the accounting rate of return of the investment.
A. Based in the initial investment.
B. Based on average investment.

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