CAPITAL BUDGETTING

THEORETICAL

1. Which of the following capital budgeting techniques may potentially ignore part of a project's relevant cash flows?

C. payback period (add all cashflows to get cost of Investment

2. Which of the following capital budgeting techniques does bot routinely rely on the assumption that all cash flows occur
at the end of the period?

B. payback period (does not consider Time value of money)

3. All other factors equal, a large number is preferred to a smaller number for all capital project evaluation measures
except

B. payback period (smaller number, mas madali bumalik yung pera the better)

4. The payback method assumes that all cash infloes are invested to yield a return equal to

D. zero (walang yield kasi walang TVM)

5. The time value of money is considered in long-range investment decisions by

C. assigning greater value to more immediate cash flows (early cash flows, higher value)

6. When using one of the discounted cash flow methods to evaluate the desirability of a capital budgeting project, which
of the following factors is generally not important?

A. method of financing the project under consideration

7. If an analyst desires a conservative net present value estimate, she will assume that cash inflows occur at

C. year-end (produces least cash inflow-conservative)

*annuity due is greater than ordinary annuity

8. If a projects generates a net present value of zero, the profitability index for the project will

B. equal 1(since ung formula niya, refer to number 1; magiging same sila kasi zero ung TVM)

9. Which method of evaluating capital projects assumes that cash inflows can be reinvested at the discount rate?

C. profitability index

10. The net present value and internal rate of return methods of decision making in capital budgeting are superior to the
payback method in that they

B. consider the time value of money (both considers TVM, the latter does not)

11. Which of the following capital expenditures planning and control techniques has been criticized because it might
mistakenly imply that earnings are reinvested at the rate of return earned by the investment?

D. internal rate of return (in lieu with #9, Trial and Error)

12. As the marginal tax rate goes up, the benefit from the depreciation tax shield
 B. increases (depn is not a cash outflow, pero deduction for taxable income; so less ung tax mo kaya increased
benefit)

13. When a profitable corporation sells an asset at a loss, the after-tax cash flow on the sale will

A. exceed the pre-tax cash flow on the sale (may tax savings kasi nagloss ka like in #12)

14. The pre-tax and after-tax cash flows would be the same for all of the following items except

D. a cash payment for salaries and wages (effect of Accruals and deferrals; may effect sa gain or loss)

15. A project's after-tax net present value is increased by all of the following except

D. expense accruals (may expense na pero wala pang cash outflow)

16. Which of the following best represents a screening decision?

B. determining if a project's internal rate of return exceeds the firm's cost of capital (screening if benefit should be
greater than cost)

17. S1: Net present value method favors larger, longer projects

S2: Internal rate of return method favors shorter period

A. True, True (NPV is reliant to length; IRR the shorter, the better)

18. S1: Payback method emphasizes profitability

S2: Payback method does not measure liquidity

D. False, False (liqudity period, short term kasi, profitability is long term)

19. If there were no income taxes

A. depreciation would be be ignored in capital budgeting (ignore tax if no income taxes)

20. The net present value 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 toral cash flows to their present value is
called the

D. total project approach

1. Three potential investment projects (A, B, and C) at Stay at Home Corporation all require the same initial investment,
have the same useful life (3 years), and have no expected salvage value. Expected net cash inflows from these three
projects each year is as follows:
ABC
Year 1 P 1,000 P 2,000 P 3,000
Year 2 P 2,000 P 2,000 P 2,000
Year 3 P 3,000 P 2,000 P 1,000
What can be determined from the information provided above?
A. the net present value of project C will be the highest.
2. The payback method assumes that all cash inflows are reinvested to yield a return equal to

A. zero (walang Time value of Money sa Payback Method)

3. When the cash flows are the same every period after the initial investment in a project, the payback period is equal to:
 C. the factor of the internal rate of return.

4. Capital budgeting techniques are least likely to be used in evaluating the

D. Adoption of a new method of allocating non-traceable costs to product lines.

5. Which of the following is always true with regard to the net present value (NPV) approach?
A. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal
rate of return (IRR) approach.

6. Which of the following would decrease the net present value of a project?

D. An increase in the discount rate (The higher the discounting rate, the lower the pv factor.)
7. A project’s net present value, ignoring income tax considerations, is normally affected by the
A. Proceeds from the sale of the asset to be replaced.
8. Sensitivity analysis, if used with capital projects,

C. Is a “what-if” technique that asks how a given outcome will change if the original estimates of the capital
budgeting model are changed. (Sensitivity analysis measures the risk kasi of the methods used)

9. S1: If a company is operating at a profit, the cash inflow resulting from the depreciation tax shield is computed by
multiplying the depreciation deduction by one minus the tax rate.
S2: In calculating the “investment required” for the project profitability index, the amount invested should be reduced by
any salvage recovered from the sale of old equipment.
S3: Depreciation is included as a cash flow in capital budgeting decisions to ensure that the original cost of the asset is
fully recovered.
A. Only one statement is correct
10. Which of the following combinations is possible?
Profitability Index NPV IRR
C. less than 1 Negative less than cost of capital

11. Which of the following is NOT a defect of the payback method?

A. It ignores cash flows because it uses net income.
12. Joy Boy. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for
the upcoming year.
Project 1 Project 2 Project 3 Project 4
Initial cash outlay P200,000 P298,000 P248,000 P272,000
Annual net cash inflows
Year 1 P 65,000 P100,000 P 80,000 P 95,000
Year 2 70,000 135,000 95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present value ( 3,798) 4,276 14,064 14,662
Profitability index 98% 101% 106% 105%
Internal rate of return 11% 13% 14% 15%
No Budget Restriction P600,000 Available Funds P300,000Available Funds
A. Projects 2, 3 & 4 Projects 3 & 4 Project 3
(No budget Restriction: Project 2,3, & 4 since positive ang NPV, mataas ang PI and IRR
600K Budget: Project 3 & 4 dahil pasok sa Budget yung required na cash outlay and sila ang pinaka mataas sa NPV, PI
and IRR
300K Budget: Project 3 dahil pinaka-favorable compared sa Project 4 na 105% lng ang PI at sa Project 3 na 13% lng sng
IRR and mababa yung NPV.
bakit hindi si Project 1? dahil negative po ang NPV which means unacceptable project.)

13. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are some of the capital
budgeting techniques. What is the effect of an increase in the cost of capital on these techniques?
B.
PP No change
PI Decrease
SARR No change
14. Front Liners Co. considering the purchase of a PPE that could potentially reduce labor costs of its operation by a
considerable margin. The new PPE would cost P 300,000 and would be fully depreciated by the straight-line method over
5 years. At the end of 5 years, the ship will have no value and will be junk. The Front Liners Co.'s cost of capital is 10
percent, and its marginal tax rate is 35 percent. If the ship produces equal annual labor cost savings over its 5-year life,
how much do the annual savings in labor costs need to be to generate a net present value of P 0 on the project?
A. P 79,139

15. Covid
Free
Corporation is
reviewing the
following data
relating to an
energy saving
investment
proposal:
Initial
investment P
50,000
Life of the
project 5
years
Salvage value
P 10,000
Annual cash savings ?
What annual cash savings would be needed in order to satisfy the company's 10% required rate of return (rounded to the
nearest one hundred pesos)?
B. P 11,551

16. Bayanihan Construction, Inc., has a large crane that cost P 70,000 when purchased ten years ago. Depreciation taken
to date totals P 50,000. The crane can be sold now for P 12,000. Assuming a tax rate of 30%, if the crane is sold the total
after-tax cash inflow for capital budgeting purposes will be:

D. 14,400

17. Vivi Co. has an antiquated high-capacity printer that needs to be upgraded. The system either can be overhauled or
replaced with a new system. The following data have been gathered concerning these two alternatives:
Overhaul Present System Purchase New System
Purchase cost when new P 300,000 P 400,000
Accumulated depreciation P 220,000 —
Overhaul costs needed now P 250,000 —
Annual cash operating costs P 120,000 P 90,000
Salvage value now P 90,000 —
Salvage value in ten years P 30,000 P 80,000
Working capital required — P 50,000
The company uses a 10% discount rate and the total-cost approach to capital budgeting analysis. The working capital
required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are
expected to have a useful life of ten years.
The net present value of the overhaul alternative and new system alternative respectively is (rounded off factors to three
decimal places) is:
18. Middle Class Industries is replacing a grinder purchased 10 years ago for P15,000 with a new one costing P25,000
cash. The original grinder is being depreciated on a straight-line basis over 15 years to a zero salvage value. Middle Class
will sell this old equipment for P6,000 cash. The new equipment will be depreciated on a straight-line basis over 10 years
to a zero salvage value. Assuming a 40% marginal tax rate, Middle Class’s net cash investment at the time of purchase is
the old grinder is sold and the new one purchased is
A. P19,400
19. Lockdown 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 P40,000
Annual net cash inflow 9,000
Salvage value now of the old machine 6,000
Salvage value of the old machine in 8 years 0
Salvage value of the new machine in 8 years 5,000
Estimated life of the new machine 8 years
What is the expected payback period for the new machine?

20. Heal as One Company has a payback goal of 2 years on new equipment acquisitions. A new sorter is being evaluated
that costs P450,000 and has a 5-year life. Straight-line depreciation will be used; no salvage value is anticipated. Heal as
One Company is subject to a 40% income tax rate. To meet the company’s payback goal, the sorter must generate
reductions in annual cash operating costs of

C. P315,000

21. Hygiene Products

Company is considering
generation of a new
product that can kill any
virus in an instant. It can
be sold for P100 and have
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 cash operating costs of P20,000 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 0.56743; present
value of annuity of 1 for 5 periods is 3.60478.
How many units per year the firm must sell for the investment to earn 12 percent internal rate of return?

22. Quarantine Inc., is considering investing in automated equipment with a ten-year useful life. Managers at Quarantine
have estimated the cash flows associated with the tangible costs and benefits of automation, but have been unable to
estimate the cash flows associated with the intangible benefits. Using the company’s 10% discount rate, the net present
value of the cash flows associated with just the tangible costs and benefits is a negative P184,350. How large would the
annual net cash inflows from the intangible benefits have to be to make this a financially acceptable investment?

B. P30,000

23. Leaves Co. is planning to buy a coin-operated machine costing P40,000. For book and tax purposes, this machine will
be depreciated P8,000 each year for five years. Leaves estimates that this machine will yield an annual cash inflow of
P12,000. Leaves’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% +P3,258
14% + 1,197
16% - 708
18% - 2,474
Leaves’s accounting rate of return on its initial investment in this machine is expected to be?

24. Young’s Town Co. is expanding its manufacturing plant, which requires an investment of P4,000,000 in new
equipment and plant modifications. Young’s Town sales are expected to increase by P3,000,000 per year as a result of the
expansion. Cash investment in current assets averages 30% of sales; accounts payable and other current liabilities are 10%
sales.
What is the estimated total investment for this expansion?

25. The Mega 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 P66,000 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%. How much will the
new machine cost?
A. P300,000

COMPUTATIONAL

1. Gene, Inc. invested in a machine

with a useful life of 6 years and no
salvage value. The machine was
depreciated using the straight-line
method. It was expected to produce
annual cash inflow from operations,
net of income taxes, of P2,000. The
present value of an ordinary annuity
of P1 for six periods at 10% is 4.355. The present value of P1 for six periods at 10% is 0.564. Assuming that Gene used a
time adjusted rate of return of 10%, what was the amount of the original investment?

a. P5,640

b. P8,710

c. P9,000

d. P11,280

2. The Fudge company is planning to purchase a new machine which it will depreciate, for book purposes, on s straight-
line basis over a 10-year period with no salvage value and full year's depreciation taken in the year of acquisition. The
new machine is expected to produce cash flow from operations net of 10 years, of P66,000 a year in each of the next 10
years. A 12% accounting (book value) rate of return on the initial investment is expected. How much will the new
machine cost?

a. P300,000

b. P550,000

c. P660,000

d. P782,000

3. Womark Company purchased a new machine on January 1 of this year for P90,000, with an estimated useful life of 5
years and a salvage value of P10,000. The machine will be depreciated using the straight-line method. The machine is
expected to produce cash flow from operations, net of income taxes, of P36,000 a year in eah of the next 5 years. The
payback period will be

a. 2.2 years

b. 2.5 years

c. 4.0 years

d. 4.5 years

4. Refer to Q. 3, assume the new machine's salvage value is P20,000 in years 1 and 2, and P15,000 in years 3 and 4. What
will be the bailout period for the Womark Company on this new machine

a. 1.4 years

b. 2.2 years

c. 1.9 years

d. 3.4 years
5. A company is investigating the possibility of acquiring a new machine that will cost P12,000 and will have annual
depreciation for tax purposes of P2,400 for 5 years. The machine is expected to result in a cash saving from operations of
P4,000 per year. If the tax rate is 50%, what is the payback period for the new machine?

a. 3 years

b. 3.75 years

c. 5 years

d. 6 years

6. Energy company is planning to spend P84,000 for a new machine, to be depreciated on the straight-line basis over 10
years with no salvage value. The related cash flow from operations, net of income taxes, is expected to be P10,000 a year
for each of the first 6 years and 12,000 for each of the next 4 years. What is the payback period?

a. 4.4 years

b. 7.6 years

c. 7.8 years

d. 8.0 years

7. Refer to Q.6 Energy Company has also estimated the salvage value of the new machine at the end of year 1 to be
P64,000. Salvage value will decline by P5,000 each year thereafter. What is the bailout payback period?

a. 2 years

b. 3 years

c. 4 years

d. 5 years

8. An investment project is expected to yield P10,000 in annual revenues has P2,000 in fixed costs per year, and requires
an initial inventory of P5,000. Given a cost of goods sold of 60% of sales. What is the payback period in years?

a. 2.50

b. 5.00

c. 2.00

d. 1.25

9. Maxwell Company has an opportunity to acquire a new machine to replace one of its present machines. The new
machine would cost P90,000, have a 5-year life, and no estimated salvage value. Variable operating costs would be
P100,000 per year. The present machine has a book value of P50,000 and a remaining life of 5 years. Its disposal value
now is P5,000, but it would be zero after 5 years. Variable operating costs eould be P125,000 per year. Ignore present
value calculations and income taxes. Considering the 5 years in total, what would be the difference in profit before income
taxes by acquiring the new machine as opposed to retaining the present one?

a. P10,000 decrease

b. P15,000 decrease

c. P35,000 increase

d. P40,000 increase

10. An investment in a new piece of equipment costing P50,000 is expected to yield the following each year of the
equipment’s 5-year useful life:

Revenues (all cash) P40,000

Operating costs (all costs) (18,000)

Depreciation (10,000)

Contribution to net income P12,000

The present value of P1 received annually for 5 years and discounted at the company's cost of capital is 4.10 assuming
that all cashflows occur at year-end. The benefit/cost ratio (profitability index) for this piece of equipment, ignoring tax
effects, is

a. .984

b. 1.200

c. 1.804

d. 3.280

e. 2.200