Chapter 3: Capital Budgeting

Question 1

3 Financing Coverage

Answer 1

1. Investment Decision
2. Financing Decision
3. Dividend Decision

Question 2

May be defined as decision-making, firms evaluate purchased of major-fixed assets (building, machinery and equipment). To determine required return from a project.

Answer 2

Capital Budgeting

Question 3

Significance of Capital Budgeting

Answer 3

1. Long term effects
2. Timing the availability of Capital assets
3. Quality of capital assets
4. Raising funds
5. Ability to compete

Question 4

Some Difficulties in Capital Budgeting

Answer 4

1. Measurement problem
2. Uncertainty

Question 5

Project classifications

Answer 5

1. Mandatory investment
2. Replacement
3. Expansion project
4. Diversification project
5. Research & Development projects

Question 6

Capital budgeting evaluation techniques

Answer 6

1. non-discounting methods
2. Discounting method

Question 7

Non-discounting methods

Answer 7

1. Urgency
2. Payback period
3. Accountng rate of return

Question 8

Discounting methods

Answer 8

1. Net Present Value
2. Profitability Index
3. Internal Rate of return

Question 9

It refer to the length of period required to recover the cost of investment

Answer 9

Payback period

Question 10

Formula of Payback period

Answer 10

Intial cost of investment / Annual cash inflow

Question 11

Find Payback Period

Given:
Year 0 = 5,000,000
Year 1 = 2,000,000
Year 2 = 2,500,000
Year 3 = 3,500,000
Year 4 = 2,000,000
Year 5 = 2,000,000

Answer 11

Year 1 = 2,000,000 = 1
Year 2 = 2,500,000 = 1
Year 3 = (5,0000,000 - 4,500,000) / 3,500,000 = 0.14

PP = 2.14 years

Question 12

Find Payback Period

Given:
Intial Capital = 3,000,000
Year 1 = 1,200,000
Year 2 = 1,200,000
Year 3 = 1,200,000
Year 4 = 1,200,000
Year 5 = 1,200,000

Answer 12

Year 1 = 1,200,000 = 1
year 2 = 1,200,000 = 1
Year 3 = (3,000,000-2,400,000) / 1,200,000 = 0.5

PP =. 2.50 years

Question 13

Find Payback Period

Given:
Intial Capital = 30,000,000
Year (1-5) = 5,000,000 per year
Year (6-10) = 6,000,000 per year

Answer 13

Year 1 - 5 = 25,000,000 (5M x 5 years) = 5
Year 6 = 5,000,000 / 6,000,000. = 0.83

PP = 5.83 years

Question 14

Formula of Accounting rate of return (ARR)

Answer 14

Average income after tax / Initial cost of investment

Question 15

Formula of Net Present Value

Answer 15

Present Value of Cash Inflows - Present Value of Cash outflow

Question 16

Formula of Profitability Index

Answer 16

Present value of cash inflow (PVCI) / Initial cost of investment

Question 17

Find Payback Period

Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000

Answer 17

Year 1 = 300,000 = 1
Year 2 = 350,000 = 1

Year 3 = (800K- 300K - 350K) / 450,000 = 0.33

Answer = 2.33 years

Question 18

Find Net Present Value

Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000

Rate = 8%

Answer 18

Year 1 = 300,000 x 0.9259 = 277,770
Year 2 = 350,000 x 0.8573 = 300,055
Year 3= 450,000 x 0.7938 = 330, 210
Year 4 = 500,000 x 0.7350 = 367,500
Year 5 = 800,000 x 0.6806 = 544,480

(PVCI) 1,847,015 - (PVCO) 800,000
NPV = 1,047,015

Question 19

Find Profitability Index

Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000

Rate = 8%

Answer 19

PI= 1,847,015 / 800,000
= 2.31

Question 20

Find Discounted Payback Period

Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000

Rate = 8%

Answer 20

Notebook

Question 21

2020

Gross Sales = 800,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 120,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?

2021

Gross Sales = 1,200,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 150,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?

Answer 21

2020

Gross Sales = 800,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 120,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?

2021

Gross Sales = 1,200,000
Less: CGS (30%) = ?
Gross Profit = ?
Less: Operating Expenses = 150,000
EBIT = ?
Less Interest Expense = 50,000
EBT = ?
Less: Tax (30%) = ?
Income after Tax = ?

Question 22

Find Accounting Rate of Return

Initial Investment = 1,500,000
Income After Tax = 273,000 (Year 1)
448,000 (Year 2)

Answer 22

ARR = ((273,000 + 448,000) / 2) / 1,500,000

= 24.03%

Question 23

Find Internal rate of Return

Given:
Intial Capital = 800,000
Year 1 = 300,000
Year 2 = 350,000
Year 3 = 450,000
Year 4 = 500,000
Year 5 = 800,000

Rate = 8%

No need to study since it will not come out on the exam

Answer 23

IRR = 42.23%

Question 24

Find Internal rate of return

Given:
Intial Capital = (350,000)
Year 1 = 100,000
Year 2 = 200,000
Year 3 = 220,000
Year 4 = 80,000

Rate of Return = 18%

Answer 24

Found in notebook

Question 25

Find NPV (use excel) Given: Intial Capital = (20,000,000) Year 1 = 5,000,000 Year 2 = 8,000,000 Year 3 = 8,500,000 Year 4 = 7,000,000 Year 5 = 8,000,000 Year 6 = 6,000,000 Required rate of Return = 20%

Answer 25

Year 1 = 5,000,000 x 0.8333 = 4,166,500 Year 2 = 8,000,000 x 0.6944 = 5,555,200 Year 3 = 8,500,000 x 0.5787 = 4,918,950 Year 4 = 7,000,000 x 0.4823 = 3,376,100 Year 5 = 8,000,000 x 0.4019 = 3,215,200 Year 6 = 6,000,000 x 0.3349 = 2,009,400 (PVCI) 23,241,350 - (PVCO) (20,000,000) NPV =

Question 26

Find IRR (use excel) Given: Intial Capital = (20,000,000) Year 1 = 5,000,000 Year 2 = 8,000,000 Year 3 = 8,500,000 Year 4 = 7,000,000 Year 5 = 8,000,000 Year 6 = 6,000,000 Required rate of Return = 20%

Answer 26

Found in Excel

Question 27

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: a. Payback period

Answer 27

Found in Test #2

Question 28

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: b. Net Present Value (16%)

Answer 28

Found in Test #2 NPV= 13,030,800 - 8,700,000 = 4,330,800

Question 29

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: c. Profitability Index

Answer 29

Found in Test #2

Question 30

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: d. Discounted payback period (16%)

Answer 30

Found in Test #2

Question 31

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: e. Internal rate of return (16%)

Answer 31

Found in Test #2 IRR= 30% + (31% - 30%) x [(₱74,105.26 - 0) / (₱74,105.26 - (₱138,387.94)) ] = 30.34874%

Question 32

Sunlight Company needs a machine for its manufacturing process. The Cost of the machine is 8.7 million with an expected useful life of 8 years. At the end of 8-year period, the machine would increse cash inflows by 3 million per year (per year 1- 8 years). Sunlight is interested to know the: f. whether to accept or reject this investment. The minimum required rate of return of the company is 16% on all capital investments.

Answer 32

Accept

Question 33

The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12 % Year 0 = (800,000) 1 = 300,000 2 = 350,000 3 = 300,000 4 = 250,000 5 = 250,000 Find the: a.) Payback period

Answer 33

Found in Test #2

Question 34

The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12% Year 0 = (800,000) 1 = 300,000 2 = 350,000 3 = 300,000 4 = 250,000 5 = 250,000 Find the: b.) NPV (discount rate is 12%)

Answer 34

Found in Test #2 NPV= 1,061,155 - 800,000 = 261,155

Question 35

The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12% Year 0 = (800,000) 1 = 300,000 2 = 350,000 3 = 300,000 4 = 250,000 5 = 250,000 Find the: c.) Profitability Index (discount rate is 12%)

Answer 35

PI= 1,061,155 / 800,000 =1.32

Question 36

The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12% Year 0 = (800,000) 1 = 300,000 2 = 350,000 3 = 300,000 4 = 250,000 5 = 250,000 Find the: b.) IRR (discount rate is 12%)

Answer 36

Found in Test #2

Question 37

The following are the expected cash inflow of a project whose economic life is 5 years and initial investment is P800,000 and discount rate of 12% Year 0 = (800,000) 1 = 300,000 2 = 350,000 3 = 300,000 4 = 250,000 5 = 250,000 Find the: e.) Will you recommend for the acceptance of the project?

Answer 37

Accept

Question 38

For a project that has an initial investment of P8.7 million, your client has asked you to determine the accounting rate of return. The data are the following: 1. Sales revenue: 30M (2022) 2. Cost of Cost: 40% 3. Interest Expense: 16% of the outstanding debt of P5,000,000 4. Tax rate: 30% 5. Operating expenses as 10M 6. It was learned that the income after tax in the preceding year was 10% lower than this year, 2022

Answer 38

Found in Test #2

Question 39

ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project: Year 1 = P50M Year 2 = P100M Year 3 = P150M Year 4-15 = P200M per year Given the information, this client asked you to provide the following: a.) Payback period of the project

Answer 39

Found in ME PP= 5.5 years

Question 40

ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project: Year 1 = P50M Year 2 = P100M Year 3 = P150M Year 4-15 = P200M per year Given the information, this client asked you to provide the following: b.) Net Present Value (WACC = 15%)

Answer 40

NPV= ₱130,549,058.77

Question 41

ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project: Year 1 = P50M Year 2 = P100M Year 3 = P150M Year 4-15 = P200M per year Given the information, this client asked you to provide the following: c.) Discounted payback period

Answer 41

PP= 10.82 years

Question 42

ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project: Year 1 = P50M Year 2 = P100M Year 3 = P150M Year 4-15 = P200M per year Given the information, this client asked you to provide the following: d.) Profitability Index

Answer 42

PI= 930,555,000 / 800,000,000 = 1.16

Question 43

ABC is contemplating on venturing a new business with initial investment of P800 million pesos. The weighted average cost of capital (WACC) was determined at 15%. It has the following cash flows with zero salvage value at the end of the project: Year 1 = P50M Year 2 = P100M Year 3 = P150M Year 4-15 = P200M per year Given the information, this client asked you to provide the following: e.) Internal rate of return

Answer 43

=17% + (18% - 17%) x [(₱32,362,435.20 -0) / (₱32,362,435.20-(₱11,053,118.88))] = 17.75%

Question 44

Purchases of long-term operational asset.

Answer 44

Capital Investment

Question 45

Once purchased, company is committed to these investments for an extended period of time.

Answer 45

Capital Investment

Question 46

A decision to exchange current cash outflows for the expectation of receiving future cash inflows

Answer 46

Capital Investment Decisions

Question 47

Understanding the time value of money concept will help you make a rational capital investment decision.

Answer 47

Capital Investment Decisions

Question 48

are concerned with: - The process of planning - Setting goals and priorities - Arranging financing - Using certain criteria to select long-term assets

Answer 48

Capital Investment Decisions

Question 49

money invested in a business venture with a thought of income and amount is expected to be recovered through earnings generated by the business over a period of time.

Answer 49

Capital investment

Question 50

funds invested in a firm or enterprise for the purpose of furthering its business goals and objectives.

Answer 50

Capital investment

Question 51

seeks to build on the future value of money which may be spent now.

Answer 51

Capital budgeting

Question 52

Uses techniques and looks into the different factors that can aid in making decision.

Answer 52

Capital budgeting

Question 53

Creates accountability and measurability of a business plan.

Answer 53

Capital budgeting

Question 54

The process of making capital investment decisions

Answer 54

Capital budgeting

Question 55

Types of capital budgeting projects

Answer 55

- Independent projects - Mutually exclusive projects

Question 56

Projects that, if accepted or rejected, will not affect the cash flows of another project.

Answer 56

Independent projects

Question 57

Projects that, if accepted, preclude the acceptance of competing projects.

Answer 57

Mutually exclusive projects

Question 58

Guidelines for Capital Budgeting

Answer 58

- Use Cash Flows rather than Book Profits - The basis for evaluating the attractiveness of a proposal is incremental cash flow - Consider Incidental or Synergistic Effects - Avoid Cash flow diverted from existing product - Consider Incremental Expenses - Consider Opportunity cost

Question 59

Administration of Capital Investment Decisions

Answer 59

- Generation of investment proposal - Estimation of cash flows - Evaluation of cash flows and selections of projects

Question 60

How to get Initial Investment

Answer 60

= Cost of asset + installation cost + working capital investment – sales from old asset + taxes on sale of old asset

Question 61

Evaluation Methods

Answer 61

- Payback Period - Average Rate of Return - Net Present Value - Internal Rate of Return - Profitability Index or Benefit-cost ratio

Question 62

length of time required for the firm to recover initial investment using cash flow basis

Answer 62

payback period

Question 63

if the payback period is less or is the company’s payback period then _______ the project

Answer 63

accept

Question 64

simple and easy but ignores timing and magnitude of inflow

Answer 64

Payback period

Question 65

Formula of payback period

Answer 65

= Net cost of investment / Annual net cash inflows

Question 66

- Help control the risks associated with the uncertainty of future cash flows. - Help minimize the impact of an investment on a firm’s liquidity problems. - Help control the risk of obsolescence. - Help control the effect of the investment on performance measures.

Answer 66

Payback period

Question 67

- Ignores the time value of money - Ignores the performance of the investment beyond the payback period

Answer 67

Payback period

Question 68

also known as accounting rate of return

Answer 68

Average Rate of Return

Question 69

Divides project’s average profit after taxes by investment

Answer 69

Average Rate of Return

Question 70

the average rate of return is compared with the minimum or required rate.

Answer 70

Average Rate of Return

Question 71

If the ARR exceeds the required, the project is _________

Answer 71

accepted

Question 72

Formula of Accounting Rate of Return

Answer 72

= Average income / Original investment or Average investment

Question 72

Formula of getting average income

Answer 72

Average annual net cash flows, less average depreciation

Question 73

Formula of getting Average investment

Answer 73

= (I + S) ÷ 2

Question 74

One of the discounted cash flow method where the difference between the present value of cash inflows and outflows

Answer 74

Net Present Value

Question 75

Potential change in an investor’s wealth caused by that project/proposal with the consideration of the time value of money

Answer 75

Net Present Value

Question 76

Decision rule: _______ a project if its NPV is positive and ______ if its NPV is negative

Answer 76

accept; reject

Question 77

Decision Criteria for NPV If NPV > 0:

Answer 77

- The initial investment has been recovered - The required rate of return has been recovered

Question 78

Formula of When cash inflows are even:

Answer 78

NPV = R × [1 − (1 + i)-n / i] − Initial Investment

Question 79

What is the following terms when cash flows are even: R = ? I = ? N = ?

Answer 79

R =net cash inflow to be received in each period I =required rate of return per period N = number of periods during which the project is expected to operate and generate cash inflows

Question 80

Formula of when cash flows are uneven

Answer 80

= [ R1/ (1 + i)^1 + R2 /(1 + i)^2 + R3 /(1 + i)^3 + .....] - Initial Investment

Question 81

In cahs flows are uneven where: I = ? R1 = ? R2 = ? R3 = ?

Answer 81

I = target rate of return per period; R1 = net cash inflow during the first period; R2 = net cash inflow during the second period; R3 = the net cash inflow during the third period, and so on ...

Question 82

is the rate at which the present value of cash inflows equals cash outflows.

Answer 82

Internal Rate of Return

Question 83

The rate that will produce a zero NPV.

Answer 83

Internal Rate of Return

Question 84

Discount rate at which the NPV of an investment becomes zero

Answer 84

Internal Rate of Return

Question 85

The discount rate which equates the PV of the future cash flows of an investment with the initial investment

Answer 85

Internal Rate of Return

Question 86

________ if IRR is not less than the target rate of return or choose which project has the highest value of IRR

Answer 86

accept

Question 87

Decision Criteria: If the IRR > Cost of Capital, _____________ If the IRR = Cost of Capital, ______________ If the IRR < Cost of Capital, ____________

Answer 87

If the IRR > Cost of Capital, accept the project If the IRR = Cost of Capital, accept or reject If the IRR < Cost of Capital, reject the project

Question 88

Formula for IRR

Answer 88

NPV = 0 Or PV of future cash flows – initial investment = 0 or [ R1/ (1 + i)^1 + R2 /(1 + i)^2 + R3 /(1 + i)^3 + .....] - Initial Investment = 0

Question 89

The simplest way of finding IRR:

Answer 89

1. Guess the value of r and calculate the NPV of the project at that value. 2. If NPV is close to zero then IRR is equal to r. 3. If NPV is greater than 0 then increase r and jump to step 4. If NPV is smaller than 0 then decrease r and jump to step 5. Recalculate NPV using the new value of r and go back to step 2.

Question 90

Is a relative measure as it gives the figure as a ratio

Answer 90

Profitability Index/benefit-cost ratio

Question 91

Helps in ranking projects based on their per dollar return

Answer 91

Profitability Index/benefit-cost ratio

Question 92

Decision rule: _________ if the profitability index is greater than 1, ____________ if it is zero __________ if it is below 1

Answer 92

accept if the profitability index is greater than 1; stay indifferent if it is zero; don’t accept if it is below 1

Question 93

Formula of Profitability Index/benefit-cost ratio

Answer 93

= Present Value of Future Cash Flows / Initial Investment Required = 1 + (Net Present Value / Initial Investment Required)

Question 94

Find the ARR Project Cost: Php 2M Estimated life: 5 yrs Estimated net income: 1 = 200,000 2 = 250,000 3 = 200,000 4 = 300,000 5 = 550,000

Answer 94

Found in notes

Question 95

Calculate the net present value of a project which requires an initial investment of $243,000 and it is expected to generate a cash inflow of $50,000 each month for 12 months. Assume that the salvage value of the project is zero. The target rate of return is 12% per annum.

Answer 95

NPV= 319,753.87

Question 96

Diamond Corporation is planning to buy a new equipment which costs Php 10M, estimated life of 10 years with no salvage value. The installation cost is Php 1,500,000 with an additional working capital of Php 100,000. There is Php 5M existing equipment of four years with a depreciable life of 8 years. This equipment can be resold for Php 3,250,000. Existing income tax rate is 35%.

Answer 96

Found in notes

Question 97

Payback analysis Unrecovered Investment Year 1 = $200,000 Year 2 = 140,000 Year 3 = 60,000 Year 4 = Year 5 = Annual Cash Inflow Year 1 = $60,000 Year 2 = 80,000 Year 3 = 100,000 Year 4 = 120,000 Year 5 = 140,000

Answer 97

Found in notes

Question 98

An initial investment of Php 1,000 on plant and machinery is expected to generate cash inflows of 500, 400, 200, 200, and 100 at the end of first, second, third, fourth, and fifth year respectively. Calculate the net present value of the investment if the discount rate is 10%.

Answer 98

Found in notes

Question 99

Find the IRR of an investment having initial cash outflow of $213,000. The cash inflow during the first, second, third, and fourth years are expected to be $65,200, $96,000, $73, 100 and $55,400 respectively. Assume that r is 10%.

Answer 99

Found in notes

Question 100

Profitability index An initial investment of Php 1,000,000 with projected annual ash inflow of Php 400,000 for 10 years at 25% required rate of return yields a present value of cash inflows of Php 1,319,410

Answer 100

Found in notes

Question 101

Star Corporation is planning to buy a new equipment which costs Php 500,000 estimated life of 5 years with no salvage value. The installation cost is Php 75,000 with an additional working capital of Php 100,00. The is a Php 200,000 existing equipment of three years with a depreciable life of 5 years. This equipment can be resold for Php 150,000. Existing income trax rate is 35%.

Answer 101

* Initial Investment = (Cost of asset) Php 500,000.00 + (Installation cost) 75,000.00 + (working capital investment) 100,000.00 – (sales from old asset) 150,000.00 + (taxes on sale of old asset) 24,500.00 Initial investment Php 549,500.00 Taxable gains from sales Sales price of old asset = 150,000.00 Less BV: 200,000(2/5) = 80,000.00 Gains = 70,000.00 = 35% Tax on sale of old = Php 24,500.00

Question 102

A company is planning to invest in a project that requires Php 500,000 initial investment and is expected to provide annual after-tax inflow of Php 100,000. Company's acceptable maximum payback period is 6 years. Will the company pursue their plan on this project?

Answer 102

Payback period = 500,000 / 100,000 = 5 years Since 5 is lesser than 6, accept the project

Question 103

An initial investment of Php 8,320 with Php 900.00 salvage value on plant and machinery is expected to generate cash inflows of Php 3,411, Php 4,070 , Php 5,824 and Php 2,065 at the end of first, second, third and fourth year respectively. Calculate the net present value of the investment if the discount rate is 18%.

Answer 103

Total PV in Cash Inflows = 10,887.67 Less: Intitial Investment = 8,320 NPV = 2,567.67 Accept the project

Question 104

The management of N marketing is considering the purchase of a new machine costing P300,000 with a salvage value of P100,000. The asset is expected to have an additional inflow of P35,000 annually for 5 years. The company's desired rate of return is at 10%. Using ARR, will the company push with the purchase of the new machine?

Answer 104

Average Rate of Return = 35,000/200,000 =17.5% , accept The average rate of return is compared with the minimum or required rate. 17.5% > 10% Note: If the ARR exceeds the required, the project is accepted

Question 105

Country Store is looking into purchasing a sea van as a storage van for years. The cost of the sea van is at P1,400,000 with salvage value of P50,000. Below is the estimated net income for 5 years. Country Store uses ARR in evaluating capital investment and have set their required rate of return at 30%. What will you recommend. Support your recommendation. Estimated net income: 1 = Php 150,000 2 = 250,000 3 = 200,000 4 = 300,000 5 = 550,000 total income = 1,450,000

Answer 105

= 290,000/ 725,000 =40% : Accept

Question 106

Calculate the net present value of a project which requires an initial investment of P900,000 and it is expected to generate a cash inflow of P400,000 for 10 years. The target rate of return is 30% per annum.

Answer 106

NPV = 400,000 × 1 − (1 + 30%)-10 − 900,000 =400,000 × 3.0915 − 900,000 =336,615.80

Question 107

An initial investment of P50,000 on plant and machinery with salvage value of P13,000 is expected to generate cash inflows of P12,500; P23,400; P12,200; P25,200; P1,100 at the end of first, second, third, fourth, and fifth year respectively. Calculate the net present value of the investment if the discount rate is 10%.

Answer 107

Found in notes

Question 108

ABC corporation plans to purchase a piece of factory equipment for P300,000 with a scrap value of P10,000 at the end of its life. The equipment would only last three years, but it is expected to generate P150,000 of additional annual profit. Factory equipment is expected to have a return of 15%.

Answer 108

At 15% =(130,434.783 + 113,421.55 + 105,202.597) -300,000 =349,058.93 – 300,000 = 49,058.93 If NPV is greater than 0 then increase r If NPV is smaller than 0 then decrease r At 25% = (120,000 + 96,000 + 81,920) – 300,000 = -2080 Decision rule: accept if IRR is not less than the target rate of return or choose which project has the highest value of IRR Accept the project.

Question 109

Capital investment decisions often involve all of the following except ________. a. qualitative factors or considerations b. short periods of time c. large amounts of money d. risk

Answer 109

b. short periods of time

Question 110

Preference decisions compare potential projects that meet screening decision criteria and will be ranked in their preference order to differentiate between alternatives with respect to all of the following characteristics except ________. a. political prominence b. feasibility c. desirability d. importance

Answer 110

a. political prominence

Question 111

The third step for making a capital investment decision is to establish baseline criteria for alternatives. Which of the following would not be an acceptable baseline criterion? a. payback method b. accounting rate of return c. internal rate of return d. inventory turnover

Question 112

You are explaining time value of money factors to your friend. Which factor would you explain as being larger? a. The future value of $1 for 12 periods at 6% 6 % is larger. b. The present value of $1for 12 periods at 6% c. Neither one is larger because they are equal. d. There is not enough information given to answer this question.

Question 113

Bob’s Auto Repair has determined that it needs new lift equipment to acquire more business opportunities. However, one or more alternatives meet or exceed the minimum expectations Bob has for the new lift equipment. As a result, what type of decision should Bob make for his company?

Question 114

If a copy center is considering the purchase of a new copy machine with an initial investment cost of $150,000 and the center expects an annual net cash flow of $ 20,000 per year, what is the payback period?

Answer 114

Payback period=initial cost/annual cash flows =150,000/20,000 which is equal to =7.5 years

Question 115

Assume a company is going to make an investment of $450,000 in a machine and the following are the cash flows that two different products would bring in years one through four. Which of the two options would you choose based on the payback method? Option A, Product A Option B, Product B $190,000 $150,000 190,000 180,000 60,000 60,000 20,000 70,000

Answer 115

Option A Payback period = (3 years + (10000/20000)) = 3.5 Years Option B Payback period = (3 years + (60000/70000)) = 3.86 Years

Question 116

If a garden center is considering the purchase of a new tractor with an initial investment cost of $120,000 and the center expects a return of $30,000 in year one, $20,000 in years two and three, $15,000 in years four and five, and $10,000 in year six and beyond, what is the payback period?

Answer 116

Payback period = 7 Years

Question 117

The management of Kawneer North America is considering investing in a new facility and the following cash flows are expected to result from the investment: Initial Cash Outflow: Year 1= $1900000 Year 2 =$550000 Initial Cash Inflow Year 1 = $100.000 Year 2 =200.000 Year 3 =360.000 Year 4 =480.000 Year 5 =510.000 Year 6 =600.000 Year 7 =590.000 Year 8 =300,000 Year 9 =250.000 Year 10 =250.000 a. What is the payback period of this uneven cash flow? b. Does your answer change if year 10 ’s cash inflow changes to $500,000 ?

Answer 117

a.) In Year 7 the Cummulative Cash Inflow is $2840,000 Hence Payback Period = 6 + ($2450000 $2250000)/$590,000 = 6 + $200,000/590000 = 6.34 years b) No, the answer will not change as the payback period is less than 10 years.

Question 118

A mini-mart needs a new freezer and the initial investment will cost $300,000. Incremental revenues, including cost savings, are $200,000 , and incremental expenses, including depreciation, are $125,000. There is no salvage value. What is the accounting rate of return (ARR)?