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11 Capital Budgeting w ans key only 165
Accounting (ACC 156)
University of Iloilo - PHINMA
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Theory Capital Budgeting Process
The long-term planning process for making and financing investments that affects a company’s financial results over a number of years is referred to as: A. capital budgeting C. master budgeting B. long-range planning D. strategic planning
Capital budgeting is the process: A. of eliminating unprofitable product line. B. of making capital expenditure decisions. C. used in a sell or process further decision. D. of determining how much capital stock to issue.
What does the term capital budgeting mean in the context of making capital expenditure decisions? A. The process of choosing assets. B. The process of allocating the funds among assets. C. The process of acquiring the funds to finance the business. D. None of the given choices.
A capital investment decision is essentially a decision to exchange current: A. assets for current liabilities. B. cash inflows for future cash outflows. C. cash outflows for the promise of receiving future cash inflows. D. cash flows from operating activities for future cash inflows from investing activities
How should the following projects be listed in their order of increasing risk? A. Expansion, replacement, new venture. B. New venture, replacement, expansion. C. Replacement, expansion, new venture. D. Replacement, new venture, expansion.
A project that when accepted or rejected will not affect the cash flows of another project refers to: A. dependent projects C. mutually exclusive projects B. independent projects D. sustaining project
Competing investment projects where accepting one project eliminates the possibility of taking the remaining projects is referred to as: A. Common projects C. Mutually-exclusive projects B. Independent projects D. Mutually-inclusive projects
Mutually exclusive projects are those that A. require all managers to consider. B. if accepted, preclude the acceptance of competing projects. C. if accepted, can have a negative effect on the company’s profit. D. if accepted, can also lead to the acceptance of a competing project.
The normal methods of analyzing investments A. cannot be used by not-for-profit entities. B. do not apply if the project will not produce revenues. C. require forecasts of cash flows expected from the project. D. cannot be used if the company plans to finance the project with funds already available internally.
Which of the following represents the biggest challenge in the decision to purchase new equipment? A. Estimating cash flows for the future. B. Estimating employee training for the new project. C. Estimating transportation costs of the new equipment. D. Estimating maintenance costs for the new equipment.
The only future costs that are relevant to deciding whether to accept an investment are those that will A. be deductible for tax purposes.
B. affect net income in the period that they are incurred. C. be saved if the project is accepted rather than rejected. D. be different if the project is accepted rather than rejected.
In which circumstances should the tax consequences be considered when making capital investment decisions? A. Depreciation C. Positive net income B. Disposal of an asset D. All of the given choices
Cost of capital is the: A. amount the company must pay for its plant assets. B. dividends a company must pay on its equity securities. C. cost the company must incur to obtain its capital resources. D. cost the company is charged by investment bankers who handle the issuance of equity or long-term debt securities.
The appropriate discount rate that the analysts use in computing the present value of future cash flows is comprised of which of the following? A. A risk factor reflecting the riskiness of the project. B. A pure rate of interest reflecting the productive capability of the capital asset. C. An increase in the rate reflecting the inflation expected to occur over the life of the project. D. All of the given choices are components of the discount rate.
Problems associated with justifying investments in high-tech projects often include A. discount rates that are too low and time horizons that are too long B. discount rates that are too high and time horizons that are too long C. discount rates that are too low and time horizons that are too short D. discount rates that are too high and time horizons that are too short
If Troy Company expects to get a one-year bank loan to help cover the initial financing of one of its capital projects, the analysis of the project should A. ignore the loan B. show the loan as an increase in the investment. C. show the loan as a cash outflow in the second year of the project’s life. D. offset the loan against any investment in inventory or receivables required by the project.
A thorough evaluation of how well a project’s actual performance matches the projections made when the project was proposed is called a A. post-audit C. risk analysis B. pre-audit D. sensitivity analysis
Post-audit of capital projects: A. is usually conclusive. B. is done using different evaluation techniques than what were used in making the original capital budgeting decision. C. provides a formal mechanism by which the company can determine whether existing projects should be supported or terminated. D. all of the given choices. m Cash Flow Computation
In addition to incremental revenues, cash inflows from capital investments can be generated from all of the following sources except A. cost savings B. debt financing C. salvage value D. reduction in the amount of working capital
Which of the following is not a typical cash outflow associated with
D. Can deduct depreciation expenses on their financial statements, reducing reported income before tax.
When evaluating depreciation methods, the managers who are concerned about capital investment decisions most likely A. choose straight line depreciation so there is minimum impact on the decision. B. use accelerated methods to have as much depreciation in the early years of an asset’s life. C. use units of production so more depreciation expense will be allocated to the later years. D. Assume that the choice of depreciation method has no impact on the capital investment decision.
The periodic cash flows associated with an investment project include which of the following? A. Purchase of asset and freight cost B. Savings in taxes caused by deductibility of depreciation on tax return C. Income tax effect of gain (loss) on disposal of existing assets in an asset replacement decision D. All of these are periodic cash flows in an investment project
Non-discounted Methods 31. The primary advantages of the average rate of return method are its ease of computation and the fact that: A. Rankings of proposals are necessary B. It is especially useful to managers whose primary concern is liquidity C. It emphasizes the amount of income earned over the life of the proposal D. There is less possibility of loss from changes in economic conditions and obsolescence when the commitment is short-
term
Which of the following capital budgeting methods is the least theoretically correct? A. internal rate of return C. payback method B. net present value D. none of the given choices
The length of time needed for a long-term project to recapture its initial investment amount is called the: A. Discount period C. Payback period B. Internal rate of return D. Present value
The technique which is most concerned with liquidity is the A. book rate of return C. net present value technique B. internal rate of return D. payback method
Which of the following is a potential use of the payback method? A. Help control the risk of obsolescence B. Help minimize the impact of the investment on liquidity C. Help managers control the risks of estimating cash flows D. All of the answers are correct
Which of the following is NOT a defect of the payback method? A. It ignores profitability. B. It ignores the present values of cash flows. C. It ignores cash flows because it uses net income. D. It ignores the pattern of cash flows beyond the payback period.
If a payback period for a project is greater than its expected useful life, the A. project will always be profitable. B. entire initial investment will not be recovered. C. project’s return will always exceed the company’s cost of capital. D. project would only be acceptable if the company’s cost of capital was low.
The payback method, as a capital budgeting technique, assumes that all intermediate cash inflows are reinvested to yield a return equal to: A. The Cost-of-Capital C. The Time-Adjusted-Rate-of- Return B. The Discount Rate D. Zero
Discounted Cash Flow Methods 39. The primary capital budgeting method that uses discounted cash flow technique is the: A. annual rate of return method. C. net present value method. B. cash payback technique. D. profitability index method.
Which of the following capital budgeting methods assumes that intermediate cash inflows are reinvested at the minimum acceptable rate of return? A. Internal rate of return method. C. Payback method. B. Net present value method. D. Unadjusted rate of return method.
The internal rate of return method assumes that intermediate cash flows are immediately reinvested at: A. The company’s discount rate. B. The actual rate of return earned by the project. C. An average of the internal rate of return and the discount rate. D. The lower of the company’s discount rate or internal rate of return.
When using the net present value method, the interest rate used to discount cash flows should not be thought of as the: A. Discount rate C. Internal rate of return B. Hurdle rate D. Minimum required rate of return
The profitability index A. will never be greater than 1.
B. does not take into account the discounted cash flows. C. Is calculated by dividing total cash flows by the initial investment. D. allows comparison of the relative desirability of projects that require varying initial investments.
Which of the following, when used as the discount rate, equates the net present value of a series of cash flows to zero? A. Breakeven time C. Internal rate of return B. External rate of return D. Investment rate of return
Which of the following statements is false regarding the interest rate used in net present value calculations? A. It may be adjusted for uncertainty. B. Some companies use their cost of capital as the discount rate. C. It may be higher or lower than the investment’s actual internal rate of return. D. It should be equal to the maximum required rate of return needed to make the investment profitable.
The rate that produces a zero net present value when a project’s discounted cash operating advantage is compared to its discounted net investment is the: A. Cost of capital C. Cutoff rate B. Discount rate D. Internal rate of return
If the internal rate of return on an investment is zero: A. its NPV is positive. B. it is generally a wise investment. C. its cash flows decrease over its life. D. its annual cash flows equal its required investment.
If the present value of the future cash flows for an investment equals the required investment, the IRR A. equals zero. B. equals the cutoff rate. C. equals the cost of borrowed capital. D. Is lower than the company’s cutoff rate return.
A. only tangible benefits should be considered. B. only intangible benefits should be considered. C. both tangible and intangible benefits should be considered. D. neither tangible nor intangible benefits should be considered.
The net present value (NPV) model can be used to evaluate and rank two or more proposed projects. The approach that computes the total impact on cash flows for each option and then converts these total cash flows to their present values is called the A. contribution approach C. incremental approach B. differential approach D. total project approach
NPV indicates that a project is deemed desirable when the net present value is: A. less than zero B. greater than or equal to zero C. less than or equal to the risk-adjusted cost of capital D. greater than or equal to the risk-adjusted cost of capital
An analysis of a proposal by the net present value method indicated that the present value of future cash inflows exceeded the amount to be invested. Which of the following statements best describes the results of this analysis? A. The proposal is desirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis B. The proposal is desirable and the rate of return expected from the proposal is less than the minimum rate used for the analysis C. The proposal is undesirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis D. The proposal is undesirable and the rate of return expected from the proposal is less than the minimum rate used for the analysis
Arbitrary Company uses IRR to evaluate long-term decisions and establishes a cutoff rate of return. Such a cutoff rate is
A. at least equal to its cost of capital. B. greater than the current book rate of return. C. at least equal to the rate used by similar companies. D. greater than the IRR on projects accepted in the past. 62. A weakness of the internal rate of return method for screening investment projects is that it: A. fails to consider the timing of cash flows B. does not consider the time value of money C. implicitly assumes that the company is able to reinvest cash flows from the project at the internal rate of return D. implicitly assumes that the company is able to reinvest cash flows from the project at the company’s discount rate 63. The NPV and IRR methods give A. different rankings of projects with unequal lives. B. the same choice from among mutually exclusive investments. C. the same decision (accept or reject) for any single investment. D. the same rankings of projects with different required investments. 64. In choosing from among mutually exclusive investments, the manager should normally select the one with the highest: A. Book rate of return C. Net present value B. Internal rate return D. Profitability index
- Project Alpha has an expected cash flow of P500,000 at the end of year 5. Project Bravo has expected cash flows of P100,000 to be received at the end of each year for the next five years. What can be said of the net present value of Project Alpha compared to Project Bravo? A. Project Alpha is preferred because of the largest lump-sum payment in year 5. B. They are the same because both cash flows total P500, over the lives of the projects. C. Both Project Alpha and Project Bravo have the same internal rate of return and either should be accepted. D. Project Bravo is preferred because of the periodic payments
made consistently throughout the years and are made earlier.
The calculation of the profitability index (PI) is most helpful for which type of decisions? A. Preference C. Screening B. Qualitative D. Short-term
Why do NPV method and the IRR method sometimes give different rankings of mutually exclusive investment projects? A. The IRR method does not assume reinvestment of the cash flows while the NPV assumes the reinvestment rate is equal to the discount rate. B. The NPV method does not assume reinvestment of cash flows while the IRR method assumes the cash flows will be reinvested at the internal rate of return. C. The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method assumes a reinvestment rate equal to the internal rate of return. D. The NPV method assumes a reinvestment rate equal to the bank loan interest rate while the IRR method assumes a reinvestment rate equal to the discount rate.
When comparing NPV and IRR, which is incorrect? A. Both NPV and IRR can be used for screening decisions B. With IRR, cash flows can be adjusted to account for risk C. NPV can be used to compare investments of various size or magnitude D. With NPV, the discount rate can be adjusted to take into account increased risk and the uncertainty of cash flows
Risk Analysis in Capital Budgeting 69. An approach that uses a number of outcome estimates to get a sense of the variability among potential returns is A. risk analysis. C. the discounted cash flow technique. B. sensitivity analysis. D. the net present value method.
Sensitivity analysis is A. typically conducted in the post investment audit B. useful in measuring the variance of the Fisher rate C. an appropriate response to uncertainty in cash flow projections D. useful to compare projects requiring vastly different levels of initial investment
In capital budgeting, sensitivity analysis is used to: A. test the relationship of the IRR and NPV. B. evaluate mutually exclusive investments. C. determine whether an investment is profitable. D. see how a decision would be affected by changes in variables.
The higher the risk element in a project, the A. higher the cost of capitals is. C. higher the net present value is. B. higher the discount rate required is. D. more attractive the investment is.
Which of the following would decrease the net present value of a project? A. An increase in the discount rate B. A decrease in the income tax rate C. A decrease in the initial investment D. An increase in the useful life of the project
XYZ Co. is adopting just-in-time approach. When evaluating an investment project that would reduce inventory, how should XYZ treat the reduction? A. Ignore it. B. Decrease the cost of the investment. C. Decrease the cost of the investment and decrease cash flows at the end of the project’s life. D. Decrease the cost of the investment and increase the cash flow at the end of the project’s life.
available by the management: Old New Equipment cost P70, 0
P120,
00
Current salvage value 14,000 - Salvage value, end of useful life
5,000 16,
Annual operating costs 44,000 32, Accumulated depreciation
55,300 -
Estimated useful life 10 yea rs
10
yea rs The company is not subject to tax and its cost of capital is 12%. What is the present value of all the relevant cash flows at time zero? A. (P 54,000) C. (P120,000) B. (P106,000) D. (P124,700)
Depreciation Tax Shield 3. Myriad Company is considering replacing its old machine with a new and more efficient one. The old machine has book value of P100,000, a remaining useful life of 4 years, and annual straight- line depreciation of P25,000. The existing machine has a current market value of P80,000. The replacement machine would cost P160,000, have a 4-year life, and will save P50,000 per year in cash operating costs. If the replacement machine would be depreciated using the straight-line method and the tax rate is 40%, what should be the increase in annual income taxes? A. P 4,000 C. P28, B. P14,000 D. P40,
Accounting Rate of Return 4. An asset was purchased for P66,000. The asset is expected to last for 6 years and will have a salvage value of P16,000. The company expects the income before tax to be P7,200 and the tax rate
applicable to the company is 30%. What is the average return on investment (accounting rate of return)? A. 7% C. 12% B. 10% D. 17%
- A piece of labor saving equipment that Marubeni Electronics Company could use to reduce costs in one of its plants in Angeles City has just come onto the market. Relevant data relating to the equipment follow: Purchase cost of the equipment P432, Annual cost savings that will be provided by the equipment 90, Life of the equipment 12 years What is the simple rate of return to be provided by the equipment? A. 12% C. 20% B. Between 15% and 18% D. 25%
Net Investment 6. The Miracle Company is planning to purchase a new machine which it will depreciate, for book purposes, on a straight-line basis over a ten-year period with no salvage value and a full year’s depreciation taken in the year of acquisition. The new machine is expected to produce cash flows from operations, net of income taxes, of P66,000 a year in each of the next ten years. The accounting (book value) rate of return on the initial investment is expected to be 12 percent. How much will the new machine cost? A. P300,000 C. P660, B. P550,000 D. P792,
- The Fields Company is planning to purchase a new machine which it will depreciate, for book purposes, on a straight-line basis over a ten-year period with no salvage value and a full year’s depreciation taken in the year of acquisition. The new machine is expected to produce cash flow from operations, net of income taxes, of P66, a year in each of the next ten years. The accounting (book value) rate of return on the initial investment is expected to be 12%.
How much will the new machine cost? A. P300,000 C. P660, B. P550,000 D. P792,
Annual Cash Flow 8. The Hills Company, a calendar company, purchased a new machine for P280,000 on January 1. Depreciation for tax purposes will be P35,000 annually for eight years. The accounting (book value) rate of return (ARR) is expected to be 15% on the initial increase in required investment. On the assumption of a uniform cash inflow, this investment is expected to provide annual cash flow from operations, net of income taxes, of A. P35,000 C. P42, B. P40,250 D. P77,
Payback Period 9. If an asset costs P35,000 and is expected to have a P5,000 salvage value at the end of its ten-year life, and generates annual net cash inflows of P5,000 each year, the cash payback period is A. 5 years C. 7 years B. 6 years D. 8 years
Machine Manufacturing Company considers a project that will require an initial investment of P500,000 and is expected to generate future cash flows of P200,000 for years 1 through 3 and P100,000 for years 4 through 7. The project’s payback period is: A. 1 years C. 3 years B. 2 years D. 3 years
Consider a project that requires cash outflow of P50,000 with a life of eight years and a salvage value of P5,000. Annual before-tax cash inflow amounts to P10,000. Salvage value is ignored in computing depreciation. Assuming a tax rate of 30% and a required rate of return of 8%, what is the payback period for the project? A. 5 years C. 6 years B. 5 years D. 6 years
Umali Corporation is considering an investment in a new cheese- cutting machine to replace its existing cheese cutter. Information on the existing machine and the replacement machine follow: Cost of the new machine P400, Net annual savings in operating costs 90, Salvage value now of the old machine 60, Salvage value of the old machine in 8 years 0 Salvage value of the new machine in 8 years 50, Estimated life of the new machine 8 years What is the expected payback period for the new machine? A. 2 years C. 4 years B. 3 years D. 8 years
Pale Products Company is considering the purchase of a new machine. The estimated cost of the machine is P300,000. The machine is not expected to have a residual value at the end of four years. The machine is expected to generate annual cash inflows for the next four years as follows: Year Annual Cash Inflow 1 P150, 2 P120, 3 P 90, 4 P 50, Pale Products has a policy of accepting a project only if it has a payback period of not longer than 3 years. What is the expected payback period for this project? A. 2 years C. 3 years B. 2 years D. 3 years
For P4,500,000, Siren Corporation purchased a new machine with an estimated useful life of five years with no salvage value at its retirement. The machine is expected to produce cash flow from operations, net of income taxes, as follows: First year P 900, Second year 1,200,
B. P25,731 D. P42,
Prime Consulting, Inc. operates consulting offices in Manila, Olongapo, and Cebu. The firm is presently considering an investment in a new mainframe computer and communication software. The computer would cost P6 million and have an expected life of 8 years. For tax purposes, the computer can be depreciated using either straight-line method or Sum-of-the-Years’- Digits (SYD) method over five years. No salvage value is recognized in computing depreciation expense and no salvage value is expected at the end of the life of the equipment. The company’s cost of capital is 10 percent and its tax rate is 40 percent. The present value of annuity of 1 for 5 periods is 3 and for 8 periods is 5. The present values of 1 end of each period are: 1 0 5 0. 2 0 6 0. 3 0 7 0. 4 0 8 0. The present value of the net advantage of using SYD method of depreciation with a five-year life instead of straight-line method of depreciating the equipment is: A. P 86,224 C. P215, B. P115,168 D. P287,
For P450,000, Maleen Corporation purchased a new machine with an estimated useful life of five years with no salvage value. The machine is expected to produce cash flow from operations, net of 40 percent income taxes, as follows: First year P160, Second year 140, Third year 180, Fourth year 120, Fifth year 100, Maleen will use the sum-of-the-years-digits’ method to depreciate the new machine as follows: First year P150,
Second year 120, Third year 90, Fourth year 60, Fifth year 30, The present value of 1 for 5 periods at 12 percent is 3. The present values of 1 at 12 percent at end of each period are: End of: Period 1 0. Period 2 0. Period 3 0. Period 4 0. Period 5 0. Had Maleen used straight-line method of depreciation instead of declining method, what is the difference in net present value provided by the machine at a discount rate of 12 percent? A. Decrease of P 9,750 C. Increase of P 9, B. Decrease of P24,376 D. Increase of P24,
Net Present Value 21. Consider a project that requires an initial cash outflow of P500, with a life of eight years and a salvage value of P20,000 upon its retirement. Annual cash inflow before tax amounts to P100, and a tax rate of 30 percent will be applicable. The required minimum rate of return for this type of investment is 8 percent. The present value of 1 and the annuity of 1, discounted at 8 percent for 8 periods are 0 and 5, respectively. Salvage value is ignored in computing depreciation. The net present value amounts to A. P 7,560 C. P 17, B. P 10,050 D. P 20,
- Polar Company purchased an asset costing P90,000. Annual operating cash inflows are expected to be P20,000 each year for six years. No salvage value is expected at the end of the asset’s life. The company applies a 16 percent minimum acceptable rate of return for this kind of investment. The details of the present
values at 16%, six periods are: Present value of ordinary annuity of 1 3. Present value of annuity due of 1 4. Assuming Polar’s cost of capital is 16 percent, what is the asset’s net present value? (ignore income taxes). A. P(16,306) C. P 4, B. P (4,514) D. P 30,
Mid-Circle Products, Inc. purchased equipment costing P100,000. Annual operating cash inflows are expected to be P30,000 each year for five years. At the end of the equipment’s life, the salvage value is expected to be P6,000. The present value of cash inflows per 1 at 1 percent, 5 years are: Present value of 1, end of 5 periods 0. Present value of ordinary annuity of 1, 5 periods3. Present value of annuity due of 1, 5 periods 3. If Mid-Circle’s cost of capital is 14 percent, what is the asset’s net present value? (ignore income taxes). A. P 6,109 C. P20, B. P 7,840 D. P23,
Blue Marine Aggregates, Inc. plans to replace one of its machines with a new efficient one. The old machine has a net book value of P120,000 with remaining economic life of 4 years. This old machine can be sold for P80,000. If the new machine were acquired, the cash operating expenses will be reduced from P240,000 to P160,000 for each of the four years, the expected economic life of the new machine. The new machine will cost Blue Marine a cash payment to the dealer of P300,000. The company is subject to 32 percent tax and for this kind of investment, a marginal cost of capital of 9 percent. The present value of annuity of 1 and the present value of 1 for 4 periods using 9 percent are 3 and 0, respectively.
The net present value to be provided by the replacement of the old machine is
A. P15,693 C. P46,
B. P28,493 D. P59,
Paulina’s Products, Inc. is considering a new piece of equipment that costs P75,000. The equipment is expected to generate revenues before-tax cash inflows of P25,000 per year for five years. The equipment would be depreciated using straight-line method over its five-year life. Upon retirement, the machine is expected to have a market value of P8,000. The company considers the maximum impact of income taxes in all of its capital investment decisions. The company has a 35 percent income tax rate and desires an after-tax rate of return of 12 percent on its investment. The present value of 1, end of 5 years at 12% is 0 and for ordinary annuity is 3. The net present value of the equipment is: A. P 4,539 C. P 7, B. P 5,453 D. P 21,
Zambales Mines, Inc. is contemplating the purchase of a piece of equipment to exploit a mineral deposit that is located on land to which the company has mineral rights. Based on an engineering and cost analysis, the following cash flows associated with opening and operating a mine in the area are expected. Cost of new equipment and timbers 2,750, Working capital required 1,000, Net annual cash receipts* 1,200, Cost to construct new road in three years400, Salvage value of equipment in 4 years 650, *Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, etc. It is estimated that the mineral deposit would be exhausted after four years of mining. At that point, the working capital would be released for reinvestment elsewhere. The company’s discount rate is 20%. The net present value for the project is:
Profitability Index 30. The Mejicano Company is planning to purchase a piece of equipment that will reduce annual cash expenses over its 5-year useful life by equal amounts. The company will depreciate the equipment using straight-line method of depreciation based on an estimated life of 5 years without any salvage value. The company is subject to 40 percent tax. The marginal cost of capital for this acquisition is 11 percent. The management accountant calculates, based on the estimated after-tax cash flows, that the internal-rate of return is 12 percent and net present value of P10,000. The president, however, wants to know the profitability index before he finally decides. What is the profitability index for this investment? A. 1 C. 1. B. 1 D. 1.
The Premiere Corporation has to replace its completely damaged boiler machine with a new one. The old machine has a net book value of P100,000 with zero market value; therefore it will give a tax shield, based on 35% tax rate if replaced, by P35,000. The company has a 10 percent cost of capital. Understandably, the new machine, through a uniform decrease in cash operating costs, will give a positive net present value because this machine will provide an internal rate of return of 12 percent. The present values at 10% and 12%, respectively, are: 10% 12% Annuity of 1, 6 periods 4 4. 1 end of 6 periods 0 0. If the machine were to be depreciated using straight-line method for 6 years without any salvage value, the estimated profitability index is: A. 0 C. 1. B. 1 D. 1.
Rainbow Company has a project that requires an initial investment of P100,000 and has the following expected stream of cash inflows:
Year Annual Cash Inflow 1 P80, 2 P60, 3 P20, The present value of annuity of 1 at 12 percent for 3 periods 2 is and the details are: Year Annual Cash Inflow 1 0. 2 0. 3 0. Assuming the company adopts the cost of capital of 12 percent as the discount rate, what is the profitability index for the project? A. 0 C. 1. B. 1 D. 2.
Internal Rate of Return 33. Vendo Company is planning to buy a coin-operated machine costing P400,000. For book and tax purposes, this machine will be depreciated P80,000 each year for five years. Vendo estimates that this machine will yield an annual inflow, net of depreciation and income taxes, of P120,000. Vendo’s desired rate of return on its investments is 12%. At the following discount rates, the NPVs of the investment in this machine are: Discount Rate NPV 12% +P3, 14% + 1, 16% - 708 18% - 2,
Vendo’s expected IRR on its investment in this machine is A. 3% C. 15% B. 12% D. 16%
Net Investment 34. Kipling Company has invested in a project that has an eight-year life. It is expected that the annual cash inflow from the project
will be P20,000. Assuming that the project has a internal rate of return of 12%, how much was the initial investment in the project if the present value of annuity of 1 for 8 periods is 4 and the present value of 1 is 0? A. P 64,640 C. P 99, B. P 80,800 D. P160,
Capital Company requires all capital investment to generate an internal rate of return of 16 percent. Capital is currently considering an investment in a machine that is expected to generate annual cash inflows of P15,000 for 7 years. The present value of ordinary annuity of 1, 16 percent for 7 years is 4. Applying the discounted technique, the amount of investment should not exceed: A. P16,800 C. P60, B. P37,150 D. P95,
Camel Company invests in a machine with a useful life of six years and no salvage value. The machine will be depreciated using the straight-line method. It is expected to produce annual cash inflow from operations, net of income taxes, of P6,000. The present value of an ordinary annuity of P1 for six periods at 10% is 4. The present value of P1 for six periods at 10% is 0. Assuming that Camel uses a time-adjusted rate of return of 10%, how much is the original investment? A. P10,640 C. P26, B. P22,750 D. P29,
Annual Cash Flow 37. Taal Company is considering the purchase of a machine that promises to reduce operating costs by equal amounts every year of its 6-year useful life. The machine will cost P840,000 and has no salvage value. The machine has a 20% internal rate of return. Taal Company is subject to 40% income tax rate. The present value of annuity of 1 for 6 periods at 20% is 3, and the present value at the end of 6 periods is 0. The approximate annual cash savings before tax is closest to:
A. P112,555 C. P252,
B. P187,592 D. P327,
An asset is purchased for P120,000. It is expected to provide an additional P28,000 of annual net cash inflows. The asset has a 10- year life and an expected salvage value of P12,000. The hurdle rate is 10%. The present value of an annuity factor of 10% for 10 years is 6, and the present value of P1, discounted for 10 years at 10% is 0. Given the data provided, the minimum amount of annual cash inflows that would provide the 10% time-adjusted return is approximately A. P18,776 C. P24, B. P22,535 D. P26,
Pacau, Inc. requires all its capital investments to generate an internal rate of return of 14 percent. The company is considering an investment costing P80,000 that is expected to generate equal annual cash inflows for 5 years. The present value of 1, end of 5 years is 0 and the present value of annuity of 1 is 3. based on 14 percent required rate of return. To meet the 14 percent minimum acceptable rate of return, the estimated annual cash inflow (ignoring income taxes) is: A. P 23,303 C. P154, B. P 51,550 D. P274,
Aloha Co. is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin. The new ship would cost P500,000 and would be fully depreciated by the straight-line method over 10 years. At the end of 10 years, the ship will have no value and will be sunk in some already polluted harbor. The Aloha Co.’s cost of capital is 12 percent, and its marginal tax rate is 40 percent. If the ship produces equal annual labor cost savings over its 10-year life, how much do the annual savings in labor costs need to be to generate a net present value of P0 on the project? Use the following PV: annuity of 1, 10 periods at 12% - 5;
is 3 based on 12 percent required rate of return. To meet the 12 percent minimum acceptable rate of return required by Mermaid, the estimated salvage value at the end of 5 years(ignoring income taxes) should be: A. P 1,611 C. P10, B. P 3,296 D. P20,
Comprehensive The next two questions are based on the following information. Paper Products Company is considering a new product that will sell for P100 and has a variable cost of P60. Expected volume is 20,000 units. New equipment costing P1,500,000 and having a five-year useful life and no salvage value is needed, and will be depreciated using the straight-line method. The machine has fixed cash operating costs of P200,000 per year. The firm is in the 40 percent tax bracket and has cost of capital of 12 percent. The present value of 1, end of five periods is 0; present value of annuity of 1 for 5 periods is 3.
How many units per year the firm must sell for the investment to earn 12 percent internal rate of return? A. 9,838 C. 17, B. 12,338 D. 28,
Suppose the 20,000 estimated sales volume is sound, but the price is in doubt, what is the selling price (rounded to nearest peso) needed to earn a 12 percent internal rate of return? A. P70 C. P90. B. P81 D. P95.
Project Screening, Project Ranking & Capital Rationing 48. Perpetual Foundation, Inc., a nonprofit organization, has one of its activities, the production of cookies for its snack food store. Several years ago, Perpetual Foundation, Inc. purchased a special
cookie-cutting machine. As of December 31, 2008, this machine would have been used for three years. Management is considering the purchase of a newer, more efficient machine. If purchased, the new machine would be acquired on December 31, 2008. Management expects to sell 300,000 dozen cookies in each of the next six years. The selling price of the cookies is expected to average P1 per dozen.
Perpetual Foundation, Inc. has two options: continue to operate the old machine, or sell the old machine and purchase the new machine. No trade-in was offered by the seller of the new machine. The following information has been assembled to help management decide which option is more desirable. Old Machine New Machine Original cost of machine at acquisition P80,000 P120, Remaining useful life as of 12/31/08 6 years 6 years Expected annual cash operating expenses: Variable cost per dozen P0 P0. Total fixed costs P21,000 P 11, Estimated cash value of machines: December 31, 2008 P40,000 P120, December 31, 2014 P 7,000 P 20, Assume all operating revenues and expenses occur at the end of the year. The net advantage in present value, using a 16% rate, of the better alternative is: A. Buy New Machine, P16,345. C. Retain Old Machine, P16,345. B. Buy New Machine, P61,675. D. Retain Old Machine, P61,675.
The next two questions are based on the following information. Savior Products is considering a purchase of any of two types of machinery. The first machine costs P50,000 more than the second machine. During the two-year life of these two alternatives, the first machine has a P155,000 more cash flow in year one and a P110, less cash flow in year two than the seconds machine. All cash flows occur at year-end. The present value of 1 at 15 percent end of 1
period and 2 periods are 0 and, 0, respectively. The present value of 1 at 8 percent end of period 1 is 0, and Period 2 is 0.
- Which machine should be purchased if the relevant discount rates are 15 percent and 8 percent, respectively? A. B. C. D. 15% Discount
Machine 1 Machine 1 Machine 2 Machine 2
8% Discount
Machine 1 Machine 2 Machine 1 Machine 2
- At what discount rate would Machine 1 be equally acceptable as machine 2’s? A. 9% C. 11% B. 10% D. 12%
Comprehensive The next two questions are based on the following information. Vivo Insurance Company’s management is considering an advertising program that would require an initial expenditure of P165,500 and bring in additional sales over the next five years. The cost of advertising is immediately recognized as expense. The projected additional sales revenue in Year 1 is P75,000, with associated expenses of P25,000. The additional sales revenue and expenses from the advertising program are projected to increase by 10 percent each year. Vivo Insurance Company’s tax rate is 40 percent. The present value of 1 at 10 percent, end of each period: Period Present value of 1 1 0. 2 0. 3 0. 4 0. 5 0.
- The payback period for the advertising program is
A. 1 years C. 3 years B. 2 years D. 4 years
- The net present value of the advertising program would be A. P(37,064) C. P 29, B. P(29,136) D. P 37, The next three question Nos. are based on the following information. Cayco Medical Center is considering purchasing an ultrasound machine for P950,000. The machine has a 10 – year life and an estimated salvage value of P55,000. Installation costs and freight charges will be P24,200 and P800, respectively. Cayco uses straight-line depreciation.
The medical center estimates that the machine will be used five times a week with the average charges to the patient for ultrasound of P800. There are P10 in medical supplies and P40 of technician costs for each procedure performed using the machine. The present value of an annuity of 1 for 10 years at 9% is 6 while the present value of 1 for 10 years at 9% is 0.
What is the accounting rate of return provided by the project? A. 10 percent C. 20 percent B. 11 percent D. 38 percent
The cash payback period is: A. 3 years C. 5 years B. 4 years D. 6 years
The project is expected to generate net present value of: A. P253,277 C. P299, B. P276,510 D. P331,
The next three question are based on the following information. Kabalikat Company has the opportunity to introduce a new product. Kabalikat expects the product to sell for P75 with variable cost per unit of P50. The annual fixed costs, excluding the amount of depreciation is P4,500,000. The company expects to sell 300,000 units. To produce
11 Capital Budgeting w ans key only 165
Course: Accounting (ACC 156)
University: University of Iloilo - PHINMA
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