Capital Budgeting Decisions

1. Of the following decisions, capital budgeting techniques would least likely be used in evaluating the:
A. Acquisition of new aircraft by a cargo company
B. Design and Implementation of a major advertising program
C. Trade for a star quarterback by a football team.
D. Adoption of a new method of allocating nontraceable costs to product lines.

2. Winneconne Company is considering replacing a machine with a book value of P400,000, a

remaining useful life of 5 years, and annual straight-line depreciation of P80,000. The existing
machine has a current market value of P400,000. The replacement machine would cost P550,000,
have a 5-year life, and save P75,000 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

(s0K
investment required to replace the existing machine?

3. A company is considering replacing a machine with one that will save P50,000 per year in cash
operating costs and have P20,000 more depreciation expense per year than the existing machine.
The tax rate is 40%. Buying the new machine will increase annual net cash flows of the company by:

38K
4. Gaello has an investment opportunity costing P300,000 that is expected to yield the following cash
flows over the next six years:
Year One P75,000 Year Four P130,000
Year Two P90,000 Year Five P100,000
Year Three P115,000
a. Find the payback period of the investment. = 3
-
15YVS
Year Six P90,000

b. Find the book rate of return of the investment. = 33.33%/16.65/

c. Find the NPV of the investment at a cutoff rate of 10%.

= 138, 644 NPV

5.

After-tax cash flows :BTCFX(1 Ty) -

(80K X100K)
+ Depr x
T%
↓ In sales ⑧M

& In cash expenses (65 x 100K) 5001

+

(7 M) (MX(1 40%)
= -

0 in cash flaws
before tax [M 70 x
40%
After cash flow
tax G00k
o 19 Depreciation
from operations =600K 0
+

salvage value of equip. 120K

on profitbefore tax /M

(300K-100K) X(1 -

10%) · In Income tax

90% ch00K) =600K
Recovery of working or · In prof itafter tax 600K
Capital 1,120,000 ↓ In Dep O
↓ -A
taxcash ft
flow cook
er
Total
ATCF
 WinneCOne:
Net Investment:

capitalized amount (550K)

increase in NW [ o

sale of Replace Machines 400K

tax impact (100K 400K)448%O
-

HOOK
other savings (during investmentpoint o

&ef Investment *(150K)

A Company:
After cash
tax flows:
Δ In sales ⑧

& In cash expenses 50K

Δ In before tax cash flows 50K

& In Depreciation (20K)
& In profitbefore tax 30K
& In Income tax (30kX00%) 12K. less
↓ in profit after tax 18K
& In Depreciation 2.0k.
· In after tax cash flow 38K

:
BTCFX (ITY) +

DePr.X T %
↳

=50k x (1 -

48%) Depreciation
+ 10K 40
+
tax shield

:
30k +

=38K
 faelO:
A:Payback period Biscounting rate ofreturn

YetInvestmentP (380K) ↑lear BTCFDeP. Profit

Year I 75K ↓ 75K -
SOK I
15K
(225k) 1 90K
-

SOKI 4019

year ( 90K 3 119K

-

50K = 65K

(135K) 4 138K -

50K = 88K4

year 3 115K 5. 100K -

50K:soK
90K gOK:48K
-

201 6

130K ⑤
/365:369.8630 Average
PBp 50K
-01
=

16.67%
=3408 504
+ ARR =
=

+15% year
548K
=G of
=
33.33%
=

=
13.15 years

C.y0
(300/9) Ys, 4243444546 90K li5K [30K100K 90K
x 0.9091 0.8264 X0.7513 48.6838 x0.628940.5645

68,18374.373 86.400 88790 62,09050,805

430,644
(130,644

FCB =

↓v. Set presentvalue

 6.

7. A corporation uses net present value techniques in evaluating its capital investment projects. The
company is considering a new equipment acquisition that will cost P100,000, fully installed, and
have a zero salvage value at the end of its five-year productive life. The corporation will depreciate
the equipment on a straight-line basis for both financial and tax purposes. The corporation
estimates P70,000 in annual recurring operating cash income and P20,000 in annual recurring
operating cash expenses. The corporation’s desired rate of return is 12% and its effective income tax
rate is 40%. What is the net present value of this investment on an after-tax basis?

⑮982
8. Don Adams Breweries is considering an expansion project with an investment of P1,500,000. The
equipment will be depreciated to zero salvage value on a straight-line basis over 5 years. The
expansion will produce incremental operating revenue of $400,000 annually for 5 years. The
company’s opportunity cost of capital is 12%. Ignore taxes. What is the IRR of the investment?

(10.4248%
9. A firm has the following investment opportunities. Required investment outlays and the profitability
index for each of these investments are as follows:
Project Investment Cost Profitability Index
I $300,000 0.5
II 450,000 1.4
capital rationing
⑭
III 650,000 1.8 a

IV 750,000 1.6 ↑
The firm’s budget ceiling for initial outlays during the present period is P1,500,000. The proposed
projects are independent of each other. Which project or projects would you recommend that the
firm accept?
Capital
Available 1.500,000
(1) 650K
850K

10 798K
100K
 #) corporation
ATCF
=
BTCFX (q -7)
+DCPr T
x

=g0kX,60
+ 20kX,48

= 384

48 y7 y24344 15
(100K) 38K 38k 35K 38K 384

<

136,982(38,000x3.0848) 12/
:136,982

DON ADAM
(i,000 4)
YOUI "BOOK YMOOR
work
10.42480).
1,500,000 (100KX3.7500)
o
 10.

=
57600
17,653 NPV
=

= 1.092
After cash
tax flows
Netinvestment:
240K
=BTC7 (.TY)
+

(A
100K
+ Dlpr.XTY
DOWC
& If (nV 340K = 80k (1-48%)
x

24k448%
+

=79,600
70 y1 y2 y3... /10
340K 57608976057688.... -300
L 12%
157,652 (97,600 45.6502 100k X.5128)
+

⑰3
<PV

profitabilityIndex
397,652/340k
1.052
=