Capital Budgeting Sample Questions

Payback Method: A new machine is expected to produce the following after-tax cash inflows
over a period of 5 years.

Year Per Year

1 P16,000
2 12,000
3 20,000
4 8,000
5 6,000

Cost of Machine: P40,000-----2.6 years

Bailout Method: Malaya Corporation is planning to buy a new machine costing P450,000. The
new machine’s useful life is 5 years. Its estimated disposal values are:

Year Disposal Value

1 P100,000
2 100,000
3 75,000
4 75,000
5 50,000

If the new machine is expected to generate cash inflows from operations net of tax, of P180,000
per year, its bailout period is?--- 1.94 years

Accounting Rate of Return: RPI, Inc., a printing and publishing firm, is considering to invest in
another offset printing machine that will cost P1.80 million. The machine will have a useful life
of four (4) years. Its estimated salvage value at the end of Year 4 is equal to its net book value.
Annual fixed running costs total P1,656,000, including straight-line depreciation of P420,000.

The new machine's printing capacity is estimated at 36 million copies per annum for each of the
first two years and 30 million copies for each of the last two years of its life. The company can
sell all the copies that the new machine will print at an average contribution margin of P800 per
10,000 copies. The company is subject to a 32% tax rate.

What is the average accounting rate of return based on the initial investment in the new machine?

NPV: King Corporation will launch its latest addition to its product line next year. King
Corporation's managers believe that the company can sell an average of 35,000 units of the new
product per year. The product will be sold at P25 per unit. Its unit variable cost is estimated at
P10.

The new product will require the acquisition of a special equipment costing P300,000 and an
Increase in working capital of P80,000. The special equipment will have a six-year useful life
with no salvage value at the end of six years. When the new product is produced, the company
will incur additional fixed costs of P350,000, excluding the depreciation cost of the special
equipment.

At the end of the life of the special equipment, the company will stop producing and selling the
product. King Corporation pays income tax at the rate of 32% of income before tax. For capital
budgeting purposes, it uses a hurdle rate of 16%.

What is the net cost of this investment opportunity? P380,000

What is the net present value of this investment opportunity?

IRR: Cheryl Corporation is evaluating a proposal to acquire a new equipment. The equipment
would require an investment of P417,860, including freight and installation cost of P20,000. It
expected to have a 10-year life with no salvage value at the end of its life.

It has been estimated that the new equipment would increase the company's cash inflows, net of
expenses and income taxes, by P68,000

The company is subject to the 32% income tax rate. Its cost of capital is 8%.

The factor for internal rate of return is? 6.145

The equipment’s internal rate of return is? 10%

Should the company buy the equipment? Buy