Alexis King BSA-2C

Capital Budgeting – Net Investments, Returns, Cash Inflow – Problem Exercises

1. A company is planning to buy cleaning equipment that can reduce its wash service cost and other cash
expenses by an average of P180,000 per year. The new cleaning equipment will cost P300,000 and will be
depreciated for 5 years on a straight-line basis. No salvage value is expected at the end of the equipment’s
life. Income tax is estimated at 30% of income before tax.

Required:

Determine the annual net returns (net income) and net cash inflows for the proposed investment.

Solution:

1.
Annual cashflow before taxes P180,000
Less: Depreciation (300,000/5) 60,000
Net income before tax 120,000
Less: Income tax (120,000/30%) 36,000
Net income after tax 84,000
Add: Depreciation 60,000
Annual cash returns P144,000

2.
Net income after taxes P 84,000
Add: Depreciation 60,000
Net cash inflows P 144,00

2. A company uses a labor-intensive manufacturing process. Existing equipment has a book value of
P20,000, a five-year remaining life, and a P12,000 market value. Annual depreciation is P4,000 and cash
operating costs is P64,000. The proposed process requires machinery costing P100,000 with a useful life of
five years and no salvage value. The new machinery, which will replace the old one, requires P40,000 in
annual cash costs. Straight-line depreciation will be used for tax purposes for the new machine. The tax
rate is 30% and the cost of capital is 12%.

Required:

1. the net investment on the new equipment

2. annual net cash inflow from the new equipment

Solution:
1. Cash outflow:
Cost of new equipment P100,000
Cash inflows:
Net proceeds from sale of
Old machine P12,000
Add: Tax benefit on loss
(P20,000-12,000)*30% 2,400 14,400
Net investment P 85,600

1. Annual cashflow before taxes P40,000

Less: Depreciation(100,000/5) 20,000
Net income before taxes 20,000
Less: Income taxes 6,000
Net income after taxes 14,000
Add: Depreciation 20,000
Annual cashflow after taxes P34,000