CHAPTER 14

CAPITAL BUDGETING

[Problem 1]
Purchase price P140,000
Trade-in allowance ( 7,000)
Saving from repairs ( 25,000)
Additional tax on savings (P25,000 x 40%) 10,000
Net cost of investment for decision analysis P118,000

[Problem 2]
Purchase price P4,800,000
Freight and installation 45,000
Trade-in allowance ( 200,000)
Salvage value of other assets 12,000
Tax savings – other assets ( 8,000)
Savings from repairs ( 400,000)
Add’l tax on savings from repairs (P400,000 x 40%) 160,000
Additional working capital 350,000
Net cost of investment for decision analysis P4,759,000

[Problem 3]
Purchase price P900,000
Freight charge 25,000
Installation costs 22,000
Special attachment 55,000
Add’l working capital 110,000
Proceeds from sale of old assets ( 22,000)
Tax savings (P38,000 x 25%) ( 9,500)
Savings from repairs ( 120,000)
Add’l tax on savings from repairs (P120,000 x 25%) 30,000
Net cost of investment for decision analysis P990,500

[Problem 4]
Furnishing and equipment P 500,000
Rental deposits 200,000
Accounts receivable (P9M x 1/3 x 2/3) 2,000 000
Inventory 400,000
Cash 120,000
Net cost of investment for decision analysis P5,020,000
 [Problem 5]
1. Sales P6,000,000
Materials ( 800,000)
Labor ( 1,200,000)
Factory overhead ( 540,000)
Selling and administrative expenses ( 700,000)
Depreciation expense (P1,200,000  5 yrs) ( 240,000)
Income before income tax 2,520,000
Tax (30%) ( 756,000)
Net income 1,764,000
Add back: Depreciation expense 240,000
2. Annual net cash flows P2,004,000

[Problem 6]
1. Weighted Average Cost of Capital (WACOC) = ?
Sources of
capital Market values Individual Cost of Capital Mix WACOC
Capital Fraction
Mortgage bonds (P300,000 x 105%) = P315,000 (10% x 55%) = 5.5% 315 / 1.007 1.72%
Preferred equity (2000 sh x P96) = 192,000 (P12 / P96) = 12.5 192 / 1.007 2.38%
Common equity (50,000 sh x P10) = 500,000 P1.50 / P10 = 15.0 500 / 1.007 7.45%
Total P1,007,000 11.55%
Preferred dividends = 12% x P100 = P12 / sh
Earnings per share = P75,000 / 50,000 sh = P1.50

2.
Proposed
Investment ROI WACOC Advise
A 7% 11.55% Reject
B 10% 11.55% Reject
C 14% 11.55% Accept

Investments are to be accepted if the WACOC is higher than the ROI.

 [Problem 7]
1. New WACOC = ?
Cost of Package 1 Package 2 Package 3
Sources of
Money Capital Amount WACOC Amount WACOC Amount WACOC
Long-term
debt 6% P10,000,000 3% P 2,000 000 0.60% P 6,000,000 1.80%
Preferred
equity 11% 3,000,000 1.65% 11,000 000 6.05% 5,000,000 2.75%
Common 7,000,
equity 14% 7,000,000 4.90% 000 4.90% 9,000,000 6.30%
Total P20,000,000 9.55% P20,000,000 11.55% P20,000,000 10.85%

2. Package 1 gives the invest WACOC at 9.55%.

[Problem 8]
Before Bonds Retirement After Bonds Retirement
Amount WACOC Amount WACOC
Bonds P 5,000,000 (8% x 60% x 5/10) = 2.4% P4,000,000 (8% x 60% x 4/10) = 1.92%
Preferred 1,
equity 1,000,000 (9% x 1/10) = 0.9% 000,000 (9% x 1/10) = 0.90%
Common 4,
equity 4,000,000 (12.5% x 4/10) = 5% 000,000 (12.5% x 4/10) = 5.0%
1,
Lease 000,000 10% x 60% x 1/10) = 0.60%
P
Totals P10,000,000 8.30% 10,000,000 8.42%

[Problem 9]
a. WACOC = ?
Individual Cost of
Funds Amount Capital WACOC
Mortgage bonds P20,000,000 [(6.5% x 50%) / 95%] 3.42% 0.684%
Common stock 25,000,000 [(P4 x 105%) /P94 + 5%] 9.47 2.3675%
Ret earnings 55,000,000 9.47 5.2085%
Total P100,000,000 8.26%

b. The weighted average cost of capital is used as a benchmark in

evaluating the acceptability or rejection of proposed investment because
it measures the point of expected return where the minimum required
return of each class of investor is met by reason of cross-subsidizing
from one class of security to another.

[Problem 10]
a. WACOC under each alternative

Alternative A Alternative B
Debt (9% x 50% x 2/6) = 1.5% (12% x 50% x 4/6) = 4.0%
Equity {[(P1/P20) + 7%] x 4/6} = 8.0% {[(P0.90/P20) + 12%] x 2/6} = 5.5%
WACOC 9.5% 9.5%

b. In alternative B, the amount of debt increases thereby increasing the

debt equity ratio signalling the firm is highly leveraged and more risky for
investment. This tends to increase the nominal rate of the bonds.

c. Yes; it is logical for stockholders to expect a higher dividend growth rate

under alternative B to compensate the higher rate implied by an increase
in the debt exposure of the firm and to validate the theory that the more
debt is used in the financing portfolio, the higher the profitability rate of
the firm, thereby, the higher the growth rate.

[Problem 11]
1. Marginal Cost of Capital for each fund
2. WACOC = ?
Capital
[a] Mix [b]
Sources Individual COC Rate WACOC
Mortgage bonds (14% x60%) = 8.4% 15.00% 1.26%
Debentures (145% x 60%) = 8.7% 25.00% 2.175%
Preferred stock (P13.50/ P99.25) = 13.60% 10.00% 1.36%
Common stock (P1.80 / P67.50 + 10%)=12.67% 16.67% 2.11%
Retained earnings = 12.67% 33.33% 4.22%
100.00% 11.125%
3. Maximum point of expansion for retained earnings:
Net income (P4.50 x 15 million shares) P67,500,000
Common dividends (P67,000,000 x 40%
or P1.80 x 15 million) ( 27,000,000)
Preferred stock dividends ( 6,750,000)
Retained earnings available for expansion P33,750,000
Common equity = 50% of total capitalization
Maximum point of expansion before common stock
shares are issued = P33,750,000 / 50% = P67.5M

4. The WACOC varies among firms in the industry even if the basic
business risk is similar for all firms in the industry. This is true because
 each firm selects the degree of financial leverage it desires. This
financial leverage affects the capital mix structure of a firm that affects
the determination of the weighted average cost of capital.

[Problem 12]
1. WACOC before and after bond retirement:
[1] Before Bond Retirement [2] After Bond retirement
Capital Amount WACOC Amount WACOC
Lease P1,000,000 (10% x 60% x 1/10) = 0.6%
8% Debentures P5,000,000 8% x 60% x 5/10) = 2.4% 4,000,000 (8% 60% x 4/10) = 1.92%
9% Preferred
stock 1,000,000 (9% x 1/10) = 0.9% 1,000,000 {same} 0.9%
Common stock 2,000,000 (13% x 2/10) = 2.6% 2,000,000 {same} 2.6%
Retained
earnings 2,000,000 (13% x 2/10) = 2.4% 2,000,000 {same} 2.4%
P10,000,000 8.30% P10,000,000 8.42%

2. The component costs and the weighting used to calculate the WACOC
in a-1 is different in a-2 because P1 M of debentures are replaced by
lease which is more expensive (from 8% to 10% nominal rate). This
brings up the WACOC to 8.42%.
3. Market values should be used in calculating the WACOC because COC
calculation is used to estimate the current marginal cost of capital for the
company. The use of market values
a. recognizes the current investor attitudes regarding the
company’s risk position and will reflect current rates for capital.
b. recognizes better the capital proportions the company must consider
in the capital sources decision; and
c. ignores the influence of past values which are not relevant to future
decision.

[Problem 13]
1. The board member’s agreement is incorrect because the facts seem to
indicate that Kia Corporation’s capitalization is not in optimum mix (i.e.,
equilibrium). The issuance of new debt will increase the financial
leverage of the firm, increases the risk, increases the note’s nominal rate,
and decreases the earnings multiple. While the marginal cost of capital
is a combination of explicit interest cost on the notes and the additional
cost of earnings that must occur to compensate the common
stockholders for the decline in the earnings multiple. The 14% return in
 this project should be compared with the new weighted average cost of
capital if the issuance of note is undertaken.

2. New level of annual earnings of the earnings multiple declines to 9 =?

1. Present market price per share = 10(P2.70) = P27.00
Required EPS (new) = P27/9 = P3.00
Required earnings before tax
(P3.00 x 10,000,000 shares / 50%) P 60,000,000
Interest expense
[(P10 M x 8%) + (P50M x 10%)] 5,800,000
Required earnings before interest and taxes 65,800,000
Less: Old earnings before interest and taxes
{[(P2.70 x 10,000,000 shares) / 50%] + P800,000} 54,800,000
Additional earnings before interest and taxes P 11,000,000
Additional informational analysis:
If the earnings multiple declines to 9, the additional earnings
provided by the new assets to maintain the same market price
per share of P27 shall be:
X = additional earnings
(new P/E) (new EPS) = P27
9 ( P2.70 + X) = P27
2.70 + X = P3
X = P0.30

[Problem14]
1. Breaks = ?
Breaks or increases in weighted marginal cost of capital will recur as
follows:
For Debt = Debt / Debt Ratio = P100,000 / 40% = P250,000
For Equity = Equity / Equity Ratio = P150,000 / 60% = P350,000

2. WACOC = ?
a. Before the break (P1 – P250,000 amount of financing)
i. Debt = 7% x 40% = 3.2%
ii. Equity = 18% x 60% = 10.8%
iii. WACOC 14.0%
b. After the break (P250,001 – above amount of financing)
Debt = 10% x 40% = 4.0%
Equity = 22% x 60% = 13.2%
WACOC 17.2%
3. Graph of marginal cost of capital (MCC) schedule and investment
opportunities schedule (IOC):
26
24 IRR ( )
22 A MCC (------)
20
18 B MCC
16
14
12 C
10
8
6
4
2

0
100 200 225 300 400 450 500 (new financing,
thousands of
pesos)
4. Projects are to be accepted as long as the IRR is greater than the MCC.
Projects A and B are acceptable; based on the following:
Project IRR MCC Advise
A 19% 14% Accept
B 15% 14% Accept
C 12% 17.20% Reject

[Problem15]
1. EPS and market price per share = ?
a. Raise P100,000 by issuing 10-year, 12% bonds
Case 1 Case 2 Case 3
Sales P 400,000 P 600,000 P 800,000
- Costs and operating expenses (90%) 360,000 540,000 720,000
EBIT 40,000 60,000 80,000
-Interest charges
[P2,000 + (12% x P100,000)] 14,000 14,000 14,000
IBIT 26,000 46,000 66,000
- Tax (50%) 13,000 23,000 33,000
Net Income P 13,000 P 23,000 P 33,000
P1.30 P2.30 P3.30
Earnings per share
 (NI / 10,000 shares)
Price / earnings rates 10x 10x 10x
Market price per share P13 P23 P33
EPS (old) = P36 / 12 = 3
No. of shares = P30,000 / P3 = 10,000 sh

b. Raise P100,000 by issuing new column stock

Case 1 Case 2 Case 3
Sales P 400,000 P 600,000 P 800,000
- Costs and D Exp (90%) 360,000 540,000 720,000
EBIT 40,000 60,000 80,000
-Interest expense 2,000 2,000 2,000
IBIT 38,000 58,000 78,000
- Tax (50%) 19,000 29,000 39,000
Net Income P 19,000 P 29,000 P 39,000
Earnings per share
(NI / 13,000Shares) P1.46 P2.23 P3.00
Price / earnings rates 12x 12x 12x
Market price per share P17.52 P26.76 P36
No. of shares
(P100,000 / P33.33 + 10,000) 13,000 13,000 13,000

2. Recommended proposal = ?
The recommendation shall be based on the following criteria:
Wealth Maximization Profit Maximization
 Brief desorption of  Wealth maximization is  Profit maximization
the criteria primordial among is a short-run strategy
shareholders in as much to satisfy the interest
as this is the end of shareholders. This
objective of business. profit maximization
This wealth maximization strategy is .best
principle is represented represented by the
by the market price per earnings per share.
share.
 The proposal chosen  The total sales of the
firm should be higher
than P600,000, since its
sales last year was
already at P600,000. At
this level and more, the
 market price per share is
higher by issuing a new
share of stock. Wealth
maximization is a
strategic reason of
managing a business,
hence, at guides
organization in its long-
term decisions, such as
financing decision.

3. No, the financing package chosen would be the same. The

higher the level of sales in excess of P600,000, the more
favorable it is on the part of the business!

4. The investment banker would rationalize that issuance of more

debt securities would mean a greater variability in earnings and
higher risk of bankruptcy created by the fixed commitment to pay
debt interest and principal. This would bring restrain by
diminishing the earnings multiple to compensate the increased
risk in leverage.

[Problem 16]
1. Sales P600,000
Out-of-pocket costs ( 450,000)
Depreciation expense (P500,000/5) ( 100,000)
IBIT 50,000
Tax (40%) ( 20,000)
Net income 30,000
Depreciation expense 100,000
Annual cash inflows P130,000
Payback period = P500,000 / P130,000 = 3.85 yrs

2. Payback reciprocal = 1 / 3.85 = 25.97%

3. ARR (original) = P30,000/P500,000 = 6%
4. ARR (average) = [P30,000 / (P500,000/2)[ = 12%

[Problem 17]
Annual
Cash
Income, Cash to Payback
Year Net of Tax Date Period
 1 P 70,000 P 70,000 1
2 90,000 160,000 1
3 85,000 245,000 1
4 160,000 400,000 0.97 (155,000/160,000)
Total 3.97 yrs.

[Problem 18]
Net Cash Cash to Salvage Total Payback
Year Inflows Date Value Cash Period
1 P300,000 P300,000 P200,000 P500,000 1
2 400,000 700,000 100,00 800,000 1
3 200,000 900,000 50,000 950,000 1
4 150,000 1,000,000 20,000 1,000,000 0.53 (100,000 - 20,000
150,000
Total 3.53 yrs.

[Problem 19]
1. Cash flows before tax P200,000
Depreciation expense (P1,000,000/ 10) ( 100,000)
IBIT 100,000
Tax (40%) ( 40,000)
Net income P 60,000

2. ARR (original) = P60,000 / P1 million = 6%

ARR (average) = [P60,000 / (P1 million/2)] = 12%

[Problem 20]
1. Sales P4,000,000
Out-of-pocket costs ( 3,100,000)
Depreciation expense [(P2M x 80%)/5] ( 320,000)
IBIT 580,000
Tax (40%) ( 232,000)
Net income 348,000
Add: Depreciation expense 320,000
Annual net cash inflows P 668,000
Payback period = P 2 million / P668,000 = 2.99 yrs.
2. Payback reciprocal = 1 / 2.99 = 33.44%
3. Payback bailout period = [(P4 4M x 80%) / P668,000] = 4.79 yrs.
4. ARR (original) = P348,000 / P4 M = 8.7%
5. ARR (average) = [(P348,000 / (P4 M + P800,000) / 2] = 14.5%
[Problem 21]
1. Cash flows before tax P15,000
- Tax [(P15,000 – P5,000) 40%] 4,000
Cash flows after tax P11,000
Payback period (P40,000 / P11,000) 3.64 yrs.

2. Cash flows after tax P11,000

Less: Depreciation expense 5,000
Net income P 6,000
ARR (original) = P6,000 / P40,000 = 15%

[Problem 22]
1. PVCI:
Annual cash inflows (P300,000 x 3.127) P938,100
Salvage value (P20,000 x 0.437) 8,740 P946,840
Less: COI 800,000
Net present value P146,840
2. Profitability index = P946,840 / P800,000 = 1.184
3. NPV index = P146,840 / P800,000 = 0.184

[Problem 23]
1.
Annual
Year Cash PVF at
Inflows 12% PVCI
1 P350,000 0.893 P312,550
2 250,000 0.797 199,250
3 150,000 0.712 106,800
4 100,000 0.636 63,600
5 50,000 0.567 28,350
SV 30,000 0.567 17,010
Total 727,560
Less: Cost of investment 600,000
Net present value P 127,560
2. Profitability index = (P727,560/P600,000) = 1.21
3. NPV index = P127,560 / P600,000 = 0.21

[Problem 24]
 PVF at
Year 14% Proj. 1 Proj. 2 Proj. 3
1 0.877 P2,104,800 P4,823,500 P175,400
2 0.769 1,691,800 1,999,400 461,400
3 0.675 1,215,000 472,500 675,000
4 0.592 651,200 118,400 473,600
SV 0.592 118,400 118,400 47,360
Total PVCI P5,781,200 P7,532,200 P1,832,760
COI P5,000,000 P8,000,000 P1,400,000
Profitability index 1.16 0.94 1.31
The company should make investments on the following projects:
Rank 1 Proj. 3 P 1,400,000
Rank 2 Proj. 1 5,000,000
Total investment P 6,400,000

[Problem25]
1. Produce Distribute
Wooden an Imported
Toy Product
Annual cash inflows:
(P500,000 x 3.889) P 1,944,500
(P400,000 x 3.889) P 1,555,600
Salvage value
(P100,000 x 0.456) 45,600
Recovery of working capital
(P200,000 x 0.456) 91,200
(P1,400,000 x 0.456) 638,400
Total PV of cash inflows 2,081,300 2,194,000
Less: COI
(P1,400,000 + P200,000) 1,600,000
(P200,000 + P1,400,000) 1,600,000
Net present value P 481,300 P 594,000

2. Profitability index (PVCI / COI) 1.30 1.37

3. The net advantage of investing in distributing an imported product is

P112,700 (i.e., P534,000 – P481,300).
{Problem 26]
Project X Project Y
Cash to Cash to
Year PVFC 14% PVCI PVCI
Date Date
1 0.887 P 1,754,000 P 1,754,000 P 3,069,500 P 3,069,500
2 0.769 1,538,000 3,292,000 1,922,500 4,992,000
3 0.675 1,350,000 4,642,000 1,012,500 5,000,000
4 0.592 1,184,000 5,000,000

Payback period – Proj X [3 yrs. + (P358,000/P1,184,000)] 3.30 yrs.

Payback period – Proj Y [2 yrs. + (P8,000/P1,012,500)] 2.01 yrs.

[Problem 27]
a. PVF Annuity = P520,000 = 2.6
P200,000
b. Using Table 2 (PVFA Table), the IRR is computed as follows:
18% 2.690
0.090
2% ? 2.600 0.102
0.012
20% 2.588

0.090
IRR = 18% + x 2% = 19.75%
0.102

[Problem 28]
a. PVF Annuity = P800,000 = 3.419
P234,000 *
* (P234,000 = [(Total cash inflows + SV)  5]

b. Using Table 2, the PVF of 3.419 is between 14% and 16%

b.1. Using 16% and 18% discount rates we have:
PVCI @ 16% PVCI @ 18%
Year Cash Inflows PVF PVF
Amount Amount
1 P 350,000 0.862 P 301,700 0.847 P 296,450
2 300,000 0.743 222,900 0.718 215,400
3 250,000 0.641 160,250 0.609 152,250
4 150,000 0.552 82,800 0.516 77,400
5 80,000 0.476 38,080 0.437 34,960
 SV 40,000 0.476 19,040 0.437 17,480
Totals P 824,770 P 793,940

b.2. Since the cost of investment of P800,000 is found the present

value of cash inflows (PVCI) of 16% and 18%, then by
interpolation, the IRR, could be determined as:

Discount
rate PVCI
16% P824,770
24,770
2% ? 800,000 30,830
6,060
18% 793,940

24,770
IRR = 16% + x 2% = 17.61%
30,830

[Problem 29]
1. PV of cash dividends (1,400 shares x P20 x 3.791) P106,148
PV of stock sales (P200,000 x 0.621) 124,200
PV of the shares of stock 230,348
Less: Cost of the share of stock 203,000
Net present value P 27,348

2 a)
PV P230,000 P203,000
= = = 2.988
Annuity {[(1,400 x P20) x 5 + P200,000] + 5} P68,000
b) Using Table 2 (PVFA Table), we have:

20% 2.991
0.006
2% 2.985 0.127
? 0.121
22% 2.864
0.006
IRR = 20% + x 2% = 20.09%
0.127

[Problem 30]
Background analysis:
 Cash savings before depreciation (P138,600 - P91,300) P47,300
Less: Depreciation expense 20,000
Income before income tax 27,300
Less: Tax (40%) 10,920
Net Income 16,380
Add: Depreciation expense 20,000
Annual Cash Inflows P36,380

1. Payback period = P160,000/P36380 = 4.40 yrs.

2. Payback reciprocal = 1/.P4.40 = 22.73%
3. ARR (original) = P16,380/P160,000 = 10.24%
ARR (average) = P16,380/(P160,000/2) = 20.48%
4. PVCI (P36,380 x 5.747) P209,076
Less: Cost of Investment 160,000
Net Present Value P 49,076
5. Profitability index = P209,076/P160,000 = 1.31
6. NPV index = P49,076/P160,000 = 0.31
7. a. PVF annuity = P160,000/P36,380 = 4.398
b. Using Table 2, we have:

14% 4.639
0.241
2% ? 4.398 0.295
0.054
16% 4.344

0.241
IRR = 14% + x 2% = 15.63%
0.295

[Problem 31]
Depreciation Tax Effect
Expense PV of Tax
PVF
at
Year
SY SL 8% Savings
P(444,480
1 P3.2M P2.0M P1.2M P(480,000) 0.926 )
2 2.4M 2.0M 0.4M (160,000) 0.857 (137,120)
3 1.6M 2.0M (0.4M) 160,000 0.794 127,040
4 0.8M 2.0M (1.2M) 480,000 0.735 352,800
Total P101,760
[Problem 32]
Cash Net Cash
Flows Inflows
Before Dep. Net Dep. After
Tax Expense IBIT Tax (30%) Income Expense Tax
Straight Line
Method
(P2,400,000 -
P1,430,000) P970,000 P360,000 P610,000 P183,000 P427,000 P360,000 P787,000
Sum-of-the-
years-digit
method
Year 1 P970,000 640,000 330,000 99,000 231,000 640,000 871,000
Year 2 P970,000 560,000 410,000 123,000 287,000 560,000 847,000
Year 3 P970,000 480,000 490,000 147,000 343,000 480,000 823,000
Year 4 P970,000 400,000 570,000 171,000 399,000 400,000 799,000
Year 5 P970,000 320,000 650,000 195,000 455,000 320,000 775,000
Year 6 P970,000 240,000 730,000 219,000 511,000 240,000 751,000
Year 7 P970,000 160,000 810,000 243,000 567,000 160,000 727,000
Year 8 P970,000 80,000 890,000 267,000 623,000 80,000 703,000

1.a. Annual cash inflows after tax:

Alternately, cash inflows after tax may be computed by deducting the
corresponding income tax from the cash flows before tax. The tax
expense equals cash flows before tax less depreciation expense.

b. Net present values, straight-line method and SYD method

PVCI: Straight-line SYD

Regular(P787,000 x 5.747) P4,523,889
Y1 (P871,000 x 0.926) P806,546
Y2 (P847,000 x 0.857) 725,879
Y3 (P823,000 X 0.794) 653,462
Y4 (P799,000 X 0.735) 587,265
Y5 (P775,000 X 0.681) 527,775
Y6 (P751,000 X 0.630) 473,130
Y7 (P727,000 X 0.583) 423,841
Y8 (P703,000 X 0.540) 379,620
SV (P120,000 X 0.540) 64,800 64,800
Recovery of working capital
 (P400,000 x 0.540) 216,000 216,000
Cost of investment(P3M + (3,40
P400,000) 0,000) (3,400,000)
Net present value P1,403.689 P1,458,328
Advantage of the SYD method P 54,639

2. The tax benefit using SYD method instead of the straight-line method
is P54,639 (i.e., P1,458,328 - P1,403,689).

[Problem 33]
1. Buy Lease
Purchase price P2,200,000
PV of lease payments (P30,000 x 5.650) P1,695,000
PV of salvage value (P200,000 x 0.322/64,400) ( 64,400) ( 64,400)
PV of tax savings on depreciation expense
(P200,00 x 35% x 5.650) ( 395,500)
PV of tax savings on lease payments
(P300,000 x 35% x 4.65) ( 93,250)
PV of relevant costs P1,740,100 P1,101,750

2. Net Advantage of leasing P638,350

PV of annual savings (P638,350/5.65) P112,982

[Problem 34]
1. Payback period = P35,000/P10,000 = 3.5 yrs.

2. PVCI (P10,000 x 3.785) P37,850

Less: Cost of investment 35,000
Net present value P 2,850
P35,000
3. Amount of investment =
Future Value Factor @ 15%, n = 6
six years ago

P35,000
= 2.313

= P15.132

[Problem 35]
1. PV of cash dividends (20,000 shares x P4 x 3.605) P288,400
PV of stock sales (P500,000 x 115% x 0.567) 326,025
PV of shares of stock 614,425
Less: cost of investment 500,000
 Net present value – common stock P114,425

2. PV of interest receipts (P500,000 x 14% x 3.605) P252,350

PV of bond redemption (P500,000 x 150% x 0.567) 425,250
PV of bonds 677,600
Less: Cost of investment 500,000
Net present value – bonds P177,600

3. The investment in bonds is more advantageous by P63,175 (i.e.,

P177,600 – P114,425) than the investment in stock.

[Problem 36]
1. Cost of investment P681,960
Less: Present values of inflows:
Y1 (P120,000 x 0.893) (107,160)
Y2 (P240,000 x 0.797) (191,280)
Y3 (P360,000 x 0.712) (256,320)
Present value of year 4 inflows 127,200
 PVFC 12%, year 4 0.636
Cash inflows, year 4 P200,000

2. PV of savings (P700,000 x 5.197) P3,637,900

Less: Cost of investment 3,000,000
Net present value of intangible benefits P 637,900

3. PVF Annuity = P1,027,750 = 4.11*

P250,000
*Using table 2, 4.11 at 12% = 6 yrs.

[Problem 37]
1.
. Y1 - Y3 Y4 - Y5
Savings from labor and materials P 820,000 P 820,000
Increase in maintenance
(P6,000 x 12) (72,000) (72,000)
Annual cash savings P 784,000 P 784,000

2. PVCI
Regular cash (P784,000 x 3.433) P2,567,884
Salvage value (P180,000 x 0.579) 93,420 P2,661,304
Less: Cost of investment (P2,700,000 – P70,000) 2,630,000
 Net present value P (31,304)

3.
Y1 - Y3 Y4 - Y5
Annual cash savings P 748,000 P 748,000
Depreciation expense
P2,700,000 - P180,000
(504,000)
5 yrs.
[P504,000 + (P150,000/2)] (579,000)
Income before income tax 244,000 169,000
Less: Tax (40%) 97,600 67,600
Net income 146,400 101,400
Add: Depreciation expense 504,000 579,000
Annual cash inflows P 650,400 P 680,400

PVCI
Y1 – Y3 (P650,400 x 2.322) P1,510,229
Y4 (P680,400 x 0.592) 402,797
Y5 (P680,400 x 0.519) 353,128
Salvage value – new (P150,000 x 0.519) 77,850 P2,344,004
Less: Cost of investment (P2,700,000 – P70,000 2,630,000
Net present value P (285,996)

[Problem 38]
1.
Make Buy
Relevant cost to buy / make
Year 1 (50,000 x P22 x 0.893) P 982,300 P 1,294,850 (50,000 x P29 x 0.893)
Year 2 (50,000 x P22 x 0.797) 876,700 1,155,650 (50,000 x P29 x 0.797)
Year 3 (52,000 x P22 x 0.712) 814,528 1,032,400 (50,000 x P29 x 0.712)
Year 4 (55,000 x P22 x 0.636) 769,560 1,014,400 (55,000 x P29 x 0.636)
Year 5 (55,000 x P22 x 0.567) 686,070 904,365 (55,000 x P29 x 0.567)
Avoidable fixed overhead
(P45,000 x 3.605) 162,225
Salvage value - old asset (1,500)
Salvage value - new (P12,000 x 0.567) (6,804)
Tax savings on depreciation expense
Year 1 (P384,000 x 40% x 9.893) (137,165)
 Year 2 (P230,400 x 40% x 0.797) (73,452)
Year 3 (P138,240 x 40% x 0.712) (39,371)
Year 4 (P82,944 x 40% x 0.636) (21,101)
Year 5 (P 124,416 x 40% x 0.567) (28,218)
PV of relevant costs - 5 yrs. P 3,883,772 P 5,401,685
Net advantage of making in 5 yrs. P 1,517,913

2. Some of the non-financial and qualitative factors to be considered

before deciding whether to make or buy a part are:
a. Availability of materials from supplier.
b. Stability of prices of material.
c. Quality of parts to be supplied.
d. Dependability of past supplier.
e. Impact of new technology.

[Problem 39]
1. Increase in direct materials [(P4.50 – P3.80) x 80,000] P (56,000)
Decrease in direct labor and variable
overhead (P1.60 x 80,000) 128,000
Net operating cash savings before tax P 72,000

Years
1 2 3 4 5
Cash savings before tax P72,000 P72,000 P72,000 P72,000 P72,000
Less: Depreciation expense using SYD 800,000 640,000 480,000 320,000 160,000
Income before income tax (728,000) (568,000) (408,000) (248,000) (88,000)
Less: Tax (40%) (291,200) (227,200) (163,200) (99,200) (35,200)
Net income (loss) (436,800) (340,800) (244,800) (148,800) (52,800)
Add: Depreciation expense 800,000 640,000 480,000 320,000 160,000
Annual cash inflows P363,200 P299,200 P235,200 P171,200 P107,200

2. Regular operating cash inflows

(P363,200 + P299,200 + P235,200 + P171,200 + P107,200) P 1,176,000
Salvage value (P100,000 x 60%) 60,000
Total cash inflows 1,236,000
Less: Cost of investment 2,500,000
Net cash inflows P(1,264,000)
Zero, there is no excess of after tax cash inflows over the cost of
initial investment because the total cash inflow is even lower than the
cost of investment.