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THEORY D. Treated as a recurring annual cash flow that is recovered at the end of six years.
Basic concepts
1. Capital budgeting techniques are least likely to be used in evaluating the Operating Cash Flows After Tax
A. Acquisition of new aircraft by a cargo company. 6. To approximate annual cash inflow, depreciation is
B. Trade for a star quarterback by a football team. A. Subtracted from net income because it is an expense.
C. Design and implementation of a major advertising program. B. Added back to net income because it is an inflow of cash.
D. Adoption of a new method of allocating non-traceable costs to product lines. C. Subtracted from net income because it is an outflow of cash.
D. Added back to net income because it is not an outflow of cash.
2. The “inflation element” refers to the
A. Future increases in the general purchasing power of the monetary unit. 7. In capital expenditures decisions, the following are relevant in estimating operating costs
B. Future deterioration of the general purchasing power of the monetary unit. except
C. Fact that the real purchasing power of a monetary unit usually increases over time. A. Cash costs. C. Future costs.
D. Impact that future price increases will have on the original cost of a capital expenditure. B. Differential costs. D. Historical costs.

3. Which of the following best identifies the reason for using probabilities in capital budgeting is Accounting Rate of Return
A. Cost of capital. C. Time value of money. 8. The following statements refer to the accounting rate of return (ARR)
B. Different life of projects. D. Uncertainty. 1. The ARR is based on the accrual basis, not cash basis.
2. The ARR does not consider the time value of money.
4. In capital budgeting decisions, the following items are considered among others: 3. The profitability of the project is considered.
1. Cash outflow for the investment. From the above statements, which are considered limitations of the ARR concept?
2. Increase in working capital requirements. A. Statements 1 and 2 only. C. Statements 3 and 1 only.
3. Profit on sale of old asset B. Statements 2 and 3 only. D. All the 3 statements.
4. Loss on write-off of old asset.
For which of the above items would taxes be relevant? Payback Period
A. Items 1 and 3 only. C. Items 3 and 4 only. 9. The payback method assumes that all cash inflows are reinvested to yield a return equal to
B. Items 1, 3 and 4 only. D. All items. A. the discount rate. C. the internal rate of return.
B. the hurdle rate. D. zero.
Net Investments
5. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient.
This equipment has an estimated useful life of six years. As part of this acquisition, a 10. As a capital budgeting technique, the payback period considers depreciation expenses (DE)
P150,000 investment in working capital is required. In a discounted cash flow analysis, this and time value of money (TVM) as follows:
investment in working capital should be A. B. C. D.
A. Disregarded because no cash is involved. DE relevant relevant Irrelevant irrelevant
B. Amortized over the useful life of the equipment. TVM relevant irrelevant Relevant irrelevant
C. Treated as an immediate cash outflow that is recovered at the end of six years.
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Bailout Payback 16. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost,
11. The bailout payback period is the value of the firm and the price of its common stock will <List B>
A. The payback period used by firms with government insured loans. A. B. C. D.
B. The length of time for payback using cash flows plus the salvage value to recover the List A Equal to Equal to Greater than Greater than
original investment List B Decrease Increase Decrease Increase
C. (A) and (B)
D. None of the above. 17. The common assumption in capital budgeting analysis is that cash inflows occur in lump sums
at the end of individual years during the life of an investment project when in fact they flow
Discounted Cash Flow Method more or less continuously during those years
12. Which of the following methods measures the cash flows and outflows of a project as if they A. Results in understated estimates of NPV.
occurred at a single point in time? B. Results in higher estimate for the IRR on the investment.
A. Capital budgeting. C. Discounted cash flow. C. Is done because present value tables for continuous flows cannot be constructed.
B. Cash flow based payback period. D. Payback method. D. Will result in inconsistent errors being made on estimating NPVs such that project cannot
be evaluated reliably.
13. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital
budgeting project, which of the following factors generally is not important? 18. Polo Co. requires higher rates of return for projects with a life span greater than 5 years.
A. The timing of cash flows relating to the project. Projects extending beyond 5 years must earn a higher specified rate of return. Which of the
B. The amount of cash flows relating to the project. following capital budgeting techniques can readily accommodate this requirement?
C. The impact of the project on income taxes to be paid. A. B. C. D.
D. The method of financing the project under consideration.
Internal Rate of Return Yes Yes No No
Net Present Value Yes No Yes No
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
overhauling is done. The finance officer insists that the overhauling be done in year 4, not in 19. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are
year 5. some of the capital budgeting techniques. What is the effect of an increase in the cost of
The most likely reason is capital on these techniques?
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. PP Decrease Increase No change No change
PI No change Decrease Decrease Increase
15. In an investment in plant the return that should keep the market price of the firm stock SARR No change Increase No change Decrease
unchanged is
A. Cost of capital C. Net present value Net Present Value
B. Discounted rate of return D. Payback 20. A company had made the decision to finance next year’s capital projects through debt rather
than additional equity. The benchmark cost of capital for these projects should be
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A. The after-tax cost of new-debt financing. C. The cost of equity financing. A. The discount rate increases.
B. The before-tax cost of new-debt financing. D. The weighted-average cost of capital. 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.
21. All of the following refer to the discount rate used by a firm in capital budgeting except D. The investment cost decreases without affecting the expected income and life of the
A. Hurdle rate. C. Opportunity cost of capital. project.
B. Opportunity cost. D. Required rate of return.
27. Which of the following is always true with regard to the net present value (NPV) approach?
22. The excess present value method is anchored on the theory that the future returns, expressed A. The NPV and the IRR approaches will always rank projects in the same order.
in terms of present value, must at least be B. The NPV and payback approaches will always rank projects in the same order.
A. Equal to the amount of investment C. More than the amount of investment C. If a project is found to be acceptable under the NPV approach, it would also be
B. Less than the amount of investment D. Cannot be determined acceptable under the payback approach.
D. If a project is found to be acceptable under the NPV approach, it would also be
23. An advantage of the net present value method over the internal rate of return model in acceptable under the internal rate of return (IRR) approach.
discounted cash flow analysis is that the net present value method
A. Computes a desired rate of return for capital projects. 28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present
B. Uses a discount rate that equates the discounted cash inflows with the outflows. value of P450,000. The project has a life of 7 years with salvage value of P200,000. The
C. Uses discounted cash flows whereas the internal rate of return model does not. company uses a discount rate of 12%. Which of the following would decrease the net present
D. Can be used when there is no constant rate of return required for each year of the project. value?
A. Increase the salvage value.
B. Increase discount rate to 15%.
C. Extend the project life and associated cash inflows.
24. When using the net present value method for capital budgeting analysis, the required rate of D. Decrease the initial investment amount to P9.0 million.
return is called all of the following except the
A. Cost of capital. C. Discount rate. Profitability Index
B. Cutoff rate. D. Risk-free rate. 29. What is the effect of changes in cash inflows, investment cost and cash outflows on
profitability (present value) index (PI)
25. A project’s net present value, ignoring income tax considerations, is normally affected by the A. PI will increase with an increase in cash inflows, a decrease in investment cost, or a
A. Proceeds from the sale of the asset to be replaced. decrease in cash outflows.
B. Carrying amount of the asset to be replaced by the project. B. PI will increase with an increase in cash inflows, an increase in investment cost, or an
C. Amount of annual depreciation on the asset to be replaced. increase in cash outflows.
D. Amount of annual depreciation on fixed assets used directly on the project. C. PI will decrease with an increase in cash inflows, a decrease in investment cost, or a
decrease in cash outflows.
26. You have determined the profitability of a planned project by finding the present value of all the D. PI will decrease with an increase in cash outflows, an increase in investment cost, or an
cash flows from that project. Which of the following would cause the project to look less increase in cash inflows.
appealing, that is, have a lower present value?
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Internal Rate of Return Investment Decisions – Independent Projects

30. Which of the following characteristics represent an advantage of the internal rate of return 35. A company is evaluating three possible investments. Information relating to the company and
techniques over the accounting rate of return technique in evaluating a project? the investments follow:
I Recognition of the project’s salvage value. Fisher rate for the three projects 7%
II Emphasis on cash flows. Cost of capital 8%
III Recognition of the time value of money. Based on this information, we know that
A. I only. C. II and III. A. all three projects are acceptable.
B. I and II. D. I, II, and III. B. none of the projects are acceptable.
C. the net present value method will provide a ranking of the projects that is superior to the
31. How are the following used in the calculation of the internal rate of return of a proposed ranking obtained using the internal rate of return method.
project? Ignore income tax considerations. D. the capital budgeting evaluation techniques profitability index, net present value, and
A. B. C. D. internal rate of return will provide a consistent ranking of the projects.
Residual sales value of project Include Include Exclude Exclude
Depreciation expense Include Exclude Include Exclude Investment Decisions – Mutually Exclusive Projects
36. When ranking two mutually exclusive investments with different initial amounts, management
32. The discount rate that equates the present value of the expected cash flows with the cost of should give first priority to the project
the investment is the A. That has the greater profitability index.
A. Accounting rate of return C. Net present value B. That has the greater accounting rate of return.
B. Internal rate of return D. Payback period. C. Whose net after-tax flows equal the initial investment.
D. That generates cash flows for the longer period of time.
33. A company has analyzed seven new projects, each of which has its own internal rate of return.
It should consider each project whose internal rate of return is _____ its marginal cost of 37. Which mutually exclusive project would you select, if both are priced at $1,000 and your
capital and accept those projects in _____ order of their internal rate of return. discount rate is 15%; Project A with three annual cash flows of $1,000, or Project B, with 3
A. Above; decreasing. C. Below; decreasing. years of zero cash flow followed by 3 years of $1,500 annually?
B. Above; increasing. D. Below; increasing. A. Project A.
B. Project B.
Relationship of NPV, PI & IRR C. The IRRs are equal, hence you are indifferent.
34. Which of the following combinations is NOT possible? D. The NPVs are equal, hence you are indifferent.
Profitability Index NPV IRR
Investment Decisions – Capital Rationing
A. Equals 1 Zero Equals cost of capital
38. Capital budgeting methods are often divided into two classifications: project screening and
B. Greater than 1 Positive More than cost of capital
project ranking. Which one of the following is considered a ranking method rather than a
C. Less than 1 Negative Less than cost of capital
screening method?
D. Less than 1 Positive Less than cost of capital
A. Accounting rate of return. C. Profitability index.
B. Net present value. D. Time-adjusted rate of return.
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machine has a current market value of $400,000. The replacement machine would cost
39. Several proposed capital projects which are economically acceptable may have to be ranked $550,000, have a 5-year life, and save $75,000 per year in cash operating costs. If the
due to constraints in financial resources. In ranking these projects, the least pertinent is this replacement machine would be depreciated using the straight-line method and the tax rate is
statement. 40%, what would be the net investment required to replace the existing machine?
A. If the internal rate of return method is used in the capital rationing problem, the higher the A. $90,000. C. $330,000
rate, the better the project. B. $150,000 D. $550,000
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. 3. Diliman Republic Publishers, Inc. is considering replacing an old press that cost P800,000 six
C. In selecting the required rate of return, one may either calculate the organization’s cost of years ago with a new one that would cost P2,250,000. Shipping and installation would cost an
capital or use a rate generally acceptable in the industry. additional P200,000. The old press has a book value of P150,000 and could be sold currently
D. A ranking procedure on the basis of quantitative criteria may be established by specifying for P50,000. The increased production of the new press would increase inventories by
a minimum desired rate of return, which rate is used in calculating the net present value of P40,000, accounts receivable by P160,000 and accounts payable by P140,000. Diliman
each project. Republic’s net initial investment for analyzing the acquisition of the new press assuming a 35%
income tax rate would be
Optimal Capital Budget A. P2,250,000 C. P2,450,000
40. An optimal capital budget is determined by the point where the marginal cost of capital is B. P2,425,000 D. P2,600,000
A. Minimized.
B. Equal to the average cost of capital. 4. Key Corp. plans to replace a production machine that was acquired several years ago.
C. Equal to the rate of return on total assets. Acquisition cost is P450,000 with salvage value of P50,000. The machine being considered is
D. Equal to the marginal rate of return on investment. worth P800,000 and the supplier is willing to accept the old machine at a trade-in value of
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
but the cost to repair is tax-deductible. The effective corporate tax rate is 35% of net income
subject to tax. For purposes of capital budgeting, the net investment in the new machine is
PROBLEMS A. P540,000 C. P660,000
Net Investments B. P610,000 D. P800,000
1. Acme is considering the sale of a machine with a book value of $80,000 and 3 years
remaining in its useful life. Straight-line depreciation of $25,000 annually is available. The 5. Great Value Company is planning to purchase a new machine costing P50,000 with freight
machine has a current market value of $100,000. What is the cash flow from selling the and installation costs amounting to P1,500. The old unit is to be traded-in will be given a
machine if the tax rate 40%. trade-in allowance of P7,500. Other assets that are to be retired as a result of the acquisition
A. $25,000 C. $92,000 of the new machine can be salvaged and sold for P3,000. The loss on retirement of these
B. $80,000 D. $100,000 other assets is P1,000 which will reduce income taxes of P400. If the new equipment is not
purchased, repair of the old unit will have to be made at an estimated cost of P4,000. This
2 Hatchet Company is considering replacing a machine with a book value of $400,000, a cost can be avoided by purchasing the new equipment. Additional gross working capital of
remaining useful life of 5 years, and annual straight-line depreciation of $80,000. The existing P12,000 will be needed to support operation planned with the new equipment.
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The net investment assigned to the new machine for decision analysis is B. $15,000 decrease D. $40,000 increase
A. P50,200 C. P53,600 End-of-Life Cash Flows
B. P52,600 D. P57,600 9. Lor Industries is analyzing a capital investment proposal for new machinery to produce a new
product over the next ten years. At the end of the ten years, the machinery must be disposed
6. It is the start of the year and St. Tropez Co. plans to replace its old sing-along equipment. of with a zero net book value but with a scrap salvage value of P20,000. It will require some
These information are available: P30,000 to remove the machinery. The applicable tax rate is 35%. The appropriate “end-of-
Old New life” cash flow based on the foregoing information is
Equipment cost P70,000 P120,000 A. Inflow of P30,000. C. Outflow of P10,000.
Current salvage value 10,000 - B. Outflow of P6,500. D. Outflow of P17,000.
Salvage value, end of useful life 2,000 16,000
Annual operating costs 56,000 38,000 10. A project under consideration by the White Corp. would require a working capital investment of
Accumulated depreciation 55,300 - $200,000. The working capital would be liquidated at the end of the project's 10-year life. If
Estimated useful life 10 years 10 years White Corp. has an after-tax cost of capital of 10 percent and a marginal tax rate of 30
The company’s income tax rate is 35% and its cost of capital is 12%. What is the present percent, what is the present value of the working capital cash flow expected to be received in
value of all the relevant cash flows at time zero? year 10?
A. (P54,000) C. (P120,000) A. $23,130 C. $53,970
B. (P110,000) D. (P124,700) B. $36,868 D. $77,100

Operating Cash Flows After Tax Accounting Rate of Return

7. C Corp. faces a marginal tax rate of 35 percent. One project that is currently under evaluation 11. Lyben Inc. is planning to produce a new product. To do this, it is necessary to acquire a new
has a cash flow in the fourth year of its life that has a present value of $10,000 (after-tax). C equipment that will cost the company P100,000. The estimated life of the new equipment is
Corp. assumes that all cash flows occur at the end of the year and the company uses 11 five years with no salvage value. The estimated income and costs based on expected sales of
percent as its discount rate. What is the pre-tax amount of the cash flow in year 4? (Round to 10,000 units per year are:
the nearest dollar.) Sales @ P10.00 per unit P100,000
A. $9,868 C. $23,356 Costs @ P8.00 per unit 80,000
B. $15,181 D. $43,375 Net income P 20,000
The accounting rate of return based on initial investment is 20%
8. Maxwell Company has an opportunity to acquire a new machine to replace one of its present What will be the accounting rate of return based on initial investment of P100,000 if
machines. The new machine would cost $90,000, have a 5-year life, and no estimated management decrease its selling price of the new product by 10%?
salvage value. Variable operating costs would be $100,000 per year. The present machine A. 5% C. 15%
has a book value of $50,000 and a remaining life of 5 years. Its disposal value now is $5,000, B. 10% D. 20%
but it would be zero after 5 years. Variable operating costs would be $125,000 per year.
Ignore income taxes. Considering the 5 years in total, what would be the difference in profit
before income taxes by acquiring the new machine as opposed to retaining the present one? 12. Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. Data
A. $10,000 decrease C. $35,000 increase on the equipment are as follows:
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Original investment $30,000 from operations, net of income taxes, of $36,000 a year in each of the next 5 years. The new
Net annual cash inflow $12,000 machine’s salvage value is $20,000 in years 1 and 2, and $15,0000 in years 3 and 4. What
Expected economic life in years 5 will be the bailout period (rounded) for the new machine?
Salvage value at the end of five years $3,000 A. 1.4 years. C. 2.2 years.
The company uses the straight-line method of depreciation with no mid-year convention. B. 1.9 years. D. 3.4 years.
What is the accounting rate of return on original investment rounded off to the nearest percent,
assuming no taxes are paid? Net Present Value
A. 20.0% C. 24.0% 16. The McNally Co. is considering an investment in a project that generates a profitability index of
B. 22.0% D. 40.0% 1.3. The present value of the cash inflows on the project is $44,000. What is the net present
value of this project?
Payback Period A. $10,154 C. $33,846
13. APJ, Inc. is planning to purchase a new machine that will take six years to recover the cost. B. $13,200 D. $57,200
The new machine is expected to produce cash flow from operations, net of income taxes, of
P4,500 a year for the first three years of the payback period and P3,500 a year of the last 17. The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of
three years of the payback period. Depreciation of P3,000 a year shall be charged to income $950,000. The investment is expected to generate $350,000 in annual cash flows for a period
of the six years of the payback period. How much shall the machine cost? of four years. The required rate of return is 14%. The old machine can be sold for $50,000.
A. P12,000 C. P24,000 The machine is expected to have zero value at the end of the four-year period. What is the net
B. P18,000 D. P36,000 present value of the investment? Would the company want to purchase the new machine?
Income taxes are not considered.
14. Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash outlay. A. $69,550; no C. $326,750; no
Below are the projected after-tax cash inflow for the five year period covering the useful life. B. $119,550; yes D. $1,019,550; yes
The company’s tax rate is 35%.
Year 1 2 3 4 5 18. Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The
P’000 600 700 480 400 400 investment required is $80 million for a plant with a capacity of 15,000 units a year for 5 years.
The founder and president of the candy company believes that the best gauge for capital The device will be sold for a price of $12,000 per unit. Sales are expected to be 12,000 units
expenditure is cash payback period and that the recovery period should not be more than 75% per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million
of the useful life of the project or the asset. Should the company undertake the project? per year. Assume Drillers employs straight-line depreciation on all depreciable assets, and
A. No, since the payback period extends beyond the life of the project. assume that they are taxed at a rate of 36%.
B. No, since the payback period is 4 years or 80% of the useful life of the project. If the required rate of return is 12%, what is the approximate NPV of the project?
C. Yes, since the payback period is 3.55 years or 71% of the useful life of the project. A. $17,225,000 C. $26,780,000
D. Yes, since the payback period is 4 years and still shorter than the useful life of the project. B. $21,511,000 D. $56,117,000
Bailout Payback
15. Womark Company purchased a new machine on January 1 of this year for $90,000, with an 19. JJ Corp. is considering the purchase of a new machine that will cost P320,000. It has an
estimated useful life of 5 years and a salvage value of $10,000. The machine will be estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated
depreciated using the straight-line method. The machine is expected to produce cash flow in the first year, 40% in the second year, and 30% in the third year. It has a resale value of
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P20,000 at the end of its economic life. Savings are expected from the use of machine
estimated at P170,000 annually. The company has an effective tax rate of 40%. It uses 16% 22. Rohan Transport is considering two alternative buses to transport people between cities that
as hurdle rate in evaluating capital projects. Should the company proceed with the P320,000 are in the Southeastern U.S., such as Baton Rouge and Gainesville. A gas-powered bus has a
capital investment? cost of $55,000, and will produce end-of-year net cash flows of $22,000 per year for 4 years. A
Year Present Value of P1 Present Value of an Ordinary Annuity of P1 new electric bus will cost $90,000, and will produce cash flows of $28,000 per year for 8 years.
1 0.862 0.862 The company must provide bus service for 8 years, after which it plans to give up its franchise
2 0.743 1.605 and to cease operating the route. Inflation is not expected to affect either costs or revenues
3 0.641 2.246 during the next 8 years. If Rohan Transport's cost of capital is 17 percent, by what amount will
A. Yes, due to NPV of P6,556. C. Yes, due to NPV of P61,820. the better project increase the company's value?
B. Yes, due to NPV of P11,684. D. No, due to negative NPV of P1,136 A. -$17,441 C. $10,701
B. $5,350 D. $27,801
20. The following forecasts have been prepared for a new investment by Oxford Industries of $20
million with an 8-year life: 23. Union Electric Company must clean up the water released from its generating plant. The
Pessimistic Expected Optimistic company's cost of capital is 11 percent for average projects, and that rate is normally adjusted
up or down by 2 percentage points for high- and low-risk projects. Clean-Up Plan A, which is of
Market size 60,000 90,000 140,000
average risk, has an initial cost of $10 million, and its operating cost will be $1 million per year
Market share, % 25 30 35
for its 10-year life. Plan B, which is a high-risk project, has an initial cost of $5 million, and its
Unit price $750 $800 $875
annual operating cost over Years 1 to 10 will be $2 million. What is the approximate PV of
Unit variable cost $500 $400 $350
costs for the better project? (VD)
Fixed cost, millions $7 $4 $3.5
A. -$5.9 million. C. -$16.8 million.
Assume that Oxford employs straight-line depreciation, and that they are taxed at 35%. B. -$15.9 million. D. -$17.8 million.
Assuming an opportunity cost of capital of 14%, what is the NPV of this project, based on
expected outcomes? Fisher rate
A. $2,626,415 C. $6,722,109 24. Berry Products is considering two pieces of machinery. The first machine costs P50,000 more
B. $4,563,505 D. $8,055,722 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
21. Cramden Armored Car Co. is considering the acquisition of a new armored truck. The truck is second machine. All cash flows occur at year-end. The present value of 1 at 15% end of 1
expected to cost $300,000. The company's discount rate is 12 percent. The firm has period and 2 periods are 0.86957 and 0.75614, respectively. The present value of 1 at 8%
determined that the truck generates a positive net present value of $17,022. However, the firm end of period 1 is 0.92593 and period 2 is 0.85734.
is uncertain as to whether it has determined a reasonable estimate of the salvage value of the At what discount rate would Machine 1 equally acceptable as machine 2?
truck. In computing the net present value, the company assumed that the truck would be A. 9% C. 11%
salvaged at the end of the fifth year for $60,000. What expected salvage value for the truck B. 10% D. 12%
would cause the investment to generate a net present value of $0? Ignore taxes.
A. $0 C. $42,978 Internal Rate of Return
B. $30,000 D. $55,278 25. Smoot Automotive has implemented a new project that has an initial cost, and then generates
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inflows of $10,000 a year for the next seven (7) years. The project has a payback period of 4.0 29. Para Co. is reviewing the following data relating to an energy saving investment proposal:
years. What is the project's internal rate of return (IRR)? Cost $50,000
A. 14.79% C. 16.33% Residual value at the end of 5 years 10,000
B. 15.61% D. 18.54% Present value of an annuity of 1 at 12% for 5 years 3.60
Present value of 1 due in 5 years at 12% 0.57
26. MLF Corporation is evaluating the purchase of a P500,000 die attach machine. The cash What would be the annual savings needed to make the investment realize a 12% yield?
inflows expected from the investment is P145,000 per year for five years with no equipment A. $8,189 C. $12,306
salvage value. The cost of capital is 12%. The net present value factor for five (5) years at B. $11,111 D. $13,889
12% is 3.6048 and at 14% is 3.4331. The internal rate of return for this investment is
A. 2.04% C. 13.8% 30. Payback Company is considering the purchase of a copier machine for P42,825. The copier
B. 3.45% D. 15.48% machine will be expected to be economically productive for 4 years. The salvage value at the
end of 4 years is negligible. The machine is expected to provide 15% internal rate of return.
27. The Zeron Corporation recently purchased a new machine for its factory operations at a cost The company is subject to 40% income tax rate. The present value of an ordinary annuity of 1
of $921,250. The investment is expected to generate $250,000 in annual cash flows for a for 4 periods is 2.85498. In order to realize the IRR of 15%, how much is the estimated
period of six years. The required rate of return is 14%. The old machine has a remaining life of before-tax cash inflow to be provided by the machine?
six years. The new machine is expected to have zero value at the end of the six-year period. A. P15,000 C. P25,000
The disposal value of the old machine at the time of replacement is zero. What is the internal B. P17,860 D. P35,700
rate of return? 31. Salvage Co. is considering the purchase of a new ocean-going vessel that could potentially
A. 15% C. 17% reduce labor costs of its operation by a considerable margin. The new ship would cost
B. 16% D. 18% $500,000 and would be fully depreciated by the straight-line method over 10 years. At the end
28. A tax-exempt foundation, Sincerely Foundation, Inc. intends to invest P1 million in a five-year of 10 years, the ship will have no value and will be sunk in some already polluted harbor. The
project. The foundation estimates that the annual savings from the project will amount to Salvage Co.'s cost of capital is 12 percent, and its marginal tax rate is 40 percent. If the ship
P325,000. The P1 million asset is depreciable over five (5) years on a straight-line basis. The produces equal annual labor cost savings over its 10-year life, how much do the annual
foundation’s hurdle rate is 12% and as a consultant of the foundation, you are asked to savings in labor costs need to be to generate a net present value of $0 on the project? (Round
determine the internal rate of return and advise if the project should be pursued. to the nearest dollar.)
To facilitate computations, below are present value factors: A. $68,492 C. $114,154
N=5 12% 14% 16% B. $88,492 D. $147,487
Present value of P1 0.57 0.52 0.48
Present value of an annuity of P1 3.60 3.40 3.30 32. A company is considering putting up P50,000 in a three-year project. The company’s
Your advice is expected rate of return is 12%. The present value of P1.00 at 12% for one year is 0.893, for
A. To proceed due to an estimated IRR of more than 16%. two years is 0.797, and for three years is 0.712. The cash flow, net of income taxes will be
B. Not to proceed due to an estimated IRR of less than 12%. P18,000 (present value of P16,074) for the first year and P22,000 (present value of P17,534)
C. To proceed due to an estimated IRR of less than 14% but not more than 12%. for the second year. Assuming that the rate of return is exactly 12%, the cash flow, net of
D. To proceed due to an estimated IRR of less than 16% but not more than 14%. income taxes, for the third year would be
A. P7,120 C. P16,392
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B. P10,000 D. P23,022 approach?

A. B. C. D.
33. The following data pertain to Sunlight Corp., whose management is planning to purchase an PI B Either Either B
automated tanning equipment. NPV A B A B
1. Economic life of equipment – 8 years.
2. Disposal value after 8 years – nil. Project Screening – Mutually Exclusive Projects
3. Estimated net annual cash inflows for each of the 8 years – P81,000. 36. Five mutually exclusive projects had the following information:
4. Time-adjusted internal rate of return – 14% A B C D
5. Cost of capital of Sunlight Corp – 16%
NPV $500 $(200) $200 $1,000
6. The table of present values of P1 received annually for 8 years has these factors: at
IRR 12% 8% 13% 10%
14% = 4.639, at 16% = 4.344
7. Depreciation is approximately P46,970 annually.
Which project is preferred?
A. A C. C
Find the required increase in annual cash inflows in order to have the time-adjusted rate of B. B D. D
return approximately equal the cost of capital.
A. P4,344 C. P5,871 Capital Rationing & Optimal Capital Budget
B. P5,501 D. P6,501 37. Information on three (3) investment projects is given below:
Project Investment Required Net Present Value
34. Booker Steel Inc. is considering an investment that would require an initial cash outlay of X P150,000 P34,005
$400,000 and would have no salvage value. The project would generate annual cash inflows G 100,000 22,670
of $75,000. The firm's discount rate is 8 percent. How many years must the annual cash flows W 60,000 13,602
be generated for the project to generate a net present value of $0? Rank the projects in terms of preference:
A. between 5 and 6 years C. between 7 and 8 years A. 1st W; 2nd G; 3rd X. C. 1st X; 2nd G; 3rd W.
B. between 6 and 7 years D. between 8 and 9 years B. 1st G; 2nd W; 3rd X. D. The ranking is the same.

Project Screening – Independent Projects 38. Telephone Corp. is contemplating four projects: L, M, N, and O. The capital costs for the
35. The following data relate to two capital-budgeting projects of equal risk: initiation of each mutually-exclusive project and its estimated after-tax, net cash flow are listed
Present Value of Cash Flows below. The company’s desired after-tax opportunity costs is 12%. It has P900,000 capital
Period Project A Project B budget for the year. Idle funds cannot be reinvested at greater than 12%.
0 $(10,000) $(30,000) In Thousand Pesos
1 4,550 13,650 L M N O
2 4,150 12,450 Initial cost 400 470 380 420
3 3,750 11,250 Annual cash flows
Which of the projects will be selected using the profitability index (PI) approach and the NPV Year 1 113 180 90 80
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2 113 170 110 100 C $450,000 10.8%

3 113 150 130 120 D $350,000 13.5%
4 113 110 140 130 E $400,000 12.0%
5 113 100 150 150 What should the company's capital budget be?
A. $0 C. $1,500,000
Net present value P7,540 P59,654 P54,666 P(15,708) B. $1,050,000 D. $1,600,000
Internal rate of return 12.7% 17.6% 17.2% 10.6%
Excess present value index 1.02 1.13 1.14 0.96 41. Mulva Inc. is considering the following five independent projects:
Project Required Amount of Capital IRR
The company will choose A $300,000 25.35%
A. Projects L & M. C. Projects M & N. B 500,000 23.22%
B. Projects L & N. D. Projects M, N & O. C 400,000 19.10%
D 550,000 9.25%
39. The Nativity Corporation has the following investment opportunities: E 650,000 8.50%
Proposal Profitability Index Initial Cash Outlay The company has a target capital structure which is 40 percent debt and 60 percent equity.
1 1.15 P200,000 The company can issue bonds with a yield to maturity of 10 percent. The company has
2 1.13 125,000 $900,000 in retained earnings, and the current stock price is $40 per share. The flotation costs
3 1.11 175,000 associated with issuing new equity are $2 per share. Mulva's earnings are expected to
4 1.08 150,000 continue to grow at 5 percent per year. Next year's dividend (D 1) is forecasted to be $2.50.
The firm has a budget constraint of P300,000. The firm faces a 40 percent tax rate. What is the size of Mulva's capital budget?
What proposal(s) should be accepted? A. $800,000 C. $1,750,000
A. Proposal 4 because it has the lowest profitability index. B. $1,200,000 D. $2,400,000
B. Proposal 1 because it has the highest profitability index.
C. Proposals 1 and 2 because their total net present values are the highest among all Comprehensive
possible proposal combinations. Problem 42 and 43 are based on the following information.
D. Proposals 2 and 3 because their total net present values are the highest among all Daneche’s, a tax-exempt entity, plans to purchase a new machine which they project to depreciate
possible proposal combinations. over a ten-year period without salvage value. The new machine will cost P200,000 and is
expected to generate cash savings of P60,000 per year in operating costs. Daneche's cost of
40. A company's marginal cost of new capital (MCC) is 10% up to $600,000. MCC increases .5% capital is 12%.
for the next $400,000 and another .5% thereafter. Several proposed capital projects are under For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an ordinary
consideration, with projected cost and internal rates of return (IRR) as follows: annuity of P1 is P5.650.
Project Cost IRR
A $100,000 10.5% 42. What is the net present value of the proposed investment, assuming Daneche uses a 12%
B $300,000 14.0% discount rate?
A. P69,980 C. P185,640
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B. P139,000 D. None of the above.

43. With the company’s initial investment on the new machine, the accounting rate of return is 47. The payback period of the investment is (M)
A. 15% C. 25% A. 5.095 years C. 5.14 years
B. 20% D. None of the above. B. 5.11 years D. 5.18 years
Questions 44 and 45 are based on the following information.
The construction of a waste treatment plant was arrived at after a careful cost-benefit analysis. Questions 48 through 55 are based on the following information.
During the construction period a status report was presented for your review: The Burgos Corporation is considering investing in a project. It requires an immediate cash outlay
 completed cost as originally estimated, P5 million of P100,000. It has a life of four years and will be depreciated on a straight-line basis (no salvage
 % of actual completion to date, 65% value). The firm’s tax rate is 25% and requires a return of 10%. Income before depreciation is
 actual cost to date, P3.75 million projected to be:
YEAR 1 2 3 4
44. Assuming cost is evenly distributed throughout the construction period, how much will the Income before depreciation P30,000 P30,000 P40,000 P40,00
completion cost be most likely? 0
A. The original cost estimate of P5 million. The present value factors for P1 at 10% is
B. P5 million plus a cost overrun of about P769,000 Year 1 2 3 4
C. P500,000 less than the original cost at completion. Present Value Factor 0.909 0.826 0.751 0.683
D. About P100,000 above the original cost at completion.
48. The net cash flow for year 1 is
45. What would be an appropriate action to take considering the situation in number 28? A. P25,850 C. P31,250
A. No need to take any action. B. P28,750 D. P34,450
B. Immediately stop further work on the project.
C. Wait for the next quarterly status report on the project. 49. The net cash flow for year 4 is
D. Recommend immediate review with the project implementation team to determine the A. P30,150 C. P35,950
cause of overrun and the corrective actions to be taken. B. P35,850 D. P36,250

Questions 46 and 47 are based on the following information. 50. The payback period for the project is
Beta Company plans to replace its company car with a new one. The new car costs P120,000 and A. 3 years C. 3.5 years
its estimated useful life is five years without scrap value. The old car has a book value of P15,000 B. 3.17 years D. 4 years.
and can be sold at P12,000. The acquisition of the new car will yield annual cash savings of
P20,000 before income tax. Income tax rate is 25%. (M) 51. The accounting rate of return of the project is
A. 7% C. 12%
46. The net investment of the new car is B. 9% D. 15%
A. P107,000 C. P108,000
B. P107,250 D. P108,750
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52. The present value of year two’s 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 project’s net cash flow is 3. D 23. D 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.
B. Accounting rate of return and profitability index results. 12. C 32. B 12. B 32. D 52. A
C. Payback results only 13. D 33. A 13. C 33. B 53. C
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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