MANAGEMENT ADVISORY SERVICES HILARIO TAN

THEORY P150,000 investment in working capital is required. In a discounted cash flow analysis, this
Basic concepts investment in working capital should be
1. Capital budgeting techniques are least likely to be used in evaluating the A. Disregarded because no cash is involved.
A. Acquisition of new aircraft by a cargo company. B. Amortized over the useful life of the equipment.
B. Trade for a star quarterback by a football team. C. Treated as an immediate cash outflow that is recovered at the end of six years.
C. Design and implementation of a major advertising program. D. Treated as a recurring annual cash flow that is recovered at the end of six years.
D. Adoption of a new method of allocating non-traceable costs to product lines.
Operating Cash Flows After Tax
2. The “inflation element” refers to the 6. To approximate annual cash inflow, depreciation is
A. Future increases in the general purchasing power of the monetary unit. A. Subtracted from net income because it is an expense.
B. Future deterioration of the general purchasing power of the monetary unit. B. Added back to net income because it is an inflow of cash.
C. Fact that the real purchasing power of a monetary unit usually increases over time. C. Subtracted from net income because it is an outflow of cash.
D. Impact that future price increases will have on the original cost of a capital expenditure. D. Added back to net income because it is not an outflow of cash.

3. Which of the following best identifies the reason for using probabilities in capital budgeting is 7. In capital expenditures decisions, the following are relevant in estimating operating costs
A. Cost of capital. C. Time value of money. except
B. Different life of projects. D. Uncertainty. A. Cash costs. C. Future costs.
B. Differential costs. D. Historical costs.
4. In capital budgeting decisions, the following items are considered among others:
1. Cash outflow for the investment. Accounting Rate of Return
2. Increase in working capital requirements. 8. The following statements refer to the accounting rate of return (ARR)
3. Profit on sale of old asset 1. The ARR is based on the accrual basis, not cash basis.
4. Loss on write-off of old asset. 2. The ARR does not consider the time value of money.
For which of the above items would taxes be relevant? 3. The profitability of the project is considered.
A. Items 1 and 3 only. C. Items 3 and 4 only. From the above statements, which are considered limitations of the ARR concept?
B. Items 1, 3 and 4 only. D. All items. A. Statements 1 and 2 only. C. Statements 3 and 1 only.
B. Statements 2 and 3 only. D. All the 3 statements.
Net Investments
5. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient. Payback Period
This equipment has an estimated useful life of six years. As part of this acquisition, a 9. The payback method assumes that all cash inflows are reinvested to yield a return equal to

MSQ-08 - CAPITAL BUDGETING Page 1 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

A. the discount rate. C. the internal rate of return.

B. the hurdle rate. D. zero. 14. Your company is purchasing a transport equipment as part of its territorial expansion strategy.
The technical services department indicated that this equipment needs overhauling in year 4
or year 5 of its useful life. The overhauling cost will be expected during the year the
10. As a capital budgeting technique, the payback period considers depreciation expenses (DE) overhauling is done. The finance officer insists that the overhauling be done in year 4, not in
and time value of money (TVM) as follows: year 5.
A. B. C. D. The most likely reason is
DE relevant relevant Irrelevant irrelevant A. There is lower tax rate in year 5. C. The time value of money is considered.
TVM relevant irrelevant Relevant irrelevant B. There is higher tax rate in year 5. D. Due to statements A and C above.

Bailout Payback 15. In an investment in plant the return that should keep the market price of the firm stock
11. The bailout payback period is unchanged is
A. The payback period used by firms with government insured loans. A. Cost of capital C. Net present value
B. The length of time for payback using cash flows plus the salvage value to recover the B. Discounted rate of return D. Payback
original investment
C. (A) and (B) 16. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost,
D. None of the above. the value of the firm and the price of its common stock will <List B>
A. B. C. D.
Discounted Cash Flow Method List A Equal to Equal to Greater than Greater than
12. Which of the following methods measures the cash flows and outflows of a project as if they List B Decrease Increase Decrease Increase
occurred at a single point in time?
A. Capital budgeting. C. Discounted cash flow. 17. The common assumption in capital budgeting analysis is that cash inflows occur in lump sums
B. Cash flow based payback period. D. Payback method. at the end of individual years during the life of an investment project when in fact they flow
more or less continuously during those years
13. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital A. Results in understated estimates of NPV.
budgeting project, which of the following factors generally is not important? B. Results in higher estimate for the IRR on the investment.
A. The timing of cash flows relating to the project. C. Is done because present value tables for continuous flows cannot be constructed.
B. The amount of cash flows relating to the project. D. Will result in inconsistent errors being made on estimating NPVs such that project cannot
C. The impact of the project on income taxes to be paid. be evaluated reliably.
D. The method of financing the project under consideration.

MSQ-08 - CAPITAL BUDGETING Page 2 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

18. Polo Co. requires higher rates of return for projects with a life span greater than 5 years.
Projects extending beyond 5 years must earn a higher specified rate of return. Which of the 23. An advantage of the net present value method over the internal rate of return model in
following capital budgeting techniques can readily accommodate this requirement? discounted cash flow analysis is that the net present value method
A. B. C. D. A. Computes a desired rate of return for capital projects.
Internal Rate of Return Yes Yes No No C. Uses a discount rate that equates the discounted cash inflows with the outflows.
Net Present Value Yes No Yes No 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.

19. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are
some of the capital budgeting techniques. What is the effect of an increase in the cost of
capital on these techniques? 24. When using the net present value method for capital budgeting analysis, the required rate of
A. B. C. D. return is called all of the following except the
A. Cost of capital. C. Discount rate.
PP Decrease Increase No change No change
B. Cutoff rate. D. Risk-free rate.
PI No change Decrease Decrease Increase
SARR No change Increase No change Decrease
25. A project’s net present value, ignoring income tax considerations, is normally affected by the
A. Proceeds from the sale of the asset to be replaced.
Net Present Value B. Carrying amount of the asset to be replaced by the project.
20. A company had made the decision to finance next year’s capital projects through debt rather C. Amount of annual depreciation on the asset to be replaced.
than additional equity. The benchmark cost of capital for these projects should be D. Amount of annual depreciation on fixed assets used directly on the project.
A. The after-tax cost of new-debt financing. C. The cost of equity financing.
B. The before-tax cost of new-debt financing. D. The weighted-average cost of capital. 26. You have determined the profitability of a planned project by finding the present value of all the
cash flows from that project. Which of the following would cause the project to look less
21. All of the following refer to the discount rate used by a firm in capital budgeting except appealing, that is, have a lower present value?
A. Hurdle rate. C. Opportunity cost of capital. A. The discount rate increases.
B. Opportunity cost. D. Required rate of return. B. The cash flows are extended over a longer period of time.
C. The cash flows are accelerated and the project life is correspondingly shortened.
22. The excess present value method is anchored on the theory that the future returns, expressed D. The investment cost decreases without affecting the expected income and life of the
in terms of present value, must at least be project.
A. Equal to the amount of investment C. More than the amount of investment
B. Less than the amount of investment D. Cannot be determined

MSQ-08 - CAPITAL BUDGETING Page 3 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

27. Which of the following is always true with regard to the net present value (NPV) approach? 30. Which of the following characteristics represent an advantage of the internal rate of return
A. The NPV and the IRR approaches will always rank projects in the same order. techniques over the accounting rate of return technique in evaluating a project?
B. The NPV and payback approaches will always rank projects in the same order. I Recognition of the project’s salvage value.
C. If a project is found to be acceptable under the NPV approach, it would also be acceptable II Emphasis on cash flows.
under the payback approach. III Recognition of the time value of money.
D. If a project is found to be acceptable under the NPV approach, it would also be acceptable A. I only. C. II and III.
under the internal rate of return (IRR) approach. B. I and II. D. I, II, and III.

28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present 31. How are the following used in the calculation of the internal rate of return of a proposed
value of P450,000. The project has a life of 7 years with salvage value of P200,000. The project? Ignore income tax considerations.
company uses a discount rate of 12%. Which of the following would decrease the net present A. B. C. D.
value? Residual sales value of project Include Include Exclude Exclude
A. Increase the salvage value. Depreciation expense Include Exclude Include Exclude
B. Increase discount rate to 15%.
C. Extend the project life and associated cash inflows. 32. The discount rate that equates the present value of the expected cash flows with the cost of
D. Decrease the initial investment amount to P9.0 million. the investment is the
A. Accounting rate of return C. Net present value
Profitability Index B. Internal rate of return D. Payback period.
29. What is the effect of changes in cash inflows, investment cost and cash outflows on profitability
(present value) index (PI) 33. A company has analyzed seven new projects, each of which has its own internal rate of return.
A. PI will increase with an increase in cash inflows, a decrease in investment cost, or a It should consider each project whose internal rate of return is _____ its marginal cost of
decrease in cash outflows. capital and accept those projects in _____ order of their internal rate of return.
B. PI will increase with an increase in cash inflows, an increase in investment cost, or an A. Above; decreasing. C. Below; decreasing.
increase in cash outflows. B. Above; increasing. D. Below; increasing.
C. PI will decrease with an increase in cash inflows, a decrease in investment cost, or a
decrease in cash outflows. Relationship of NPV, PI & IRR
D. PI will decrease with an increase in cash outflows, an increase in investment cost, or an 34. Which of the following combinations is NOT possible?
increase in cash inflows. Profitability Index NPV IRR
A. Equals 1 Zero Equals cost of capital
Internal Rate of Return
B. Greater than 1 Positive More than cost of capital

MSQ-08 - CAPITAL BUDGETING Page 4 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

C. Less than 1 Negative Less than cost of capital D. The NPVs are equal, hence you are indifferent.
D. Less than 1 Positive Less than cost of capital
Investment Decisions – Capital Rationing
Investment Decisions – Independent Projects 38. Capital budgeting methods are often divided into two classifications: project screening and
35. A company is evaluating three possible investments. Information relating to the company and project ranking. Which one of the following is considered a ranking method rather than a
the investments follow: screening method?
Fisher rate for the three projects 7% A. Accounting rate of return. C. Profitability index.
Cost of capital 8% B. Net present value. D. Time-adjusted rate of return.
Based on this information, we know that
A. all three projects are acceptable. 39. Several proposed capital projects which are economically acceptable may have to be ranked
B. none of the projects are acceptable. due to constraints in financial resources. In ranking these projects, the least pertinent is this
C. the net present value method will provide a ranking of the projects that is superior to the statement.
ranking obtained using the internal rate of return method. A. If the internal rate of return method is used in the capital rationing problem, the higher the
D. the capital budgeting evaluation techniques profitability index, net present value, and rate, the better the project.
internal rate of return will provide a consistent ranking of the projects. 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.
Investment Decisions – Mutually Exclusive Projects C. In selecting the required rate of return, one may either calculate the organization’s cost of
36. When ranking two mutually exclusive investments with different initial amounts, management capital or use a rate generally acceptable in the industry.
should give first priority to the project D. A ranking procedure on the basis of quantitative criteria may be established by specifying
A. That has the greater profitability index. a minimum desired rate of return, which rate is used in calculating the net present value of
B. That has the greater accounting rate of return. each project.
C. Whose net after-tax flows equal the initial investment.
D. That generates cash flows for the longer period of time. Optimal Capital Budget
40. An optimal capital budget is determined by the point where the marginal cost of capital is
37. Which mutually exclusive project would you select, if both are priced at $1,000 and your A. Minimized.
discount rate is 15%; Project A with three annual cash flows of $1,000, or Project B, with 3 B. Equal to the average cost of capital.
years of zero cash flow followed by 3 years of $1,500 annually? C. Equal to the rate of return on total assets.
A. Project A. D. Equal to the marginal rate of return on investment.
B. Project B.
C. The IRRs are equal, hence you are indifferent.

MSQ-08 - CAPITAL BUDGETING Page 5 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

4. Key Corp. plans to replace a production machine that was acquired several years ago.
Acquisition cost is P450,000 with salvage value of P50,000. The machine being considered is
PROBLEMS worth P800,000 and the supplier is willing to accept the old machine at a trade-in value of
Net Investments P60,000. Should the company decide not to acquire the new machine, it needs to repair the
1. Acme is considering the sale of a machine with a book value of $80,000 and 3 years remaining old one at a cost of P200,000. Tax-wise, the trade-in transaction will not have any implication
in its useful life. Straight-line depreciation of $25,000 annually is available. The machine has but the cost to repair is tax-deductible. The effective corporate tax rate is 35% of net income
a current market value of $100,000. What is the cash flow from selling the machine if the tax subject to tax. For purposes of capital budgeting, the net investment in the new machine is
rate 40%. A. P540,000 C. P660,000
A. $25,000 C. $92,000 B. P610,000 D. P800,000
B. $80,000 D. $100,000
5. Great Value Company is planning to purchase a new machine costing P50,000 with freight and
2 Hatchet Company is considering replacing a machine with a book value of $400,000, a installation costs amounting to P1,500. The old unit is to be traded-in will be given a trade-in
remaining useful life of 5 years, and annual straight-line depreciation of $80,000. The existing allowance of P7,500. Other assets that are to be retired as a result of the acquisition of the
machine has a current market value of $400,000. The replacement machine would cost new machine can be salvaged and sold for P3,000. The loss on retirement of these other
$550,000, have a 5-year life, and save $75,000 per year in cash operating costs. If the assets is P1,000 which will reduce income taxes of P400. If the new equipment is not
replacement machine would be depreciated using the straight-line method and the tax rate is purchased, repair of the old unit will have to be made at an estimated cost of P4,000. This
40%, what would be the net investment required to replace the existing machine? cost can be avoided by purchasing the new equipment. Additional gross working capital of
A. $90,000. C. $330,000 P12,000 will be needed to support operation planned with the new equipment.
B. $150,000 D. $550,000 The net investment assigned to the new machine for decision analysis is
A. P50,200 C. P53,600
3. Diliman Republic Publishers, Inc. is considering replacing an old press that cost P800,000 six B. P52,600 D. P57,600
years ago with a new one that would cost P2,250,000. Shipping and installation would cost an
additional P200,000. The old press has a book value of P150,000 and could be sold currently 6. It is the start of the year and St. Tropez Co. plans to replace its old sing-along equipment.
for P50,000. The increased production of the new press would increase inventories by These information are available:
P40,000, accounts receivable by P160,000 and accounts payable by P140,000. Diliman Old New
Republic’s net initial investment for analyzing the acquisition of the new press assuming a 35% Equipment cost P70,000 P120,000
income tax rate would be Current salvage value 10,000 -
A. P2,250,000 C. P2,450,000 Salvage value, end of useful life 2,000 16,000
B. P2,425,000 D. P2,600,000 Annual operating costs 56,000 38,000
Accumulated depreciation 55,300 -

MSQ-08 - CAPITAL BUDGETING Page 6 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

Estimated useful life 10 years 10 years A. Inflow of P30,000. C. Outflow of P10,000.

The company’s income tax rate is 35% and its cost of capital is 12%. What is the present B. Outflow of P6,500. D. Outflow of P17,000.
value of all the relevant cash flows at time zero?
A. (P54,000) C. (P120,000) 10. A project under consideration by the White Corp. would require a working capital investment of
B. (P110,000) D. (P124,700) $200,000. The working capital would be liquidated at the end of the project's 10-year life. If
White Corp. has an after-tax cost of capital of 10 percent and a marginal tax rate of 30 percent,
Operating Cash Flows After Tax what is the present value of the working capital cash flow expected to be received in year 10?
7. C Corp. faces a marginal tax rate of 35 percent. One project that is currently under evaluation A. $23,130 C. $53,970
has a cash flow in the fourth year of its life that has a present value of $10,000 (after-tax). C B. $36,868 D. $77,100
Corp. assumes that all cash flows occur at the end of the year and the company uses 11
percent as its discount rate. What is the pre-tax amount of the cash flow in year 4? (Round to Accounting Rate of Return
the nearest dollar.) 11. Lyben Inc. is planning to produce a new product. To do this, it is necessary to acquire a new
A. $9,868 C. $23,356 equipment that will cost the company P100,000. The estimated life of the new equipment is
B. $15,181 D. $43,375 five years with no salvage value. The estimated income and costs based on expected sales of
10,000 units per year are:
8. Maxwell Company has an opportunity to acquire a new machine to replace one of its present Sales @ P10.00 per unit P100,000
machines. The new machine would cost $90,000, have a 5-year life, and no estimated Costs @ P8.00 per unit 80,000
salvage value. Variable operating costs would be $100,000 per year. The present machine Net income P 20,000
has a book value of $50,000 and a remaining life of 5 years. Its disposal value now is $5,000, The accounting rate of return based on initial investment is 20%
but it would be zero after 5 years. Variable operating costs would be $125,000 per year. What will be the accounting rate of return based on initial investment of P100,000 if
Ignore income taxes. Considering the 5 years in total, what would be the difference in profit management decrease its selling price of the new product by 10%?
before income taxes by acquiring the new machine as opposed to retaining the present one? A. 5% C. 15%
A. $10,000 decrease C. $35,000 increase B. 10% D. 20%
B. $15,000 decrease D. $40,000 increase
End-of-Life Cash Flows
9. Lor Industries is analyzing a capital investment proposal for new machinery to produce a new 12. Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. Data
product over the next ten years. At the end of the ten years, the machinery must be disposed on the equipment are as follows:
of with a zero net book value but with a scrap salvage value of P20,000. It will require some Original investment $30,000
P30,000 to remove the machinery. The applicable tax rate is 35%. The appropriate Net annual cash inflow $12,000
“end-of-life” cash flow based on the foregoing information is Expected economic life in years 5

MSQ-08 - CAPITAL BUDGETING Page 7 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

Salvage value at the end of five years $3,000 estimated useful life of 5 years and a salvage value of $10,000. The machine will be
The company uses the straight-line method of depreciation with no mid-year convention. depreciated using the straight-line method. The machine is expected to produce cash flow
What is the accounting rate of return on original investment rounded off to the nearest percent, from operations, net of income taxes, of $36,000 a year in each of the next 5 years. The new
assuming no taxes are paid? machine’s salvage value is $20,000 in years 1 and 2, and $15,0000 in years 3 and 4. What
A. 20.0% C. 24.0% will be the bailout period (rounded) for the new machine?
B. 22.0% D. 40.0% A. 1.4 years. C. 2.2 years.
B. 1.9 years. D. 3.4 years.
Payback Period
13. APJ, Inc. is planning to purchase a new machine that will take six years to recover the cost. Net Present Value
The new machine is expected to produce cash flow from operations, net of income taxes, of 16. The McNally Co. is considering an investment in a project that generates a profitability index of
P4,500 a year for the first three years of the payback period and P3,500 a year of the last 1.3. The present value of the cash inflows on the project is $44,000. What is the net present
three years of the payback period. Depreciation of P3,000 a year shall be charged to income value of this project?
of the six years of the payback period. How much shall the machine cost? A. $10,154 C. $33,846
A. P12,000 C. P24,000 B. $13,200 D. $57,200
B. P18,000 D. P36,000
17. The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of
14. Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash outlay.
$950,000. The investment is expected to generate $350,000 in annual cash flows for a period
Below are the projected after-tax cash inflow for the five year period covering the useful life.
of four years. The required rate of return is 14%. The old machine can be sold for $50,000.
The company’s tax rate is 35%.
The machine is expected to have zero value at the end of the four-year period. What is the net
Year 1 2 3 4 5 present value of the investment? Would the company want to purchase the new machine?
P’000 600 700 480 400 400 Income taxes are not considered.
The founder and president of the candy company believes that the best gauge for capital A. $69,550; no C. $326,750; no
expenditure is cash payback period and that the recovery period should not be more than 75% B. $119,550; yes D. $1,019,550; yes
of the useful life of the project or the asset. Should the company undertake the project?
A. No, since the payback period extends beyond the life of the project. 18. Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The
B. No, since the payback period is 4 years or 80% of the useful life of the project. investment required is $80 million for a plant with a capacity of 15,000 units a year for 5 years.
C. Yes, since the payback period is 3.55 years or 71% of the useful life of the project. The device will be sold for a price of $12,000 per unit. Sales are expected to be 12,000 units
D. Yes, since the payback period is 4 years and still shorter than the useful life of the project. per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million
Bailout Payback per year. Assume Drillers employs straight-line depreciation on all depreciable assets, and
15. Womark Company purchased a new machine on January 1 of this year for $90,000, with an assume that they are taxed at a rate of 36%.

MSQ-08 - CAPITAL BUDGETING Page 8 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

If the required rate of return is 12%, what is the approximate NPV of the project? B. $4,563,505 D. $8,055,722
A. $17,225,000 C. $26,780,000
B. $21,511,000 D. $56,117,000 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
19. JJ Corp. is considering the purchase of a new machine that will cost P320,000. It has an determined that the truck generates a positive net present value of $17,022. However, the firm
estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated is uncertain as to whether it has determined a reasonable estimate of the salvage value of the
in the first year, 40% in the second year, and 30% in the third year. It has a resale value of truck. In computing the net present value, the company assumed that the truck would be
P20,000 at the end of its economic life. Savings are expected from the use of machine salvaged at the end of the fifth year for $60,000. What expected salvage value for the truck
estimated at P170,000 annually. The company has an effective tax rate of 40%. It uses 16% would cause the investment to generate a net present value of $0? Ignore taxes.
as hurdle rate in evaluating capital projects. Should the company proceed with the P320,000 A. $0 C. $42,978
capital investment? B. $30,000 D. $55,278
Year Present Value of P1 Present Value of an Ordinary Annuity of P1
1 0.862 0.862 22. Rohan Transport is considering two alternative buses to transport people between cities that
2 0.743 1.605 are in the Southeastern U.S., such as Baton Rouge and Gainesville. A gas-powered bus has a
3 0.641 2.246 cost of $55,000, and will produce end-of-year net cash flows of $22,000 per year for 4 years. A
A. Yes, due to NPV of P6,556. C. Yes, due to NPV of P61,820. new electric bus will cost $90,000, and will produce cash flows of $28,000 per year for 8 years.
B. Yes, due to NPV of P11,684. D. No, due to negative NPV of P1,136 The company must provide bus service for 8 years, after which it plans to give up its franchise
and to cease operating the route. Inflation is not expected to affect either costs or revenues
20. The following forecasts have been prepared for a new investment by Oxford Industries of $20 during the next 8 years. If Rohan Transport's cost of capital is 17 percent, by what amount will
million with an 8-year life: the better project increase the company's value?
Pessimistic Expected Optimistic A. -$17,441 C. $10,701
B. $5,350 D. $27,801
Market size 60,000 90,000 140,000
Market share, % 25 30 35
23. Union Electric Company must clean up the water released from its generating plant. The
Unit price $750 $800 $875
company's cost of capital is 11 percent for average projects, and that rate is normally adjusted
Unit variable cost $500 $400 $350
up or down by 2 percentage points for high- and low-risk projects. Clean-Up Plan A, which is of
Fixed cost, millions $7 $4 $3.5
average risk, has an initial cost of $10 million, and its operating cost will be $1 million per year
Assume that Oxford employs straight-line depreciation, and that they are taxed at 35%. for its 10-year life. Plan B, which is a high-risk project, has an initial cost of $5 million, and its
Assuming an opportunity cost of capital of 14%, what is the NPV of this project, based on annual operating cost over Years 1 to 10 will be $2 million. What is the approximate PV of
expected outcomes? costs for the better project? (VD)
A. $2,626,415 C. $6,722,109

MSQ-08 - CAPITAL BUDGETING Page 9 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

A. -$5.9 million. C. -$16.8 million. period of six years. The required rate of return is 14%. The old machine has a remaining life of
B. -$15.9 million. D. -$17.8 million. six years. The new machine is expected to have zero value at the end of the six-year period.
The disposal value of the old machine at the time of replacement is zero. What is the internal
Fisher rate rate of return?
24. Berry Products is considering two pieces of machinery. The first machine costs P50,000 more A. 15% C. 17%
than the second machine. During the two-year life of these two alternatives, the first machine B. 16% D. 18%
has P155,000 more cash flow in year one and a P110,000 less cash flow in year two than the 28. A tax-exempt foundation, Sincerely Foundation, Inc. intends to invest P1 million in a five-year
second machine. All cash flows occur at year-end. The present value of 1 at 15% end of 1 project. The foundation estimates that the annual savings from the project will amount to
period and 2 periods are 0.86957 and 0.75614, respectively. The present value of 1 at 8% end P325,000. The P1 million asset is depreciable over five (5) years on a straight-line basis. The
of period 1 is 0.92593 and period 2 is 0.85734. foundation’s hurdle rate is 12% and as a consultant of the foundation, you are asked to
At what discount rate would Machine 1 equally acceptable as machine 2? determine the internal rate of return and advise if the project should be pursued.
A. 9% C. 11% To facilitate computations, below are present value factors:
B. 10% D. 12% N=5 12% 14% 16%
Present value of P1 0.57 0.52 0.48
Internal Rate of Return Present value of an annuity of P1 3.60 3.40 3.30
25. Smoot Automotive has implemented a new project that has an initial cost, and then generates Your advice is
inflows of $10,000 a year for the next seven (7) years. The project has a payback period of 4.0 A. To proceed due to an estimated IRR of more than 16%.
years. What is the project's internal rate of return (IRR)? B. Not to proceed due to an estimated IRR of less than 12%.
A. 14.79% C. 16.33% C. To proceed due to an estimated IRR of less than 14% but not more than 12%.
B. 15.61% D. 18.54% D. To proceed due to an estimated IRR of less than 16% but not more than 14%.
26. MLF Corporation is evaluating the purchase of a P500,000 die attach machine. The cash 29. Para Co. is reviewing the following data relating to an energy saving investment proposal:
inflows expected from the investment is P145,000 per year for five years with no equipment Cost $50,000
salvage value. The cost of capital is 12%. The net present value factor for five (5) years at Residual value at the end of 5 years 10,000
12% is 3.6048 and at 14% is 3.4331. The internal rate of return for this investment is Present value of an annuity of 1 at 12% for 5 years 3.60
A. 2.04% C. 13.8% Present value of 1 due in 5 years at 12% 0.57
B. 3.45% D. 15.48% What would be the annual savings needed to make the investment realize a 12% yield?
A. $8,189 C. $12,306
27. The Zeron Corporation recently purchased a new machine for its factory operations at a cost B. $11,111 D. $13,889
of $921,250. The investment is expected to generate $250,000 in annual cash flows for a

MSQ-08 - CAPITAL BUDGETING Page 10 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

30. Payback Company is considering the purchase of a copier machine for P42,825. The copier 1. Economic life of equipment – 8 years.
machine will be expected to be economically productive for 4 years. The salvage value at the 2. Disposal value after 8 years – nil.
end of 4 years is negligible. The machine is expected to provide 15% internal rate of return. 3. Estimated net annual cash inflows for each of the 8 years – P81,000.
The company is subject to 40% income tax rate. The present value of an ordinary annuity of 1 4. Time-adjusted internal rate of return – 14%
for 4 periods is 2.85498. In order to realize the IRR of 15%, how much is the estimated 5. Cost of capital of Sunlight Corp – 16%
before-tax cash inflow to be provided by the machine? 6. The table of present values of P1 received annually for 8 years has these factors: at
A. P15,000 C. P25,000 14% = 4.639, at 16% = 4.344
B. P17,860 D. P35,700 7. Depreciation is approximately P46,970 annually.
31. Salvage Co. is considering the purchase of a new ocean-going vessel that could potentially
reduce labor costs of its operation by a considerable margin. The new ship would cost
$500,000 and would be fully depreciated by the straight-line method over 10 years. At the end Find the required increase in annual cash inflows in order to have the time-adjusted rate of
of 10 years, the ship will have no value and will be sunk in some already polluted harbor. The return approximately equal the cost of capital.
Salvage Co.'s cost of capital is 12 percent, and its marginal tax rate is 40 percent. If the ship A. P4,344 C. P5,871
produces equal annual labor cost savings over its 10-year life, how much do the annual B. P5,501 D. P6,501
savings in labor costs need to be to generate a net present value of $0 on the project? (Round
to the nearest dollar.) 34. Booker Steel Inc. is considering an investment that would require an initial cash outlay of
A. $68,492 C. $114,154 $400,000 and would have no salvage value. The project would generate annual cash inflows
B. $88,492 D. $147,487 of $75,000. The firm's discount rate is 8 percent. How many years must the annual cash flows
be generated for the project to generate a net present value of $0?
32. A company is considering putting up P50,000 in a three-year project. The company’s A. between 5 and 6 years C. between 7 and 8 years
expected rate of return is 12%. The present value of P1.00 at 12% for one year is 0.893, for B. between 6 and 7 years D. between 8 and 9 years
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) Project Screening – Independent Projects
for the second year. Assuming that the rate of return is exactly 12%, the cash flow, net of 35. The following data relate to two capital-budgeting projects of equal risk:
income taxes, for the third year would be Present Value of Cash Flows
A. P7,120 C. P16,392 Period Project A Project B
B. P10,000 D. P23,022 0 $(10,000) $(30,000)
1 4,550 13,650
33. The following data pertain to Sunlight Corp., whose management is planning to purchase an 2 4,150 12,450
automated tanning equipment. 3 3,750 11,250

MSQ-08 - CAPITAL BUDGETING Page 11 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

Which of the projects will be selected using the profitability index (PI) approach and the NPV budget for the year. Idle funds cannot be reinvested at greater than 12%.
approach? In Thousand Pesos
A. B. C. D. L M N O
PI B Either Either B Initial cost 400 470 380 420
NPV A B A B Annual cash flows
Year 1 113 180 90 80
Project Screening – Mutually Exclusive Projects 2 113 170 110 100
36. Five mutually exclusive projects had the following information: 3 113 150 130 120
A B C D 4 113 110 140 130
5 113 100 150 150
NPV $500 $(200) $200 $1,000
IRR 12% 8% 13% 10%
Net present value P7,540 P59,654 P54,666 P(15,708)
Internal rate of return 12.7% 17.6% 17.2% 10.6%
Which project is preferred? Excess present value index 1.02 1.13 1.14 0.96
A. A C. C
B. B D. D The company will choose
A. Projects L & M. C. Projects M & N.
Capital Rationing & Optimal Capital Budget B. Projects L & N. D. Projects M, N & O.
37. Information on three (3) investment projects is given below:
Project Investment Required Net Present Value 39. The Nativity Corporation has the following investment opportunities:
X P150,000 P34,005 Proposal Profitability Index Initial Cash Outlay
G 100,000 22,670 1 1.15 P200,000
W 60,000 13,602 2 1.13 125,000
Rank the projects in terms of preference: 3 1.11 175,000
A. 1st W; 2nd G; 3rd X. C. 1st X; 2nd G; 3rd W. 4 1.08 150,000
B. 1st G; 2nd W; 3rd X. D. The ranking is the same. The firm has a budget constraint of P300,000.
What proposal(s) should be accepted?
38. Telephone Corp. is contemplating four projects: L, M, N, and O. The capital costs for the A. Proposal 4 because it has the lowest profitability index.
initiation of each mutually-exclusive project and its estimated after-tax, net cash flow are listed B. Proposal 1 because it has the highest profitability index.
below. The company’s desired after-tax opportunity costs is 12%. It has P900,000 capital C. Proposals 1 and 2 because their total net present values are the highest among all

MSQ-08 - CAPITAL BUDGETING Page 12 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

possible proposal combinations. A. $800,000 C. $1,750,000

D. Proposals 2 and 3 because their total net present values are the highest among all B. $1,200,000 D. $2,400,000
possible proposal combinations.
Comprehensive
Problem 42 and 43 are based on the following information.
40. A company's marginal cost of new capital (MCC) is 10% up to $600,000. MCC increases .5%
Daneche’s, a tax-exempt entity, plans to purchase a new machine which they project to depreciate
for the next $400,000 and another .5% thereafter. Several proposed capital projects are under
over a ten-year period without salvage value. The new machine will cost P200,000 and is
consideration, with projected cost and internal rates of return (IRR) as follows:
expected to generate cash savings of P60,000 per year in operating costs. Daneche's cost of
Project Cost IRR capital is 12%.
A $100,000 10.5% For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an ordinary
B $300,000 14.0% annuity of P1 is P5.650.
C $450,000 10.8%
D $350,000 13.5% 42. What is the net present value of the proposed investment, assuming Daneche uses a 12%
E $400,000 12.0% discount rate?
What should the company's capital budget be? A. P69,980 C. P185,640
A. $0 C. $1,500,000 B. P139,000 D. None of the above.
B. $1,050,000 D. $1,600,000
43. With the company’s initial investment on the new machine, the accounting rate of return is
41. Mulva Inc. is considering the following five independent projects: A. 15% C. 25%
Project Required Amount of Capital IRR B. 20% D. None of the above.
A $300,000 25.35% Questions 43 and 44 are based on the following information.
B 500,000 23.22% The construction of a waste treatment plant was arrived at after a careful cost-benefit analysis.
C 400,000 19.10% During the construction period a status report was presented for your review:
D 550,000 9.25% ● completed cost as originally estimated, P5 million
E 650,000 8.50% ● % of actual completion to date, 65%
The company has a target capital structure which is 40 percent debt and 60 percent equity. ● actual cost to date, P3.75 million
The company can issue bonds with a yield to maturity of 10 percent. The company has
$900,000 in retained earnings, and the current stock price is $40 per share. The flotation costs 44. Assuming cost is evenly distributed throughout the construction period, how much will the
associated with issuing new equity are $2 per share. Mulva's earnings are expected to completion cost be most likely?
continue to grow at 5 percent per year. Next year's dividend (D1) is forecasted to be $2.50. A. The original cost estimate of P5 million.
The firm faces a 40 percent tax rate. What is the size of Mulva's capital budget? B. P5 million plus a cost overrun of about P769,000

MSQ-08 - CAPITAL BUDGETING Page 13 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

C. P500,000 less than the original cost at completion. YEAR 1 2 3 4

D. About P100,000 above the original cost at completion. Income before depreciation P30,000 P30,000 P40,000 P40,00
0
45. What would be an appropriate action to take considering the situation in number 28? The present value factors for P1 at 10% is
A. No need to take any action. Year 1 2 3 4
B. Immediately stop further work on the project. Present Value Factor 0.909 0.826 0.751 0.683
C. Wait for the next quarterly status report on the project.
D. Recommend immediate review with the project implementation team to determine the 48. The net cash flow for year 1 is
cause of overrun and the corrective actions to be taken. A. P25,850 C. P31,250
B. P28,750 D. P34,450
Questions 46 and 47 are based on the following information.
Beta Company plans to replace its company car with a new one. The new car costs P120,000 and 49. The net cash flow for year 4 is
its estimated useful life is five years without scrap value. The old car has a book value of P15,000 A. P30,150 C. P35,950
and can be sold at P12,000. The acquisition of the new car will yield annual cash savings of B. P35,850 D. P36,250
P20,000 before income tax. Income tax rate is 25%. (M)
50. The payback period for the project is
46. The net investment of the new car is A. 3 years C. 3.5 years
A. P107,000 C. P108,000 B. 3.17 years D. 4 years.
B. P107,250 D. P108,750
51. The accounting rate of return of the project is
A. 7% C. 12%
47. The payback period of the investment is (M) B. 9% D. 15%
A. 5.095 years C. 5.14 years
B. 5.11 years D. 5.18 years
52. The present value of year two’s cash flow is
Questions 48 through 55 are based on the following information. A. P23,747.50 C. P26,100.75
The Burgos Corporation is considering investing in a project. It requires an immediate cash outlay B. P25,856.25 D. P29,750.75
of P100,000. It has a life of four years and will be depreciated on a straight-line basis (no salvage
value). The firm’s tax rate is 25% and requires a return of 10%. Income before depreciation is 53. The present value of the project’s net cash flow is
projected to be: A. P95,650.15 C. P101,863.75

MSQ-08 - CAPITAL BUDGETING Page 14 of 15

MANAGEMENT ADVISORY SERVICES HILARIO TAN

B. P98,151.25 D. P104,750.25 Theory Problem

1. D 21. B 1. C 21. B 41. C
54. The profitability index of the project (rounded to the nearest hundredth) is 2. B 22. A 2. B 22. D 42. B
A. 0.96 C. 1.02 3. D 23. B 3. B 23. B 43. B
B. 0.98 D. 1.05 4. C 24. D 4. B 24. B 44. B
5. C 25. A 5. A 25. C 45. D
55. The project would be accepted on the basis of the 6. D 26. A 6. B 26. C 46. B
A. Payback and present value results.
7. D 27. D 7. C 27. B 47. B
B. Accounting rate of return and profitability index results.
8. A 28. B 8. D 28. A 48. B
C. Payback results only
D. A and B combined 9. D 29. A 9. B 29. C 49. D
10. D 30. C 10. D 30. B 50. B
11. B 31. B 11. B 31. C 51. D
12. C 32. B 12. B 32. D 52. A
13. D 33. A 13. C 33. B 53. C
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

MSQ-08 - CAPITAL BUDGETING Page 15 of 15