ACTIVITY- CAPITAL INVESTMENT ANALYSIS

Name: _______________________________________________

Year/Section: _________________________________________

THEORIES- Choose the best answer among the given choices.

For Items 1-5, choose from the choices below.

A- Statement 1 and 2 are both true
B- Statement 1 is true and Statement 2 is false
C- Statement 1 is false and Statement 2 is true
D- Statement 1 and 2 are both false

___1. Statement 1: When cash flows are uneven and vary from year to year, the internal rate of return
method is easier to use than the net present value method

Statement 2: For capital budgeting decisions, the net present value method is superior to the
simple rate of return method.

___2. Statement 1: Depreciation is included as a cash flow in capital budgeting decisions to ensure
that the original cost of the asset is fully recovered.

Statement 2: Even when done properly, the total cost and incremental cost approaches to
choosing between alternatives will sometimes yield different answers.

___3. Statement 1: An increase in the expected salvage value at the end of a capital budgeting project
will have no effect on the internal rate of return for that project.

Statement 2: The intangible benefits of automation cannot be estimated with any accuracy and
therefore should be ignored in capital budgeting decisions.

___4. Statement 1: When making preference decisions about competing investment proposals, the
project profitability index is superior to the internal rate of return.

Statement 2: The project profitability index is computed by dividing the net present value of the
project by the investment required by the project.

___5. Statement 1: In calculating the “investment required” for the project profitability index, the
amount invested should be reduced by any salvage recovered from the sale of old equipment.

Statement 2: The payback method is most appropriate for projects whose cash flows extend far
into the future.

___6. Which of the following capital budgeting techniques ignores the time value of money?

a. Payback period
b. Net present value
c. Internal rate of return
d. Profitability index
___7. Which of the following capital budgeting techniques may potentially ignore part of a project’s
relevant cash flows?

a. Net present value

b. Internal rate of return
c. Payback period
d. Profitability index

___8. If Investment A has a payback period of three years and investment B has a payback period of
four years, then

a. A is more profitable than B

b. A is less profitable than B
c. A and B are equally profitable
d. The relative profitability of A and B cannot be determined from the information given

___9. When using one of the discounted cash flow methods to evaluate the desirability of a capital
budgeting project, which of the following factors is generally not important?

a. Method of financing the project under consideration

b. Timing of cash flows relating to the project
c. Impact of the project on income taxes to be paid
d. Amounts of cash flows relating to the project

___10. As to a capital investment, net cash inflow is equal to the

a. Cost savings resulting from the investment

b. Sum of all future revenues from the investment
c. Net increase in cash receipts over cash payments
d. Net increase in cash payments over cash receipts

PROBLEMS- Provide the answer and show your solutions.

1. An investment project is expected to yield P10,000 in annual revenues, has P2,000 in fixed costs
per year, and requires an initial investment of P5,000. Given a cost of goods sold of 60% of sales,
what is the payback period in years?
a. 2.50
b. 5
c. 2
d. 1.25
2. A project has initial cost of P100,000 and generates a present value of net cash inflows of
P120,000. What is the project’s profitability index?
a. 0.20
b. 1.20
c. 0.80
d. 5.00
3. Rabbit Company faces a marginal tax rate of 35%. One project that is currently under evaluation
has a cash flow in the fourth year of its life that has a present value of P10,000 (after-tax). Rabbit
 Company assumes that all cash flows occur at the end of the year and the company uses 11% as
its discount rate. What is the pre-tax amount of the cash flow in year 4? (Note: Round to the
nearest peso)
a. P15,181
b. P23,256
c. 9,868
d. 43,375
4. LBC Shipment Company is considering the purchase of a new ocean-going vessel that could
potentially reduce labor costs of its operation by a considerable margin. The new ship would
cost P500,000 and would be fully depreciated by the straight-line method over ten years. At the
end of ten years the ship will have no value and will be sunk in some already polluted harbor.
The LBC Shipment Company’s cost of capital is 12%, and its marginal tax rate of 40%. What is the
present value of the depreciation tax benefit of the new ship? (Note: Round to the nearest peso)
a. P113,004
b. P282,510
c. P169,506
d. P200,000

Toyota Company is considering an investment in a machine that would reduce that would reduce annual
labor costs by P30,000. The machine has an expected life of ten years with no salvage value. The
machine would be depreciated according to the straight-line method over its useful life. The company’s
marginal tax rate is 30%.

5. Assume that the company will invest in the machine if it generates an internal rate of return of
16%. What is the maximum amount the company can pay for the machine and still meet the
internal rate of return criterion?
a. P180,000
b. P210,000
c. P187,500
d. P144,996
6. Assume the company pays P250,000 for the machine. What is the expected internal rate of
return on the machine?
a. Between 8% and 9%
b. Between 3% and 4%
c. Between 17% and 18%
d. Less than 1%
7. Beams Company is considering two alternative ways to depreciate a proposed investment. The
investment has an initial cost of P100,000 and an expected five-year life. The two alternative
depreciation schedules follow:

Method 1 Method 2
Year 1 depreciation P20,000 P40,000
Year 2 depreciation 20,000 30,000
Year 3 depreciation 20,000 20,000
Year 4 depreciation 20,000 10,000
Year 5 depreciation 20,000 0
Assuming that the company faces a marginal tax rate of 40% and has a cost of capital of 10%,
what is the difference between the two methods in the present value of the depreciation tax
benefit?

a. P7,196
b. P0
c. P2,878
d. P6,342
8. Small Sisters, Inc. is considering an investment in a computer that is capable of producing
various images that are useful in the production of commercial art. The computer would cost
P20,000 and have an expected life of eight years. The computer is expected to generate
additional annual net cash receipts (before-tax) of P6,000 per year. The computer will be
depreciated according to the straight-line method and the firm’s marginal tax rate is 25%.

What is the after-tax payback period for the computer project?

a. 7.62 years
b. 3.90 years
c. 4.44 years
d. 3.11 years
Banana Company is considering purchasing one of two new machines. The following estimates are
available for each machine:

Machine X Machine Y
Initial cost P152,000 P170,000
Annual cash inflows 50,000 60,000
Annual cash outflows 15,000 20,000
Estimated useful life 6 years 6 years

The Company’s minimum required rate of return is 9%

Present value of an Annuity of P1

Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784

Requirements:

9. Compute the (1) net present value (2) profitability index, and (3) internal rate of return for each
machine
10. Which machine should be purchased?