CAPITAL BUDGETING M. B.

GUIA

Group Name Study Buddies

Group Leader Coronacion, Jan Gray

Group Member Calangi, John Lester

Coronacion, Jan Gray
Cruz, Annjela
Guia, Shantelle
Orata, Hanz
Ofrecio, Camille
Pingol, Shaira

Problem 1: A company is considering the purchase of new equipment costing P260,000. In

addition, it will require the company to pay for the installation and delivery charges
amounting to P20,000. Also, the company will invest on additional current assets
(Receivables and Inventory) totaling P56,000. Currently the company has old equipment
with a net book value of P40,000 and a current market value of P45,000. The company is
subject to the 30% income tax rate.

Required: Compute the net investment cost of the company to the new equipment.

Purchase Price of New Equipment P260,000

Installation and Delivery Costs 20,000

Increase in Working Capital (Receivables 56,000

and Inventory)

Total Amount Required at the P336,000

Implementation Stage

Current Market Value P45,000

Less: Tax on the gain on

sale

Current Market Value 45,000

Current Net Book Value (40,000)

Taxable Gain 5,000

Income Tax Rate 30% (1,500)

 Net Proceeds P43,500

Total Amount Required at the P336,000

Implementation Stage

Less: Net Proceeds 43,500

Net Investment Cost for the new P292,500

equipment

Problem 2: It was estimated by the company that the equipment will be able to produce an
additional 100,000 units of its only product, which can all be sold by the company at P 10.00
each. Information about the production and other operating costs follow:

Direct materials, labor & overhead P5.00

Selling and Administrative 3.00
Fixed costs requiring cash outlay P50,000

The equipment was estimated to have a useful life of 5 years and the company uses the
straight-line method of depreciation. Income tax rate is still 30%.

Required: Compute the Annual Net Benefit from the equipment.

DEPRECIATION COMPUTED USING STRAIGHT LINE METHOD

Purchase Price of New Equipment P260,000

Other Costs (Installation and Delivery) 20,000

Total Cost Capitalized as PPE 280,000

Divided by: Useful life 5

Annual Depreciation P56,000

OPERATING PERIOD

Additional Annual Cash P1,000,000

Revenue

LESS: ANNUAL
EXPENSES

CASH EXPENSES

Direct materials, labor, 500,000

overhead
 Selling and Administrative 300,000

Fixed Costs 50,000 (850,000)

NON-CASH EXPENSES

Depreciation (56,000)

Income Before Taxes 94,000

Less: Taxes (30%) (28,200)

Net Income 65,800

Add: Non-Cash Expense 56,000

deducted

After-Tax Net Annual Cash P121,800

Inflow

Problem 3: After five years, the company expects the equipment to have a salvage value of
P 5,000, but for tax purposes, such equipment will be depreciated down to zero. Disposal
cost of removing the equipment is estimated at P 15,000. All current assets invested are
likewise expected to be recovered.

Required: Compute the equipment’s terminal value

Salvage Value (Net of Tax) 3500

Recovery of CA Invested 56000

Disposal Cost (Net Tax) (10500)

Terminal Value 49000

Problem 4: The following pertains to X Corporation’s investment plan

Investment Costs (Equipment) Annual net cash benefit Useful life

Tax Rate

P 200,000 120,000 5 years 30%

Required:

1. Determine the accounting rate of return on initial investment.

2. Compute the payback period of the investment in equipment.

Investment Cost (Equipment) (P200,000)

Annual Net Cash Benefit 120,000

Depreciation (200,000 - 5,000 / 5) (39,000)

Earnings Before Tax 81,000

Net Income (81,000 x 70%) 56,700

Add: Depreciation 39,000

After Tax Cash Flow 95,700

56,700
ROI = 200,000
= 28.35%
200,000
PBP = 95,700
= 2.09 years

Problem 5: The following information pertains to X Corporation: Total Investment Costs

Annual net benefit Year 1

Year 2

Year 3
Required: Compute the Payback Period.
P 200,000

90,000 120,000 110,000

 200,000
𝑃𝐵𝑃 = 90,000+ 120,000+ 110,000 = 1.88 years
3

Problem 6: Assume the following information for a particular investment:

Total Investment Costs Annual Operations:

Year 1 2 3

Cash Inflow P 40,000 30,000 25,000

P 150,000

Salvage Value P 100,000 70,000 60,000

4 20,000 50,000

Required: Compute the investments Bail-Out Period.

Salvage Value Cost Inflow Balance

Investment
Cost 150000

Year 1 100000 40000 110000

Year 2 70000 30000 80000

Year 3 60000 25000 55000

Year 4 50000 20000

Bail Out Period = (Year 2 Investment Cost Balance - Year 3 Salvage Value)/ Year 3 Cash
Inflow

=(80,000-60,000)/25,000

= 0.8 + 2

= 2.8 Bail Out Period

_________________________________________________________________________

Problem 7: The following pertains to X Corporation’s investment plan

Net Annual Cash Inflow Equipment

Useful life
Salvage Value

Tax Rate

P 80,000 200,000 5 years P 50,000 30%

Required: Compute the accounting rate of return of the investment

1. Based on Initial Investments

2. Based on Average Investments

ANSWER:

Investment Cost 200,000

Net Annual Cash Inflow 80,000

Depreciation Expense (200k - 50k/5) 30,000

Operating Income 50,000
x 0.7
Net Income 35,000

1. 35,000/200,000 = 17.50%
2. 35,000 .
(200,000 + 50,000) / 2 = 28%
_________________________________________________________________________

Problem 8: Calvin Inc. is considering the purchase of a new state-of-art machine to replace
its hand-operated machine. Calvin’s effective tax rate is 40%, and its cost of capital is 12%.
Data regarding the existing and new machines are presented below.
Original Cost
Installation Costs
Freight and Insurance Expected end salvage value Depreciation Method Expected useful life

Existing Machine P 50,000 -0- -0- -0- Straight-line 10 years

New Machine P 90,000 4,000 6,000 -0- Straight-line 5 years

The existing machine has been in service for seven years and could be sold currently for
P25,000. Calvin expects to realize a before-tax annual reduction in labor costs of P 30,000 if
the new machine is purchased and placed in service.
Required:

1. Compute the investment’s net present value

2. Determine the profitability index and net present value index

Problem 9: Olson Industries needs to add a small plant to accommodate a special contract
to supply building materials over a five year period. The required initial cash outlays at Time
0 are as follows.
Land
New Building Equipment

P500,000 2,000,000 3,000,000

Olson uses straight-line depreciation for tax purposes and will depreciate the building over
10 years and the equipment over 5 years. Olson’s effective tax rate is 40% and its cost of
capital is 14%. Revenues from the special contract are estimated at P 1.2 million annually,
and cash expenses are estimated at P 300,000 annually. At the end of the fifth year, the
assumed sales values of the land and building are P 800,000 and P 500,000, respectively. It
is further assumed the equipment will be removed at a cost of P 50,000 and sold for P
300,000.

Required:

1. Compute the investment’s net present value

2. Determine the profitability index and net present value index

Problem 10: Kell Inc. is analyzing an investment for a new product expected to have annual
sales of 100,000 units for the next 5 years and then be discontinued. New equipment will be
purchased for P1,200,000 and cost P 300,000 to install. The equipment will be depreciated
on a straight-line basis over 5 years for financial reporting purposes and 3 years for tax
purposes. At

the end of the fifth year, it will cost P 100,000 to remove the equipment, which can be sold
for P300,000. Additional working capital of P 400,000 will be required immediately and
needed for the life of the product. The product will sell for P80, with direct labor and material
costs of P65 per unit. Annual indirect costs will increase by P 500,000. Kell’s effective tax
rate is 40% and cost of capital of 15%

Required:

1. Compute the investment’s net present value

Investment Cost Amount After Tax Amount Disposable Amount

Cash Flow Cost

Purchase Price (1 200 000) Depreciation 160 000 Equipment 180 000
* Sale [300k x (1 - 40%)]
proceeds

Installment Cost ( 300 000) Sales** 520 000 Removal (60 000)
Cost [100k x (1 - 40%)]

Working Capital ( 400 000) Recovery 400 000

of Working
Capital
TOTAL (1 900 000) 680 000 TOTAL 520 000

**Solving for ATCF: Sales

Sales 8 000 000 Inc Before tax and 1 000 000

depreciation

Direct Costs (6 500 000) Depreciation (240 000)

(finance purposes)

Indirect Costs (500 000) Tax expense (240 000)

Gross Inc 1 000 000 Income After tax 520 000

Depreciation (Tax (400 000)

purp)

Inc Before Tax 600 000

Tax Rate 40%

Tax Expense 240 000

Solving for Depreciation*

Depreciation = (1 200 000 + 300 000 - 300 000) / 3

= 400 000 * 40%

= 160 000

Investment (1 900 000) Already at PV

Cost (IC)

After Tax 2 279 360 680 000* 3.352

Cash Flow
(ATCF) PVf = [ 1- (1 / 1.15^5) / .15 ]

Disposable 258 440 520 000 * 0.497

Cost (DC) PVf = 1.15^-5

Net Present 637 800

Value (NPV)
 2. Determine the profitability index and net present value index

NPV index = NPV/IC = 637 800 / 1 900 000

= 0..3357 or 33.57%

Profitability Index = 1 + NPV index or PV of all cash inflows / IC

= 1 + 0.3357 or 2 537 800 / 1 900 000

= 1.3357 (1.34*)

Problem 11: Allstar Company invests in a project with expected cash inflows of P9,000 per
year for four years. All cash flows occur at year-end. The required return on investment is
9%. Required: If the project generates a net present value (NPV) of P 3,000, what is the
amount of the initial investment in the project?

Investment Cost (IC) (26 157)

After Tax Cash Flow (ATCF) 29 157

Disposable Cost (DC) 0

Net Present Value (NPV) 3000

1. Solve for After Tax Cash Flow

- Solve for Present value factor of the sum of annuity/annual inflow

= 9000 x [ 1- (1 / 1.09^4) / .09 ]

= 9000 x 3.2397
= 29 157

Another method

= 9000 x [(1.09)^-4 -1 / .09]

= 9000 x 3.2397
 Total PVatf =29 157

2. Solve for Investment Cost (initial Investment)

3000 = 29 157 - IC
IC = 29 157 - 3000
IC = 26 157*

Problem 12: Jenson Copying Company is planning to buy a coping machine costing
P25,310. The net present values (NPV) of this investment, at various discount rates, are as
follows.

Discount Rate 4%
6%
8%
10%

NPV P 2,440 1,420 460 (440)

Required: Jenson’s approximate internal rate of return on this investment is

ANSWER:

Discount Rate NPV

4% P 2,440
6% 1,420
8% 460
10% (440)

= 0.08 + [ 460 - 0/460 - (-440)] x (0.1 - 0.08)

= 0.08 + (460/900) x (0.02)
= 9.02%

Making ppt- Guia and Ofrecio