Management Advisory Services: Capital Budgeting
Batangas CPA Review “Committed to your CPA review needs” RLCAPUNO, CPA, LLB The Capital Budgeting Evaluation Process The capital budgeting evaluation process generally has the following steps: Project proposals are requested from departments, plants, and authorized personnel. Proposals are screened by a capital budget committee. Officers determine which projects are worthy of funding and !oard of directors approves capital budget.
Cash Flow Inormation "hile accrual accounting has advantages over cash accounting in many conte#ts, for purposes of capital budgeting, estimated cash inflows and outflows are preferred for inputs into the capital budgeting decision tools. $ometi $ometimes mes cash flow flow inform informati ation on is not availab available, le, in which which cas case e adjust adjustme ments nts can be made made to acc accrua ruall accounting numbers to estimate cash flows. The capital budgeting decision, under any technique, depends in part on a variety of considerations: The availability of funds %elationships among proposed projects The company&s basic decision'ma(ing approach and The ris( associated with a particular project.
Cash Pay!ac" The cash pay!ac" techni#ue identifies the time period required to recover the cost of the capital investment from the net annual cash inflow produced by the investment. The formula for computing the cash paybac( period is: )ost of )apital *nvestment + et -nnual )ash low / )ash Paybac( Period et annual cash flow can be appro#imated by adding depreciation e#pense e#pense to net income. The evaluation of the paybac( period is often related to the e#pected useful life of the asset. "ith this technique, the shorter the paybac( period, the more attractive the investment. This technique is useful as an initial screening tool. This technique ignores both the e#pected profitability of the investment and the time value of money.
$et Present %alue Method 0nder 0nder the net present value &$P%' method( method( cash flows are discounted to their present value and then compared with the capital outlay required by the investment. The difference between these two amounts is the net present value &$P%') The interest rate used in discounting the future net cash flows is the required minimum rate of return. - proposal is acceptable when P1 is zero or positive. The higher the positive P1, the more attractive the investment.
"hen there are e#ual annual cash inlows( the table showing the present value of an annuity of 2 can be used in determini determining ng present value. "hen there are une#ual annual annual cash inlows( the table showing the present value of a single future amount must be used in determining present value. The discount rate used by most companies companies is its cost o capital3that capital 3that is, the rate that the company must pay to obtain funds from creditors and stoc(holders. The net present value method demonstrated in the te#t requires the following assumptions: -ll cash flows come at the end of each year -ll cash flows are immediately reinvested in another project that has a similar return and -ll cash flows can be predicted with certainty.
Intangi!le Beneits !y ignoring intangi!le !eneits( such as increased quality or improved safety, capital budgeting techniques might incorrectly eliminate projects that could be financially beneficial to the company. To avoid rejecting projects that actually should be accepted, two possible approaches are suggested )alculate net present value ignoring intangible benefits, and then, if the P1 is negative, as( whether the intangible benefits are worth at least the amount of the negative P1. Project rough, conservative estimates of the value of the intangible benefits, and incorporate these values into the P1 calculation.
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Management Advisory Services: Capital Budgeting Mutually E*clusive Pro+ects *n theory, all projects with positive P1s should be accepted. 4owever, companies rarely are able to adopt all positive' positive'P1 P1 proposals proposals because 526 the proposals proposals are mutually mutually e*clusiv e*clusive e 5if the compa company ny adopts adopts one proposal, it would be impossible to also adopt the other proposal6, and 576 companies have limited resources. *n choosi choosing ng betwe between en two project projects, s, one one method method that ta(es ta(es into account account both both the size of the origi original nal investmen investmentt and the discounted discounted cash flows is the proita!i proita!ility lity inde*) inde*) The profitability inde# formula is as follows: Present 1alue of uture )ash lows + *nitial *nvestment / Profitability *nde# The project with the greater profitability inde# should be the one chosen. -nother -nother consideratio consideration n made by financial financial analysts analysts is uncertain uncertainty ty or ris" ris")) One approach for dealing with uncertainty is sensitivity analysis) $ensitivity analysis uses a number of outcome estimates to get a sense of the variability among potential returns. *n general, a higher ris( project should be evaluated using a higher discount rate. Post,Audit o Investment Pro+ects - post,aud post,audit it is a thorough evaluation of how well a project&s actual performance matches the projections made when the project was proposed. Performing a post'audit is beneficial for the following reasons: 8anagement will be encouraged to submit reasonable and accurate data when they ma(e investment proposals - formal formal mechan mechanism ism is used used for determ determini ining ng wheth whether er e#isti e#isting ng proje projects cts should should be suppo supporte rted d or terminated 8anagement improves their estimation techniques by evaluating their past successes and failures.
- post'audit involves the same evaluation techniques that were used in ma(ing the original capital budgeting decision3for e#ample, use of the net present value method. The difference is that, in the post'audit, actual figures are inserted where (nown, and estimation of future amounts is revised based on new information. Internal -ate o -eturn Method The internal rate o return method results in finding the interest yield of the potential investment. This is the interest rate that will cause the present value of the proposed capital e#penditure to equal the present value of the e#pected annual cash inflows. 9etermining the internal rate of return can be done with a financial 5business6 calculator, computerized spreadsheet, or by employing a trial'and'error procedure. The decision decision rule rule is: -ccept the project when the internal rate of return is equal to or greater than the required rate of return, and reject the project when the internal rate of return is less than the required rate. Annual -ate o -eturn Method The annual rate o return method indicates the profitability of a capital e#penditure and its formula is: #pected -nnual et *ncome + -verage *nvestment / -nnual %ate of %eturn -verage investment is based on the following: Original investment ; 1alue at end of useful life / -verage *nvestment The annual rate of return is compared with management&s required minimum rate of return for investments of similar ris(. The minimum rate of return 5the hurdle rate or cutoff rate6 is generally based on the company&s cost of capital. The decision rule is: - project is acceptable if its rate of return is greater than management&s minimum rate of return it is unacceptable when the reverse is true. "hen the rate of return technique is used in deciding among several acceptable projects, the higher the rate of return for a given ris(, the more attractive the investment. .ET/s -E%IE0 Theory 2. The capital capital budge budgett for the the year year is approv approved ed by a company company
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Management Advisory Services: Capital Budgeting =. 8ost 8ost of a. b. c. d.
the capi capital tal budg budgeti eting ng metho methods ds use use accruall acco accrua account unting ing number numbers. s. cash cash flo flow w numb number ers. s. net income. accrua acc ruall acco account unting ing reven revenues ues..
>. The first first step in the the capital capital budgetin budgeting g evaluation evaluation proce process ss is to a. reque request st prop proposa osals ls for for proje projects cts.. b. screen screen propo proposals sals by by a capita capitall budgeting budgeting committee committee.. c. determine determine which projects projects are worthy worthy of fundin funding. g. d. approv approve e the the capita capitall budg budget. et. ?. The capital capital budge budgeting ting decisi decision on depends depends in part part on the a. avai availa labi bili lity ty of fund funds. s. b. relationsh relationships ips among among propose proposed d project projects. s. c. ris( ris( assoc associat iated ed with with a partic particula ularr projec project. t. d. all of of th these. @. )apita )apitall a. b. c. d.
budg budgeti eting ng is is the the proc process ess used in sell sell or process process further further decisions. decisions. of deter determining mining how much capital capital stoc( stoc( to issue. issue. of ma(in ma(ing g capita capitall e#pend e#penditu iture re decis decision ions. s. of eliminating eliminating unprofitab unprofitable le product product lines.
A. et annu annual al cash cash flow flow can can be esti estimat mated ed by by a. deduct deducting ing cred credit it sales sales from from net net income income.. b. adding adding depre depreciati ciation on e#pen e#pense se to net net income income.. c. deduct deducting ing cred credit it purcha purchases ses from from net net income. income. d. adding adding adver advertising tising e#pense e#pense to net net incom income. e. B.
"hic "hich h of the the foll follow owin ing g is not a typical cash flow related to equipment purchase and replacement decisionsC a. *ncr *ncrea ease sed d opera operati ting ng cost costs s b. Over Overha haul ul of equi equipm pmen entt c. $alvage $alvage value value of equipm equipment ent when when proje project ct is complete complete d. 9epr 9eprec ecia iati tion on e#pe e#pens nse e
D. )apital )apital a. b. c. d.
e#pendit e#penditure ure propos proposals als are initial initially ly screened screened by the boar board d of dire direct ctor ors. s. e#ec e#ecut utiv ive e com commi mitt ttee ee.. capita capitall budget budgeting ing commi committe ttee. e. stoc stoc(h (hol old ders. ers.
2E. )apital a. b. c. d.
budgeting decisions decisions depend in part on all all of the following except the the relationsh relationships ips among among propose proposed d project projects. s. profi profitab tabilit ility y of of the the compa company. ny. compa company& ny&s s basic basic decisi decision on ma(ing ma(ing appro approach ach.. ris(s ris(s associ associated ated with a parti particular cular project. project.
22. The corporate capital capital budget authorization process process consists of how how many stepsC a. > b. = c. 7 d. 2 27. "hich a. b. c. d.
of the the following following is not a a capital budgeting decisionC )ons )onstr truc ucti ting ng new new stu studi dios os %epl %eplac acin ing g old old equip equipme ment nt $crapp $crapping ing obsol obsolete ete invent inventor ory y %emod %emodeli eling ng an offic office e buil buildin ding g
2=. "hich a. b. c. d.
of the following is a disadvantage disadvantage of the cash paybac( paybac( techniqueC *t is is diffi difficu cult lt to to ca calc lcul ulat ate e *t reli relies es on on the time time value value of mone money y *t can only only be calculated calculated when there there are are equal equal annual annual net net cash flows flows *t ignores ignores the e#pect e#pected ed profitab profitability ility of of a projec projectt
2>. The paybac( period is often compared to an asset&s a. esti estima mate ted d use usefu full lif life. e. b. warr warran anty ty per perio iod d. c. net net pre prese sent nt valu value. e. d. inte intern rnal al rat rate e of ret retur urn. n.
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Management Advisory Services: Capital Budgeting 2?. "hich a. b. c. d.
of the following following ignores the time value of moneyC moneyC *nte *ntern rnal al rat rate e of of ret retur urn n Prof Profit itab abili ility ty inde# inde# et et pres presen entt valu value e )ash ash payb aybac( ac(
2@. !rady !rady )orp. )orp. is consider considering ing the purchase purchase of a piece piece of equipment equipment that costs costs P7=,EEE P7=,EEE.. Projecte Projected d net annual cash flows over the project&s life are: Fear et -nnual )ash low 2 P =,EEE 7 B,EEE = 2?,EEE > D,EEE The cash paybac( period is a. 7.@= ye years. b. 7.BE ye years. c. 7.7E years. d. 7.=A ye years. 2A. !radshaw *nc. is contemplating contemplating a capital investment of PB?,EEE. PB?,EEE. The cash flows over the project&s project&s four years are: #pected -nnual Fear 2 7 = >
#pected -nnual )ash *nflows P=E,EEE >?,EEE @E,EEE ?E,EEE
)ash Outflows P27,EEE 7E,EEE 7?,EEE =E,EEE
The cash paybac( period is a. 7.2A ye years. b. =.=? ye years. c. 7.=E years. d. =.>A ye years. 2B. Gordan )ompany is considering considering the purchase purchase of a machine with the following data: data: *nitial cost One'time training cost -nnual maintenance costs -nnual cost savings $alvage value
P2=E,EEE 27,EEE 2?,EEE A?,EEE 7E,EEE
The cash paybac( period is a. 7.=A ye years. b. 7.2A ye years. c. 2.BD years. d. 2.A= ye years. 2D. *f project - has a lower paybac( period than project project !, this may indicate that project - may have a a. lower lower P1 P1 and and be be less less pro profita fitable ble.. b. higher higher P1 and be be less less pro profita fitable ble.. c. higher higher P1 and be more more profit profitabl able. e. d. lower lower P1 P1 and and be more more profi profitab table. le. 7E. "hich a. b. c. d.
of the followin following g does not consider consider a company&s required rate of returnC et et pre prese sent nt valu value e *nte *ntern rnal al rat rate e of retu return rn -nnu -nnual al rat rate eo off retu return rn )ash ash payb aybac( ac(
Pro!lems Cost vs $et Investment 2. -n individual individual is planning planning to buy a new car costing costing P2,?EE,E P2,?EE,EEE. EE. The dealer dealer of the car will allow allow a trade' in value for his old car at P=EE,EEE. *f he retains his old car, he needs to overhaul the same for P=?,EEE. *ncome ta#es are 7?H. "hat is the net investment for decision ma(ing purposesC - company is planning to replace an old machine which is out of order with a new machine. Purchase price of the new machine is P2=E,EEE e#clusive of freight and installation costs of P?,EEE. The old machine has a carrying amount of P@E,EEE and can be sold for P7E,EEE. The old machine will require P=E,EEE to have it overhauled. *ncome ta#es are 7EH. 7. or boo(( boo((eepin eeping g purposes purposes,, what is the the cost of of the new machin machineC eC =. or decisi decision on ma(ing ma(ing purpos purposes, es, what what is the the net invest investmentC mentC >. -ssume -ssume that the old machine machine can be sold sold instead instead for P@7,EEE P@7,EEE,, how much is the net investme investment nt for purposes of using the discounted cash flow for evaluating the investmentC
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Management Advisory Services: Capital Budgeting -! )ompany is planning to replace an old machine purchased > years ago for P27E,EEE. The estimated life is 2? years with no salvage value. The new machine will cost P7EE,EEE inclusive of freight charges of PB,EEE. The old machine can be sold to a third party at P=B,EEE or traded for P=?,EEE. *ncome ta#es are >EH. ?. *f the old machin machine e is sold, sold, what is is the net invest investmentC mentC @. *f the old old machine machine is is instead instead traded traded'in, 'in, what what is the investment investmentC C A. The management management of -!) -!) )ompany plans to replace an equipment acquired acquired several several years years ago at a cost cost of PBE,EEE. The equipment is fully depreciated but can still be sold for P?,EEE. *t will cost P27,EEE to have it overhauled. *ncome ta#es are 2?H. The new equipment costs P2BE,EEE. *f the new equipment is acquired, what is the net investmentC B. - new machine machine was acquired acquired with with a net investment investment of P22?,EE P22?,EEE. E. %epair %epair cost of P2E,EEE P2E,EEE was was avoided avoided as a result of the acquisition and the old machine with a carrying amount of P?E,EEE was sold for P=E,EEE. *ncome ta#es are =EH. "hat is the cost of the machine for boo((eeping purposesC D. - compa company ny plans plans to buy a compu computer ter costin costing g P2@E,E P2@E,EEE EE.. Other Other assets assets are to be retired retired and sold sold for P2E,EEE with a loss on sale of P>,EEE which will reduce income ta#es by P2,EEE. The old computer needs to be repaired at a cost of P@,EEE. "hat is the net investmentC 2E. - company plans to invest PA7?,EEE PA7?,EEE in furnishing and equipment equipment for a new outlet. $ales for this outlet are estimated at P2,?EE,EEE a year 2I2E of which remain uncollected at the end of the year. The gross gross profit profit rate is 7?H. 7?H. The investment investment in inventory inventory will be P7>E,EE P7>E,EEE E with estimated estimated acco accounts unts payable of PBE,EEE at the end of the year. )ash of P27E,EEE will be needed to meet operating e#penses. "hat is the net investmentC Capital Investment Pro!lem 1 The following relevant data pertains to a proposed capital capital investment: )ost of machine P2@E,EEE Ji fe 2E years $alvage value P2E,EEE The acquisition of the machine will generate cash savings of P>A,EEE annually. *ncome ta#es are =?H. %equired: valuate the desirability of acquiring the machine by computing the f ollowing: a. Paybac( b. Payb Paybac ac( ( peri period od c. -cco -ccounting unting rate of of return return on the the origina originall cost of of investme investment nt d. -cco -ccounting unting rate of of return return on the the averag average e cost cost of investm investment ent Pro!lem 2 -!) )orporation is considering the acquisition of a mini'computer which costs P27E,EEE with an economic useful life of 27 years and a terminal salvage value of P27,EEE. *t is estimated that the annual net income before ta#es from this investment will amount to PA,EEE. *ncome ta#es are =?H. The company uses the straight line method f or computing depreciation. %equired: 9etermine the following: a. "hat "hat is the the annual annual cash cash inco income me after after ta#e ta#esC sC b. "hat is the the paybac paybac( ( and paybac( paybac( reciproc reciprocalC alC c. "hat is the account accounting ing rate rate of return return on the original original and averag average e cost of investme investmentC ntC d. "hat "hat is is the the annual annual ta# shield shieldC C Pro!lem 3 8K )ompany acquired a new machine for P2@E,EEE which it will depreciate on a straight line basis over ten years. The accounting rate of return on the original cost of investment 5after'ta#es6 is computed at 27H. %equired: 9etermine the following: a. 4ow much much is the the annual annual cash cash inco income me after after ta#es ta#esC C b. "hat is the the paybac paybac( ( and paybac( paybac( reciproc reciprocalC alC c. "hat is the the accounting accounting rate rate of return return on the the average average cost cost of investm investmentC entC Pro!lem 4 - certain investment has a paybac( reciprocal of 7EH 5after'ta#es6. The cost of investment is P>E,EEE. $alvage value is P2E,EEE. -nnual depreciation is P>E,EEE. *ncome ta#es are 7EH. %equire: 9etermine the following: a. "hat "hat is the life life of the the inve investm stment entC C b. "hat "hat is the the annual annual net net income income afte afterr ta#esC ta#esC c. "hat is the the accounting accounting rate rate of return return on the the average average cost cost of investm investmentC entC Pro!lem 5 -ssume the following date: -nnual depreciation 5using straight line method6 stimated useful life $alvage value -ccounting rate of return on original cost
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Management Advisory Services: Capital Budgeting %equire: 9etermine the following: a. "hat is the the accounting accounting rate rate of return return on the the average average cost cost of investm investmentC entC b. 4ow much much is the annual annual cas cash h inco incomeC meC Pro!lem 6 The average rate of return on the average cost of investment of a certain project is 2DH. The average cost of investment is P=7@,EEE. The investment has a terminal salvage value of PB,EEE. %equired: "hat is the accounting rate of return on the original cost of investmentC Pro!lem 7 - project costing P2>7,EEE will generate annual cash savings of P>?,EEE. *t has an estimated life of > years. The salvage value at the end of the first year is estimated at P=E,EEE which will decline by P2E,EEE at the end of each subsequent years. %equired: "hat is the bail'out paybac( of the project Pro!lem 8 )hipipay )ompany is considering an investment which will require P7EE,EEE. The estimated cash inflows from the investment are as follows: nd of year 2 P2EE,EEE 7 BE,EEE = @E,EEE > ?E,EEE ? >E,EEE %equired: *gnoring income ta#es. )ompute the following: a. Paybac( b. %O* c. -cco -ccounting unting rate rate of return return on the origina originall cost and the the average average cost cost of investment investment Pro!lem 9 ). Jahis )ompany plans to acquire a machine costs P2?E,EEE with an estimated useful life of = years with no salvage value. The cash income from this investment is non'uniform. The pattern of the inflows is as follows: nd of year 2 P2EE,EEE 7 27E,EEE = 2?E,EEE -ssume a ta# rate of >EH each year. %equired: 9etermine the following: a. "hat "hat is is the the payb paybac ac( ( peri period odC C b. "hat "hat is the the %O %O*C d. "hat is the accounting rate rate of return return on the original cost cost and the average cost of investmentC investmentC Pro!lem 1 -langanin )orporation wants to acquire an equipment with a purchase price of P=EE,EEE with a ='year life and no salvage value. This equipment is e#pected to generate additional earnings before ta#es as f ollows: nd of year 2 P2EE,EEE 7 2?E,EEE = 7EE,EEE -ssume a ta# rate of 7EH each year. %equired: a. The numbe numberr of years years to recoup recoup the the investme investment nt b. The accountin accounting g rate of of return return on the averag average e cost of of investment investment.. Pro!lem 11 -'T1 )ompany invested in a project which required an investment of P2EE,EEE with an estimated salvage value of P2E,EEE at the end of its life, which is = years. The earnings after ta#es 5>EH each year6 from this investment were as follows: nd of year 2 P=E,EEE 7 >B,EEE = A7,EEE The company uses the straight line method for computing depreciation. %equired: 9etermine the following: a. Payb Paybac ac( ( peri period od b. %*O c. -cco -ccounting unting rate rate of return return on the origina originall cost and the the average average cost cost of investment investment Pro!lem 12 The management of !'4on )ompany has been considering an investment of P7>E,EEE in a project with a 7E' year life. The earnings after ta#es are P@E,EEE per year for ? years, then P27,EEE each year thereafter. %equired: 9etermine the following: a. Paybac( b. -cco -ccounting unting rate of of return return on the the averag average e cost cost of investm investment ent
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Management Advisory Services: Capital Budgeting Pro!lem 13 - project requiring an investment of P27E,EEE with no salvage value and having a = year life will generate cash savings as follows: nd of year 2 P@>,EEE 7 B2,EEE = DB,EEE %equired: 9etermine the following: a. "hat "hat is is the the aver averag age e %O*C %O*C b. "hat "hat is the accounti accounting ng rate of return return on the average average cost cost of investm investment entC C 5The 5The compa company ny uses $F9 method6 Pro!lem 14 -ssume the following data pertaining to an investment -mount of investment require Jife et income income after after ta#es ta#es nd of year 2 P2E,EEE 7 7E,EEE = 22,EEE > 2B,EEE %equired: "hat is the bail'out paybac(C
proposal: P2AE,EEE > years $alvage $alvage value value P=E,EEE 7E,EEE 2E,EEE '
;iscounted Cash Flow Analysis Pro!lem 1 The following projects have been submitted for inclusion in the coming year&s capital e#penditure budget: Fear E 2
Project 5P2EE,EEE6 7B,EEE
Project ! 5P22?,EEE6 >E,EEE
Project ) 5P22?,EEE6 @E,EEE
Project 9 5P2EE,EEE6 2E,EEE
Project 5PB@,EEE6 52E,EEE6
Project 5P2?7,EEE6 '
Project L 5P227,EEE6 7?,EEE
7
7B,EEE
?E,EEE
?E,EEE
=E,EEE
?,EEE
'
7?,EEE
=
7B,EEE
@E,EEE
>E,EEE
7E,EEE
=E,EEE
2EE,EEE
7?,EEE
>
7B,EEE
?E,EEE
>E,EEE
27E,EEE
7?,EEE
?
7B,EEE
>E,EEE
A?,EEE
7,EEE
2,EEE
$1
>E,EEE @,EEE
2E,EEE
%equired: )ompute the following for each project: 5*gnore income ta#es6 a. et pres present ent valu value e using using desire desired d %O* of of 2EH b. Prof Profit itab abili ility ty *nde *nde# # c. %an( %an( the projec projects ts in he order order of their their profita profitabil bility ity assumin assuming g all proje projects cts are indepen independen dentt of one another. d. -ssume -ssume that projects projects -, 9 M are mutually e#clusi e#clusive, ve, which which project project should be be selectedC selectedC e. -ssu -ssume me that proje project cts s -, 9 M are are mutu mutual ally ly e#clus e#clusiv ive, e, ran( the proje project cts s in the the orde orderr of thei theirr profitability. f. -ssume -ssume that only only P7@E,EEE P7@E,EEE cash cash is available available for for investment investment,, which projec projects ts should should be selectedC selectedC Pro!lem 2 !illy )ompany is considering two projects. %elevant data follows: Project 2 )ost of machine P2EE,EEE stimated life = years -nnual cash income 5before ta#es6 nd of year 2 P@E,EEE 7 @E,EEE = @E,EEE $alvage value 2E,EEE )ost of capital, 27H *ncome ta#es, 7EH
Project 7 P27?,EEE = years PBE,EEE AE,EEE @E,EEE 7E,EEE
%equired: 9etermine the following: a. )ompute )ompute the the P1 5e#ce 5e#cess ss presen presentt value6 value6 for each each projec project. t. b. )omput )ompute e the P1 P1 inde# inde# for for each each proj project ect c. -ssume -ssume that the projects projects are mutually mutually e#clusi e#clusive, ve, which which projects projects should should be selectedC selectedC "hyC "hyC d. -ssume -ssume that the projects projects are independ independent ent of one another, another, which which should be selecte selectedC dC "hyC e. or each each proje project ct compute compute the discou discounted nted paybac(. paybac(. Pro!lem 3 -'T1 )ompany acquired a turning machine which generated annual cash income of P7E,EEE. The machine has a useful life of 2E years with no salvage value. The annual net income after ta#es from this investment is
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Management Advisory Services: Capital Budgeting PA,?EE. *ncome ta#es are >EH each year. The P1 of annuity of 2 for 2E years is @.2>?. The cost of capital is 2EH. *f the P1 is positive P2A,2A?, how much is the amount of investmentC Pro!lem 4 44 )ompany invested in a project which generated cash inflow after ta#es as follows: nd of year 2 PBE,EEE 7 AE,EEE = ?E,EEE )ost of capital is 2?H. %equired: a. *f the profitab profitability ility inde# inde# is 2.7?, 2.7?, how how much is is the amount amount of investm investmentC entC b. *f the P1 is P=2, P=2, A>E A>E and the investme investment nt is P2?E P2?E,EE ,EEE, E, how much should should be the cash inflow inflow after after ta#es at the end of the =rd yearC Pro!lem 5 - certain project which requires an investment of PBE,EEE will produce annual cash savings after ta#es of P7E,EEE for B years. The P1 of an annuity of 2 for B years at various rates are shown as follows: 2?H 2@H 2BH 7EH B years >.>BA >.=>> >.EAB =.B=A %equired: a. "hat "hat is is the the appro appro#im #imate ate *%%C *%%C b. "hat "hat is the the e#a e#act ct *%%C *%%C Pro!lem 6 K )ompany invested in project costing P27E,EEE with an economic life of B years with no salvage value. The project generated annual earnings after ta#es of P72,?EE. The company&s cost of capital is 2>H. The company evaluates projects using the discounted cash flow analysis. %equired: a. 9id the inves investment tment earn earn at lest lest the minimum minimum rate rate of return return requir requiredC edC b. "hat "hat is is the the appro appro#im #imate ate *%%C *%%C c. "hat "hat is the the e#a e#act ct *%%C *%%C Pro!lem 7 F )ompany invested in a project costing P2@ P2@E,EEE E,EEE which generated cash inflows from operations after ta#es as follows: nd of year 2 PBE,EEE 7 AE,EEE = >?,?EE The project has a salvage value of P?,?EE after = years. )ost of capital is 2AH. %equired: a. )om )omput pute the the %* b. )omp )omput ute e the the e#ac e#actt *%% *%% Pro!lem 8 The following information is available for a proposed capital investment: -nnual )ash *ncome P1 of P2 at 7EH nd of year 2 P2E,EEE .AB2 7 7E,EEE .@2E = =E,EEE .>AA
P1 of P2 at =EH .A@D .?D7 .>??
The project costs P=>,EEE and the appro#imate *%% has been computed between 7BH and =EH. "hat is the e#act *%%C Pro!lem 9 $$ )ompany is planning to invest in a project which will produce the following cash flows af ter ta#es: nd of year 2 P=E,EEE 7 =@,EEE = 7>,?EE %equired: *f the *%% is 2EH, how much is the amount of investmentC Pro!lem 1 T4 )ompany is planning to acquire a new machine at a cost of P2E7,@E@. The company&s cost of capital is 2?H. The P1 of 2 at 2?H for one year is .BAE, for two years is .A?@ and for three years is .@?B. The cash flows from operations net of ta#es are P>7,EEE for the first year and P>=,EEE for the second year. *f the *%% is equal to the cost of capital, what would be the cash flow from operations, net of ta#es at the end of the third yearC Pro!lem 11 8arimar )orporation plans to replace an old machine acquired ? years ago at cost of PBE,EEE. *t has a remaining useful of ? years with a salvage value of P>,EEE. -nnual cash operating costs for this old machine are PA?,EEE. - new machine can be acquired with a life of ? years at a cost of PBB,?EE. - trade in allowance of P2?,EEE on the old machine is to be deducted. This machine will slash annual operating costs by P=E,EEE. *t will have a salvage value of P7,EEE.
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Management Advisory Services: Capital Budgeting
%equired: a. "hat is the the present present value value of the net net ash outflow outflows s if the old old machine machine is (eptC (eptC b. "hat is the present present value value of the net net cash outflows outflows if the new new added added machine machine is acquiredC acquiredC c. *s it advis advisabl able e to repla replace ce the the old machi machineC neC "hyC "hyC Pro!lem 12 %itzy )ompany is contemplating buying a new machine with an economic life of ? years with a salvage value of P?,EEE. The annual depreciation is computed at p2B,AEE. -t present an old machine is being leased at P7D,EEE payable at the end of each year for the ?'year lease term. )ost of money is 2BH. "hich is better, buy or leaseC Pro!lem 13 Lary )orporation acquired a building 2? years ago at a cost of P2EE,EEE. The estimated life is 7E years with no salvage value. -t present the building is being leased at P2?,EEE annually payable at the end of each year. The company can sell now at a price of P@E,EEE. *ncome ta#es are >EH. The P1 of an annuity of P2 for ? years at 2@H is =.=A>. "hat is better, sell or leaseC
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