1.

Both the net present value method and the internal
rate of return method can be used as a screening
tool in capital budgeting decisions.
2. When considering a number of investment projects,
the project that has the best payback period will
also always have the highest net present value.
3. The salvage value of new equipment should not be
considered when using the internal rate of return
method to evaluate a project.
Compute the payback period for this proposal.
Would the company purchase new machine if
maximum desired payback period of the
management is 4 years?
11. Kings Manufacturing Company uses accounting rate
of return to analyze investment in plant assets. The
company wants to reduce its total annual cost by
purchasing a new equipment to be installed in the
factory. The relevant information about investment
in new equipment is presented to you:

4. When the internal rate of return method is used to
rank investment proposals, the lower the internal
rate of return, the more desirable the investment.
5. When computing the project profitability index of
an investment project, the investment required will
include any investment made in working capital at
the beginning of the project.
6. If investment funds are limited, the net present
value of one project should not be compared
directly to the net present value of another project
unless the initial investments in these projects are
equal.
7. Kings Company is considering the replacement of an
old machine with one that has a purchase price of
P90,000. The current market value of the old
machine is P20,000 but the book value is P32,000.
The firm’s tax rate for ordinary income is 30%. What
is the net cash outflow for the new machine?
 Amount required to purchase the
equipment: P90,000
 Expected annual cost savings: P18,750
 Useful life of the equipment: 16 years
 Straight line depreciation per year: P5,625
 Residual value of the equipment at the end of
16-year period: P0
 Desired rate of return: 16%
Required:
 Compute accounting rate of return (or simple rate
of return) of the equipment.
 Is this investment desirable?
12. The investment and expected cash inflows of a
project over 8-year period is given below:

8. Prince Company is planning to purchase a new

equipment costing P60,000 by trading in an old
equipment for P7,500. Freight and installation costs
of the new equipment will be P1,500. Acquiring the
new equipment will result to retirement of other
assets with book value of P4,000 but can be sold for
P3,000. If the new equipment is not purchased, Compute the payback period of the project. Would the
extensive repairs on the old equipment will have to project be acceptable if the maximum desired payback
be made at an estimated cost of P6,000. Additional period is 7 years?
working capital of P12,000 will be needed to
support the operation of new equipment. Prince is 13. Kings company is trying to choose the best
subject to 30% income tax. For decision making investment project from two alternative projects.
purposes, the net investment on the new The company has $30,000 to invest. The
equipment must be? information about two alternatives is given below:

9. A company considers a project that will generate

cash sales of P50,000 per year. Fixed costs will be
P10,000 per year, variable costs will be 40% of sales,
and depreciation of the equipment in the project
will be P5,000 per year. Taxes are 30%, How much is
the expected annual cash flow to the company.

10. Kings Stone Crushing company is considering to

purchase a new machine. The cost of the machine is
P360,000 and the life of the machine is 10 years.
The machine will reduce annual costs by P75,000. The discount rate of Kings Company is 15%.
The management uses payback period method to
evaluate capital investments because the quick Required:
recovery of any capital investment is very important
for the company.
Give your recommendation to the company in selecting production as well as improve the quality of
the best project to invest $30,000. Use net present crushed stone. The information about annual
value (NPV) method for your answer. incremental revenues and costs associated with the
new equipment is given below:
14. The Kings Transport company wants to purchase a
new truck. The truck would cost $225,000 and its
salvage value would be 10% at the end of its 20-
year useful life. The annual estimated revenues and
costs associated with the new truck are given
below:

The only non-cash expense in the above income

statement is the depreciation. The new equipment
would cost $240,000 and the old equipment can be sold
to a small company for its salvage value of $15,000.

Required: Required: Would the company invest in new equipment

1. Compute payback period of the truck. Is the
investment in new truck desirable if maximum
desired payback period of the Kings Transport
company is 5 years?
2. Compute the accounting rate of return
promised by the truck. Would the Kings
Transport company be interested in new truck
if minimum required accounting rate of return
is 12%?
if the desired payback period is 2.5 years or less?
17. The management of Kings Company is considering
three competing investments – investment P,
investment Q and investment R. The information
about the requirement of initial amount of
investment, present value of net cash inflow and
net present value of all three investments is given
below:

15. The Kings company is considering two projects,

project A and project B. Project A requires the
purchase of an equipment but no working capital
investment whereas project B requires a working
capital investment but no equipment. The relevant
information for net present value analysis is given
below:

Required:

Choose the most desirable proposal using present value

index (profitability index).

18. The Kings Food Company is comparing two

The working capital required for project B will be
released at the end of project life. Kings company uses
an 18% discount rate.
Required: Are the two projects comparable using net
present value (NPV)? If yes, Select the best investment
using net present value (NPV) method. (Ignore income
tax).
proposals – proposal L and proposal M. Proposal L
has a useful life of 7 years whereas proposal M has
a useful life of 4 years. Both the proposals require
an equal initial investment of $180,000. The
information about cash inflow expected from
proposal L and proposal M is given below:

16. Kings Stone company sells crushed stone to

government contractors as well as to small business
owners involved in construction business. The
company needs to replace an old equipment with a
new one. The new equipment can increase
 subject to 30% tax rate, what is the after-tax cost of
preference share?

25. A company presented the following information

related to the firm’s ordinary share:
 Expected cash dividends- P2.50
 Dividend yield- 6%
 Flotation cost- 4%
 Growth Rate- 3%
Compute the cost of capital for new ordinary shares to
be issued by the firm assuming the firm is subject to
The management of Kings Food Company wants a 10% corporate income tax rate of 30%?
rate of return on capital investments.
26. A new company requires P1 million of financing and
Required: Compare two proposals using net present is considering two arrangements as shown in the
value method. (Hint: An expert valuer estimates that the table below:
residual value of proposal L will be $60,000 at the end of Arrangement Equity Debt Before-
Year 4.) Raised Financing tax cost
of debt
19. The Kings company has just purchased an asset #1 P700,000 P300,000 8% per
costing P420,000. The straight line method of annum
depreciation will be used and the entire cost of the #2 300,000 700,000 10%per
asset will be depreciated over 6 years. The tax rate annum
of Kings company is 30%. Calculate annual tax What is the WACC under arrangement #1 if the cost
savings from depreciation tax shield. of equity was 12% and the tax rate is 30%?

20. Kings Inc. is planning to purchase a new machine
which will depreciate in 10 years with no salvage
value using straight line method. The new machine
is expected to produce P66,000 annual cash flow
from operations, net of income taxes. How much
will the new machine cost if the expected ARR is
12%?
21. Given the following information, compute for the
IRR.
YEAR NET CASH INFLOW
1 160,000
2 150,000
3 130,000
4 120,000
5 100,000
Salvage 17,500
Value
 Net Investment Cost-350,000
 PVFA of 24%-2.7454
 PVFA of 26%-2.6351
 PVFA of 28%-2.5320
 PVFA of 30%-2.4356
22. Kings Development Corp has an after-tax cost of
debt of 6.3 percent. With a tax rate of 30%, what is
the yield on the debt?
23. Kings is paying an annual dividend of P3.63 for its
preferred stock which is selling for P62.70. Selling
cost is P3.30. What is the after-tax cost of preferred
stock if the firm is subject to 30% income tax?
24. Princess Co. issued P100 par value preference
shares at P125 per share. The shares pay 10%
annual dividend. Assuming a 5% flotation cost is
incurred in issuing the bonds and the company is
27. A Corporation has the following capital structure,
which it considers optimal:
Bonds 7% (now selling at P300,000
par)
PS(5/sh dividend) 240,000
OS 360,000
R/E 300,000
Total P1,200,000
Ordinary share dividends are currently P3/share
and are expected to grow at a constant rate of 6%.
Ordinary shares and preference shares are currently
selling at P40 and P50 respectively. Flotation cost
on new issues of ordinary shares is 10%. Interest on
bond is paid annually. The company’s tax rate is
30%. Compute for the WACC.
28. The management of Kings Company is deciding
where to raise the funds needed to finance its
prospective capital investment projects.
Alternatives of the firm include:
a. Using the company’s retained earnings
b. Issuing additional OS which are currently selling
in the stock market at P50/sh. A 10% flotation
cost (FC) is associated with issuing new ordinary
shares
Last year’s annual dividend was P4/sh. Both
earnings and dividends are expected to grow at a
rate of 8%. The company’s beta coefficient is 1.5.
The return of a market portfolio is 12% and the risk-
free rate is 8%. The company’s A-rated bonds are
yielding 12%. Compute the COC of R/E and OS using
CAPM and DGM.