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THEORY A. Disregarded because no cash is involved.

Basic concepts B. Amortized over the useful life of the equipment.
1. Capital budgeting techniques are least likely to be used in evaluating the C. Treated as an immediate cash outflow that is recovered at the end of six years.
A. Acquisition of new aircraft by a cargo company. D. Treated as a recurring annual cash flow that is recovered at the end of six years.
B. Trade for a star quarterback by a football team.
C. Design and implementation of a major advertising program. Operating Cash Flows After Tax
D. Adoption of a new method of allocating non-traceable costs to product lines. 6. To approximate annual cash inflow, depreciation is
A. Subtracted from net income because it is an expense.
2. The inflation element refers to the B. Added back to net income because it is an inflow of cash.
A. Future increases in the general purchasing power of the monetary unit. C. Subtracted from net income because it is an outflow of cash.
B. Future deterioration of the general purchasing power of the monetary unit. D. Added back to net income because it is not an outflow of cash.
C. Fact that the real purchasing power of a monetary unit usually increases over time.
D. Impact that future price increases will have on the original cost of a capital expenditure. 7. In capital expenditures decisions, the following are relevant in estimating operating costs
except
3. Which of the following best identifies the reason for using probabilities in capital budgeting is A. Cash costs. C. Future costs.
A. Cost of capital. C. Time value of money. B. Differential costs. D. Historical costs.
B. Different life of projects. D. Uncertainty.
Accounting Rate of Return
4. In capital budgeting decisions, the following items are considered among others: 8. The following statements refer to the accounting rate of return (ARR)
1. Cash outflow for the investment. 1. The ARR is based on the accrual basis, not cash basis.
2. Increase in working capital requirements. 2. The ARR does not consider the time value of money.
3. Profit on sale of old asset 3. The profitability of the project is considered.
4. Loss on write-off of old asset. From the above statements, which are considered limitations of the ARR concept?
For which of the above items would taxes be relevant? A. Statements 1 and 2 only. C. Statements 3 and 1 only.
A. Items 1 and 3 only. C. Items 3 and 4 only. B. Statements 2 and 3 only. D. All the 3 statements.
B. Items 1, 3 and 4 only. D. All items.
Payback Period
Net Investments 9. The payback method assumes that all cash inflows are reinvested to yield a return equal to
5. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient. A. the discount rate. C. the internal rate of return.
This equipment has an estimated useful life of six years. As part of this acquisition, a B. the hurdle rate. D. zero.
P150,000 investment in working capital is required. In a discounted cash flow analysis, this
investment in working capital should be

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10. As a capital budgeting technique, the payback period considers depreciation expenses (DE) The most likely reason is
and time value of money (TVM) as follows: A. There is lower tax rate in year 5. C. The time value of money is considered.
A. B. C. D. B. There is higher tax rate in year 5. D. Due to statements A and C above.
DE relevant relevant Irrelevant irrelevant
TVM relevant irrelevant Relevant irrelevant 15. In an investment in plant the return that should keep the market price of the firm stock
unchanged is
Bailout Payback A. Cost of capital C. Net present value
11. The bailout payback period is B. Discounted rate of return D. Payback
A. The payback period used by firms with government insured loans.
B. The length of time for payback using cash flows plus the salvage value to recover the 16. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost,
original investment the value of the firm and the price of its common stock will <List B>
C. (A) and (B) A. B. C. D.
D. None of the above. List A Equal to Equal to Greater than Greater than
List B Decrease Increase Decrease Increase
Discounted Cash Flow Method
12. Which of the following methods measures the cash flows and outflows of a project as if they 17. The common assumption in capital budgeting analysis is that cash inflows occur in lump sums
occurred at a single point in time? at the end of individual years during the life of an investment project when in fact they flow
A. Capital budgeting. C. Discounted cash flow. more or less continuously during those years
B. Cash flow based payback period. D. Payback method. A. Results in understated estimates of NPV.
B. Results in higher estimate for the IRR on the investment.
13. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital C. Is done because present value tables for continuous flows cannot be constructed.
budgeting project, which of the following factors generally is not important? D. Will result in inconsistent errors being made on estimating NPVs such that project cannot
A. The timing of cash flows relating to the project. be evaluated reliably.
B. The amount of cash flows relating to the project.
C. The impact of the project on income taxes to be paid. 18. Polo Co. requires higher rates of return for projects with a life span greater than 5 years.
D. The method of financing the project under consideration. Projects extending beyond 5 years must earn a higher specified rate of return. Which of the
following capital budgeting techniques can readily accommodate this requirement?
14. Your company is purchasing a transport equipment as part of its territorial expansion strategy. A. B. C. D.
The technical services department indicated that this equipment needs overhauling in year 4 Internal Rate of Return Yes Yes No No
or year 5 of its useful life. The overhauling cost will be expected during the year the Net Present Value Yes No Yes No
overhauling is done. The finance officer insists that the overhauling be done in year 4, not in
year 5.
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19. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are 24. When using the net present value method for capital budgeting analysis, the required rate of
some of the capital budgeting techniques. What is the effect of an increase in the cost of return is called all of the following except the
capital on these techniques? A. Cost of capital. C. Discount rate.
A. B. C. D. B. Cutoff rate. D. Risk-free rate.
PP Decrease Increase No change No change
PI No change Decrease Decrease Increase 25. A projects net present value, ignoring income tax considerations, is normally affected by the
SARR No change Increase No change Decrease A. Proceeds from the sale of the asset to be replaced.
B. Carrying amount of the asset to be replaced by the project.
Net Present Value C. Amount of annual depreciation on the asset to be replaced.
20. A company had made the decision to finance next years capital projects through debt rather D. Amount of annual depreciation on fixed assets used directly on the project.
than additional equity. The benchmark cost of capital for these projects should be
A. The after-tax cost of new-debt financing. C. The cost of equity financing. 26. You have determined the profitability of a planned project by finding the present value of all the
B. The before-tax cost of new-debt financing. D. The weighted-average cost of capital. cash flows from that project. Which of the following would cause the project to look less
appealing, that is, have a lower present value?
21. All of the following refer to the discount rate used by a firm in capital budgeting except A. The discount rate increases.
A. Hurdle rate. C. Opportunity cost of capital. B. The cash flows are extended over a longer period of time.
B. Opportunity cost. D. Required rate of return. C. The cash flows are accelerated and the project life is correspondingly shortened.
D. The investment cost decreases without affecting the expected income and life of the
22. The excess present value method is anchored on the theory that the future returns, expressed project.
in terms of present value, must at least be
A. Equal to the amount of investment C. More than the amount of investment 27. Which of the following is always true with regard to the net present value (NPV) approach?
B. Less than the amount of investment D. Cannot be determined A. The NPV and the IRR approaches will always rank projects in the same order.
B. The NPV and payback approaches will always rank projects in the same order.
23. An advantage of the net present value method over the internal rate of return model in C. If a project is found to be acceptable under the NPV approach, it would also be
discounted cash flow analysis is that the net present value method acceptable under the payback approach.
A. Computes a desired rate of return for capital projects. D. If a project is found to be acceptable under the NPV approach, it would also be
C. Uses a discount rate that equates the discounted cash inflows with the outflows. acceptable under the internal rate of return (IRR) approach.
D. Uses discounted cash flows whereas the internal rate of return model does not.
B. Can be used when there is no constant rate of return required for each year of the project. 28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present
value of P450,000. The project has a life of 7 years with salvage value of P200,000. The
company uses a discount rate of 12%. Which of the following would decrease the net present
value?

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A. Increase the salvage value. 32. The discount rate that equates the present value of the expected cash flows with the cost of
B. Increase discount rate to 15%. the investment is the
C. Extend the project life and associated cash inflows. A. Accounting rate of return C. Net present value
D. Decrease the initial investment amount to P9.0 million. B. Internal rate of return D. Payback period.

Profitability Index 33. A company has analyzed seven new projects, each of which has its own internal rate of return.
29. What is the effect of changes in cash inflows, investment cost and cash outflows on It should consider each project whose internal rate of return is _____ its marginal cost of
profitability (present value) index (PI) capital and accept those projects in _____ order of their internal rate of return.
A. PI will increase with an increase in cash inflows, a decrease in investment cost, or a A. Above; decreasing. C. Below; decreasing.
decrease in cash outflows. B. Above; increasing. D. Below; increasing.
B. PI will increase with an increase in cash inflows, an increase in investment cost, or an
increase in cash outflows. Relationship of NPV, PI & IRR
C. PI will decrease with an increase in cash inflows, a decrease in investment cost, or a 34. Which of the following combinations is NOT possible?
decrease in cash outflows. Profitability Index NPV IRR
D. PI will decrease with an increase in cash outflows, an increase in investment cost, or an A. Equals 1 Zero Equals cost of capital
increase in cash inflows. B. Greater than 1 Positive More than cost of capital
C. Less than 1 Negative Less than cost of capital
Internal Rate of Return D. Less than 1 Positive Less than cost of capital
30. Which of the following characteristics represent an advantage of the internal rate of return
techniques over the accounting rate of return technique in evaluating a project? Investment Decisions Independent Projects
I Recognition of the projects salvage value. 35. A company is evaluating three possible investments. Information relating to the company and
II Emphasis on cash flows. the investments follow:
III Recognition of the time value of money. Fisher rate for the three projects 7%
A. I only. C. II and III. Cost of capital 8%
B. I and II. D. I, II, and III. Based on this information, we know that
A. all three projects are acceptable.
31. How are the following used in the calculation of the internal rate of return of a proposed B. none of the projects are acceptable.
project? Ignore income tax considerations. C. the net present value method will provide a ranking of the projects that is superior to the
A. B. C. D. ranking obtained using the internal rate of return method.
Residual sales value of project Include Include Exclude Exclude D. the capital budgeting evaluation techniques profitability index, net present value, and
Depreciation expense Include Exclude Include Exclude internal rate of return will provide a consistent ranking of the projects.

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Investment Decisions Mutually Exclusive Projects D. A ranking procedure on the basis of quantitative criteria may be established by specifying
36. When ranking two mutually exclusive investments with different initial amounts, management a minimum desired rate of return, which rate is used in calculating the net present value of
should give first priority to the project each project.
A. That has the greater profitability index.
B. That has the greater accounting rate of return. Optimal Capital Budget
C. Whose net after-tax flows equal the initial investment. 40. An optimal capital budget is determined by the point where the marginal cost of capital is
D. That generates cash flows for the longer period of time. A. Minimized.
B. Equal to the average cost of capital.
37. Which mutually exclusive project would you select, if both are priced at $1,000 and your C. Equal to the rate of return on total assets.
discount rate is 15%; Project A with three annual cash flows of $1,000, or Project B, with 3 D. Equal to the marginal rate of return on investment.
years of zero cash flow followed by 3 years of $1,500 annually?
A. Project A.
B. Project B.
C. The IRRs are equal, hence you are indifferent.
D. The NPVs are equal, hence you are indifferent. PROBLEMS
Net Investments
Investment Decisions Capital Rationing 1. Acme is considering the sale of a machine with a book value of $80,000 and 3 years
38. Capital budgeting methods are often divided into two classifications: project screening and remaining in its useful life. Straight-line depreciation of $25,000 annually is available. The
project ranking. Which one of the following is considered a ranking method rather than a machine has a current market value of $100,000. What is the cash flow from selling the
screening method? machine if the tax rate 40%.
A. Accounting rate of return. C. Profitability index. A. $25,000 C. $92,000
B. Net present value. D. Time-adjusted rate of return. B. $80,000 D. $100,000

39. Several proposed capital projects which are economically acceptable may have to be ranked
due to constraints in financial resources. In ranking these projects, the least pertinent is this
statement.
A. If the internal rate of return method is used in the capital rationing problem, the higher the
rate, the better the project.
B. If the net present value method is used, the profitability index is calculated to rank the
projects. The lower the index, the better the project.
C. In selecting the required rate of return, one may either calculate the organizations cost of
capital or use a rate generally acceptable in the industry.
2 Hatchet Company is considering replacing a machine with a book value of $400,000, a
remaining useful life of 5 years, and annual straight-line depreciation of $80,000. The existing
machine has a current market value of $400,000. The replacement machine would cost
$550,000, have a 5-year life, and save $75,000 per year in cash operating costs. If the
replacement machine would be depreciated using the straight-line method and the tax rate is
40%, what would be the net investment required to replace the existing machine?
A. $90,000. C. $330,000
B. $150,000 D. $550,000

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3. Diliman Republic Publishers, Inc. is considering replacing an old press that cost P800,000 six 6. It is the start of the year and St. Tropez Co. plans to replace its old sing-along equipment.
years ago with a new one that would cost P2,250,000. Shipping and installation would cost an These information are available:
additional P200,000. The old press has a book value of P150,000 and could be sold currently Old New
for P50,000. The increased production of the new press would increase inventories by Equipment cost P70,000 P120,000
P40,000, accounts receivable by P160,000 and accounts payable by P140,000. Diliman Current salvage value 10,000 -
Republics net initial investment for analyzing the acquisition of the new press assuming a 35% Salvage value, end of useful life 2,000 16,000
income tax rate would be Annual operating costs 56,000 38,000
A. P2,250,000 C. P2,450,000 Accumulated depreciation 55,300 -
B. P2,425,000 D. P2,600,000 Estimated useful life 10 years 10 years
The companys income tax rate is 35% and its cost of capital is 12%. What is the present
4. Key Corp. plans to replace a production machine that was acquired several years ago. value of all the relevant cash flows at time zero?
Acquisition cost is P450,000 with salvage value of P50,000. The machine being considered is A. (P54,000) C. (P120,000)
worth P800,000 and the supplier is willing to accept the old machine at a trade-in value of B. (P110,000) D. (P124,700)
P60,000. Should the company decide not to acquire the new machine, it needs to repair the
old one at a cost of P200,000. Tax-wise, the trade-in transaction will not have any implication Operating Cash Flows After Tax
but the cost to repair is tax-deductible. The effective corporate tax rate is 35% of net income 7. C Corp. faces a marginal tax rate of 35 percent. One project that is currently under evaluation
subject to tax. For purposes of capital budgeting, the net investment in the new machine is has a cash flow in the fourth year of its life that has a present value of $10,000 (after-tax). C
A. P540,000 C. P660,000 Corp. assumes that all cash flows occur at the end of the year and the company uses 11
B. P610,000 D. P800,000 percent as its discount rate. What is the pre-tax amount of the cash flow in year 4? (Round to
the nearest dollar.)
5. Great Value Company is planning to purchase a new machine costing P50,000 with freight A. $9,868 C. $23,356
and installation costs amounting to P1,500. The old unit is to be traded-in will be given a B. $15,181 D. $43,375
trade-in allowance of P7,500. Other assets that are to be retired as a result of the acquisition
of the new machine can be salvaged and sold for P3,000. The loss on retirement of these 8. Maxwell Company has an opportunity to acquire a new machine to replace one of its present
other assets is P1,000 which will reduce income taxes of P400. If the new equipment is not machines. The new machine would cost $90,000, have a 5-year life, and no estimated
purchased, repair of the old unit will have to be made at an estimated cost of P4,000. This salvage value. Variable operating costs would be $100,000 per year. The present machine
cost can be avoided by purchasing the new equipment. Additional gross working capital of has a book value of $50,000 and a remaining life of 5 years. Its disposal value now is $5,000,
P12,000 will be needed to support operation planned with the new equipment. but it would be zero after 5 years. Variable operating costs would be $125,000 per year.
The net investment assigned to the new machine for decision analysis is Ignore income taxes. Considering the 5 years in total, what would be the difference in profit
A. P50,200 C. P53,600 before income taxes by acquiring the new machine as opposed to retaining the present one?
B. P52,600 D. P57,600 A. $10,000 decrease C. $35,000 increase
B. $15,000 decrease D. $40,000 increase
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End-of-Life Cash Flows 12. Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. Data
9. Lor Industries is analyzing a capital investment proposal for new machinery to produce a new on the equipment are as follows:
product over the next ten years. At the end of the ten years, the machinery must be disposed Original investment $30,000
of with a zero net book value but with a scrap salvage value of P20,000. It will require some Net annual cash inflow $12,000
P30,000 to remove the machinery. The applicable tax rate is 35%. The appropriate end-of- Expected economic life in years 5
life cash flow based on the foregoing information is Salvage value at the end of five years $3,000
A. Inflow of P30,000. C. Outflow of P10,000. The company uses the straight-line method of depreciation with no mid-year convention.
B. Outflow of P6,500. D. Outflow of P17,000. What is the accounting rate of return on original investment rounded off to the nearest percent,
assuming no taxes are paid?
10. A project under consideration by the White Corp. would require a working capital investment of A. 20.0% C. 24.0%
$200,000. The working capital would be liquidated at the end of the project's 10-year life. If B. 22.0% D. 40.0%
White Corp. has an after-tax cost of capital of 10 percent and a marginal tax rate of 30
percent, what is the present value of the working capital cash flow expected to be received in Payback Period
year 10? 13. APJ, Inc. is planning to purchase a new machine that will take six years to recover the cost.
A. $23,130 C. $53,970 The new machine is expected to produce cash flow from operations, net of income taxes, of
B. $36,868 D. $77,100 P4,500 a year for the first three years of the payback period and P3,500 a year of the last
three years of the payback period. Depreciation of P3,000 a year shall be charged to income
Accounting Rate of Return of the six years of the payback period. How much shall the machine cost?
11. Lyben Inc. is planning to produce a new product. To do this, it is necessary to acquire a new A. P12,000 C. P24,000
equipment that will cost the company P100,000. The estimated life of the new equipment is B. P18,000 D. P36,000
five years with no salvage value. The estimated income and costs based on expected sales of
14. Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash outlay.
10,000 units per year are:
Below are the projected after-tax cash inflow for the five year period covering the useful life.
Sales @ P10.00 per unit P100,000
The companys tax rate is 35%.
Costs @ P8.00 per unit 80,000
Net income P 20,000 Year 1 2 3 4 5
The accounting rate of return based on initial investment is 20% P000 600 700 480 400 400
What will be the accounting rate of return based on initial investment of P100,000 if The founder and president of the candy company believes that the best gauge for capital
management decrease its selling price of the new product by 10%? expenditure is cash payback period and that the recovery period should not be more than 75%
A. 5% C. 15% of the useful life of the project or the asset. Should the company undertake the project?
B. 10% D. 20% A. No, since the payback period extends beyond the life of the project.
B. No, since the payback period is 4 years or 80% of the useful life of the project.
C. Yes, since the payback period is 3.55 years or 71% of the useful life of the project.
D. Yes, since the payback period is 4 years and still shorter than the useful life of the project.
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Bailout Payback If the required rate of return is 12%, what is the approximate NPV of the project?
15. Womark Company purchased a new machine on January 1 of this year for $90,000, with an A. $17,225,000 C. $26,780,000
estimated useful life of 5 years and a salvage value of $10,000. The machine will be B. $21,511,000 D. $56,117,000
depreciated using the straight-line method. The machine is expected to produce cash flow
from operations, net of income taxes, of $36,000 a year in each of the next 5 years. The new 19. JJ Corp. is considering the purchase of a new machine that will cost P320,000. It has an
machines salvage value is $20,000 in years 1 and 2, and $15,0000 in years 3 and 4. What estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated
will be the bailout period (rounded) for the new machine? in the first year, 40% in the second year, and 30% in the third year. It has a resale value of
A. 1.4 years. C. 2.2 years. P20,000 at the end of its economic life. Savings are expected from the use of machine
B. 1.9 years. D. 3.4 years. estimated at P170,000 annually. The company has an effective tax rate of 40%. It uses 16%
as hurdle rate in evaluating capital projects. Should the company proceed with the P320,000
Net Present Value capital investment?
16. The McNally Co. is considering an investment in a project that generates a profitability index of Year Present Value of P1 Present Value of an Ordinary Annuity of P1
1.3. The present value of the cash inflows on the project is $44,000. What is the net present 1 0.862 0.862
value of this project? 2 0.743 1.605
A. $10,154 C. $33,846 3 0.641 2.246
B. $13,200 D. $57,200 A. Yes, due to NPV of P6,556. C. Yes, due to NPV of P61,820.
B. Yes, due to NPV of P11,684. D. No, due to negative NPV of P1,136
17. The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of
$950,000. The investment is expected to generate $350,000 in annual cash flows for a period 20. The following forecasts have been prepared for a new investment by Oxford Industries of $20
of four years. The required rate of return is 14%. The old machine can be sold for $50,000. million with an 8-year life:
The machine is expected to have zero value at the end of the four-year period. What is the net Pessimistic Expected Optimistic
present value of the investment? Would the company want to purchase the new machine?
Market size 60,000 90,000 140,000
Income taxes are not considered.
Market share, % 25 30 35
A. $69,550; no C. $326,750; no
Unit price $750 $800 $875
B. $119,550; yes D. $1,019,550; yes
Unit variable cost $500 $400 $350
Fixed cost, millions $7 $4 $3.5
18. Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The
investment required is $80 million for a plant with a capacity of 15,000 units a year for 5 years. Assume that Oxford employs straight-line depreciation, and that they are taxed at 35%.
The device will be sold for a price of $12,000 per unit. Sales are expected to be 12,000 units Assuming an opportunity cost of capital of 14%, what is the NPV of this project, based on
per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million expected outcomes?
per year. Assume Drillers employs straight-line depreciation on all depreciable assets, and A. $2,626,415 C. $6,722,109
assume that they are taxed at a rate of 36%. B. $4,563,505 D. $8,055,722

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21. Cramden Armored Car Co. is considering the acquisition of a new armored truck. The truck is
expected to cost $300,000. The company's discount rate is 12 percent. The firm has
determined that the truck generates a positive net present value of $17,022. However, the firm
is uncertain as to whether it has determined a reasonable estimate of the salvage value of the
truck. In computing the net present value, the company assumed that the truck would be
salvaged at the end of the fifth year for $60,000. What expected salvage value for the truck
would cause the investment to generate a net present value of $0? Ignore taxes.
A. $0 C. $42,978
B. $30,000 D. $55,278
24. Berry Products is considering two pieces of machinery. The first machine costs P50,000 more
than the second machine. During the two-year life of these two alternatives, the first machine
has P155,000 more cash flow in year one and a P110,000 less cash flow in year two than the
second machine. All cash flows occur at year-end. The present value of 1 at 15% end of 1
period and 2 periods are 0.86957 and 0.75614, respectively. The present value of 1 at 8%
end of period 1 is 0.92593 and period 2 is 0.85734.
At what discount rate would Machine 1 equally acceptable as machine 2?
A. 9% C. 11%
B. 10% D. 12%

22. Rohan Transport is considering two alternative buses to transport people between cities that Internal Rate of Return
are in the Southeastern U.S., such as Baton Rouge and Gainesville. A gas-powered bus has a 25. Smoot Automotive has implemented a new project that has an initial cost, and then generates
cost of $55,000, and will produce end-of-year net cash flows of $22,000 per year for 4 years. A inflows of $10,000 a year for the next seven (7) years. The project has a payback period of 4.0
new electric bus will cost $90,000, and will produce cash flows of $28,000 per year for 8 years. years. What is the project's internal rate of return (IRR)?
The company must provide bus service for 8 years, after which it plans to give up its franchise A. 14.79% C. 16.33%
and to cease operating the route. Inflation is not expected to affect either costs or revenues B. 15.61% D. 18.54%
during the next 8 years. If Rohan Transport's cost of capital is 17 percent, by what amount will
the better project increase the company's value? 26. MLF Corporation is evaluating the purchase of a P500,000 die attach machine. The cash
A. -$17,441 C. $10,701 inflows expected from the investment is P145,000 per year for five years with no equipment
B. $5,350 D. $27,801 salvage value. The cost of capital is 12%. The net present value factor for five (5) years at
12% is 3.6048 and at 14% is 3.4331. The internal rate of return for this investment is
23. Union Electric Company must clean up the water released from its generating plant. The A. 2.04% C. 13.8%
company's cost of capital is 11 percent for average projects, and that rate is normally adjusted B. 3.45% D. 15.48%
up or down by 2 percentage points for high- and low-risk projects. Clean-Up Plan A, which is
of average risk, has an initial cost of $10 million, and its operating cost will be $1 million per 27. The Zeron Corporation recently purchased a new machine for its factory operations at a cost
year for its 10-year life. Plan B, which is a high-risk project, has an initial cost of $5 million, and of $921,250. The investment is expected to generate $250,000 in annual cash flows for a
its annual operating cost over Years 1 to 10 will be $2 million. What is the approximate PV of period of six years. The required rate of return is 14%. The old machine has a remaining life of
costs for the better project? (VD) six years. The new machine is expected to have zero value at the end of the six-year period.
A. -$5.9 million. C. -$16.8 million. The disposal value of the old machine at the time of replacement is zero. What is the internal
B. -$15.9 million. D. -$17.8 million. rate of return?
A. 15% C. 17%
Fisher rate B. 16% D. 18%

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28. A tax-exempt foundation, Sincerely Foundation, Inc. intends to invest P1 million in a five-year 31. Salvage Co. is considering the purchase of a new ocean-going vessel that could potentially
project. The foundation estimates that the annual savings from the project will amount to reduce labor costs of its operation by a considerable margin. The new ship would cost
P325,000. The P1 million asset is depreciable over five (5) years on a straight-line basis. The $500,000 and would be fully depreciated by the straight-line method over 10 years. At the end
foundations hurdle rate is 12% and as a consultant of the foundation, you are asked to of 10 years, the ship will have no value and will be sunk in some already polluted harbor. The
determine the internal rate of return and advise if the project should be pursued. Salvage Co.'s cost of capital is 12 percent, and its marginal tax rate is 40 percent. If the ship
To facilitate computations, below are present value factors: produces equal annual labor cost savings over its 10-year life, how much do the annual
N=5 12% 14% 16% savings in labor costs need to be to generate a net present value of $0 on the project? (Round
Present value of P1 0.57 0.52 0.48 to the nearest dollar.)
Present value of an annuity of P1 3.60 3.40 3.30 A. $68,492 C. $114,154
Your advice is B. $88,492 D. $147,487
A. To proceed due to an estimated IRR of more than 16%.
B. Not to proceed due to an estimated IRR of less than 12%. 32. A company is considering putting up P50,000 in a three-year project. The companys
C. To proceed due to an estimated IRR of less than 14% but not more than 12%. expected rate of return is 12%. The present value of P1.00 at 12% for one year is 0.893, for
D. To proceed due to an estimated IRR of less than 16% but not more than 14%. two years is 0.797, and for three years is 0.712. The cash flow, net of income taxes will be
P18,000 (present value of P16,074) for the first year and P22,000 (present value of P17,534)
29. Para Co. is reviewing the following data relating to an energy saving investment proposal: for the second year. Assuming that the rate of return is exactly 12%, the cash flow, net of
Cost $50,000 income taxes, for the third year would be
Residual value at the end of 5 years 10,000 A. P7,120 C. P16,392
Present value of an annuity of 1 at 12% for 5 years 3.60 B. P10,000 D. P23,022
Present value of 1 due in 5 years at 12% 0.57
What would be the annual savings needed to make the investment realize a 12% yield? 33. The following data pertain to Sunlight Corp., whose management is planning to purchase an
A. $8,189 C. $12,306 automated tanning equipment.
B. $11,111 D. $13,889 1. Economic life of equipment 8 years.
2. Disposal value after 8 years nil.
30. Payback Company is considering the purchase of a copier machine for P42,825. The copier 3. Estimated net annual cash inflows for each of the 8 years P81,000.
machine will be expected to be economically productive for 4 years. The salvage value at the 4. Time-adjusted internal rate of return 14%
end of 4 years is negligible. The machine is expected to provide 15% internal rate of return. 5. Cost of capital of Sunlight Corp 16%
The company is subject to 40% income tax rate. The present value of an ordinary annuity of 1 6. The table of present values of P1 received annually for 8 years has these factors: at
for 4 periods is 2.85498. In order to realize the IRR of 15%, how much is the estimated 14% = 4.639, at 16% = 4.344
before-tax cash inflow to be provided by the machine? 7. Depreciation is approximately P46,970 annually.
A. P15,000 C. P25,000
B. P17,860 D. P35,700
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Find the required increase in annual cash inflows in order to have the time-adjusted rate of Which project is preferred?
return approximately equal the cost of capital. A. A C. C
A. P4,344 C. P5,871 B. B D. D
B. P5,501 D. P6,501
Capital Rationing & Optimal Capital Budget
34. Booker Steel Inc. is considering an investment that would require an initial cash outlay of 37. Information on three (3) investment projects is given below:
$400,000 and would have no salvage value. The project would generate annual cash inflows Project Investment Required Net Present Value
of $75,000. The firm's discount rate is 8 percent. How many years must the annual cash flows X P150,000 P34,005
be generated for the project to generate a net present value of $0? G 100,000 22,670
A. between 5 and 6 years C. between 7 and 8 years W 60,000 13,602
B. between 6 and 7 years D. between 8 and 9 years Rank the projects in terms of preference:
A. 1st W; 2nd G; 3rd X. C. 1st X; 2nd G; 3rd W.
Project Screening Independent Projects B. 1st G; 2nd W; 3rd X. D. The ranking is the same.
35. The following data relate to two capital-budgeting projects of equal risk:
Present Value of Cash Flows 38. Telephone Corp. is contemplating four projects: L, M, N, and O. The capital costs for the
Period Project A Project B initiation of each mutually-exclusive project and its estimated after-tax, net cash flow are listed
0 $(10,000) $(30,000) below. The companys desired after-tax opportunity costs is 12%. It has P900,000 capital
1 4,550 13,650 budget for the year. Idle funds cannot be reinvested at greater than 12%.
2 4,150 12,450 In Thousand Pesos
3 3,750 11,250 L M N O
Which of the projects will be selected using the profitability index (PI) approach and the NPV Initial cost 400 470 380 420
approach? Annual cash flows
A. B. C. D. Year 1 113 180 90 80
PI B Either Either B 2 113 170 110 100
NPV A B A B 3 113 150 130 120
4 113 110 140 130
Project Screening Mutually Exclusive Projects 5 113 100 150 150
36. Five mutually exclusive projects had the following information:
A B C D Net present value P7,540 P59,654 P54,666 P(15,708)
Internal rate of return 12.7% 17.6% 17.2% 10.6%
NPV $500 $(200) $200 $1,000
Excess present value index 1.02 1.13 1.14 0.96
IRR 12% 8% 13% 10%

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The company will choose 41. Mulva Inc. is considering the following five independent projects:
A. Projects L & M. C. Projects M & N. Project Required Amount of Capital IRR
B. Projects L & N. D. Projects M, N & O. A $300,000 25.35%
B 500,000 23.22%
39. The Nativity Corporation has the following investment opportunities: C 400,000 19.10%
Proposal Profitability Index Initial Cash Outlay D 550,000 9.25%
1 1.15 P200,000 E 650,000 8.50%
2 1.13 125,000 The company has a target capital structure which is 40 percent debt and 60 percent equity.
3 1.11 175,000 The company can issue bonds with a yield to maturity of 10 percent. The company has
4 1.08 150,000 $900,000 in retained earnings, and the current stock price is $40 per share. The flotation costs
The firm has a budget constraint of P300,000. associated with issuing new equity are $2 per share. Mulva's earnings are expected to
What proposal(s) should be accepted? continue to grow at 5 percent per year. Next year's dividend (D1) is forecasted to be $2.50.
A. Proposal 4 because it has the lowest profitability index. The firm faces a 40 percent tax rate. What is the size of Mulva's capital budget?
B. Proposal 1 because it has the highest profitability index. A. $800,000 C. $1,750,000
C. Proposals 1 and 2 because their total net present values are the highest among all B. $1,200,000 D. $2,400,000
possible proposal combinations.
Comprehensive
D. Proposals 2 and 3 because their total net present values are the highest among all
Problem 42 and 43 are based on the following information.
possible proposal combinations.
Daneches, a tax-exempt entity, plans to purchase a new machine which they project to depreciate
over a ten-year period without salvage value. The new machine will cost P200,000 and is
40. A company's marginal cost of new capital (MCC) is 10% up to $600,000. MCC increases .5%
expected to generate cash savings of P60,000 per year in operating costs. Daneche's cost of
for the next $400,000 and another .5% thereafter. Several proposed capital projects are under
capital is 12%.
consideration, with projected cost and internal rates of return (IRR) as follows:
For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an ordinary
Project Cost IRR annuity of P1 is P5.650.
A $100,000 10.5%
B $300,000 14.0% 42. What is the net present value of the proposed investment, assuming Daneche uses a 12%
C $450,000 10.8% discount rate?
D $350,000 13.5% A. P69,980 C. P185,640
E $400,000 12.0% B. P139,000 D. None of the above.
What should the company's capital budget be?
A. $0 C. $1,500,000 43. With the companys initial investment on the new machine, the accounting rate of return is
B. $1,050,000 D. $1,600,000 A. 15% C. 25%
B. 20% D. None of the above.
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Questions 43 and 44 are based on the following information. 47. The payback period of the investment is (M)
The construction of a waste treatment plant was arrived at after a careful cost-benefit analysis. A. 5.095 years C. 5.14 years
During the construction period a status report was presented for your review: B. 5.11 years D. 5.18 years
completed cost as originally estimated, P5 million
% of actual completion to date, 65% Questions 48 through 55 are based on the following information.
actual cost to date, P3.75 million The Burgos Corporation is considering investing in a project. It requires an immediate cash outlay
of P100,000. It has a life of four years and will be depreciated on a straight-line basis (no salvage
44. Assuming cost is evenly distributed throughout the construction period, how much will the value). The firms tax rate is 25% and requires a return of 10%. Income before depreciation is
completion cost be most likely? projected to be:
A. The original cost estimate of P5 million. YEAR 1 2 3 4
B. P5 million plus a cost overrun of about P769,000 Income before depreciation P30,000 P30,000 P40,000 P40,000
C. P500,000 less than the original cost at completion. The present value factors for P1 at 10% is
D. About P100,000 above the original cost at completion. Year 1 2 3 4
Present Value Factor 0.909 0.826 0.751 0.683
45. What would be an appropriate action to take considering the situation in number 28?
A. No need to take any action. 48. The net cash flow for year 1 is
B. Immediately stop further work on the project. A. P25,850 C. P31,250
C. Wait for the next quarterly status report on the project. B. P28,750 D. P34,450
D. Recommend immediate review with the project implementation team to determine the
cause of overrun and the corrective actions to be taken. 49. The net cash flow for year 4 is
A. P30,150 C. P35,950
Questions 46 and 47 are based on the following information. B. P35,850 D. P36,250
Beta Company plans to replace its company car with a new one. The new car costs P120,000 and
its estimated useful life is five years without scrap value. The old car has a book value of P15,000 50. The payback period for the project is
and can be sold at P12,000. The acquisition of the new car will yield annual cash savings of A. 3 years C. 3.5 years
P20,000 before income tax. Income tax rate is 25%. (M) B. 3.17 years D. 4 years.

46. The net investment of the new car is 51. The accounting rate of return of the project is
A. P107,000 C. P108,000 A. 7% C. 12%
B. P107,250 D. P108,750 B. 9% D. 15%

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52. The present value of year twos cash flow is

A. P23,747.50 C. P26,100.75 Theory Problem
B. P25,856.25 D. P29,750.75 1. D 21. B 1. C 21. B 41. C
2. B 22. A 2. B 22. D 42. B
53. The present value of the projects net cash flow is 3. D 23. B 3. B 23. B 43. B
A. P95,650.15 C. P101,863.75 4. C 24. D 4. B 24. B 44. B
B. P98,151.25 D. P104,750.25 5. C 25. A 5. A 25. C 45. D
6. D 26. A 6. B 26. C 46. B
54. The profitability index of the project (rounded to the nearest hundredth) is 7. D 27. D 7. C 27. B 47. B
A. 0.96 C. 1.02 8. A 28. B 8. D 28. A 48. B
B. 0.98 D. 1.05 9. D 29. A 9. B 29. C 49. D
10. D 30. C 10. D 30. B 50. B
55. The project would be accepted on the basis of the
11. B 31. B 11. B 31. C 51. D
A. Payback and present value results.
12. C 32. B 12. B 32. D 52. A
B. Accounting rate of return and profitability index results.
13. D 33. A 13. C 33. B 53. C
C. Payback results only
D. A and B combined 14. A 34. D 14. C 34. C 54. C
15. A 35. D 15. B 35. B 55. D
16. D 36. A 16. A 36. D
17. A 37. A 17. B 37. D
18. A 38. C 18. B 38. C
19. C 39. B 19. B 39. D
20. D 40. D 20. B 40. B

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