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THEORY B. Differential costs. D. Historical costs.

Basic concepts
1. Capital budgeting techniques are least likely to be used in evaluating the Accounting Rate of Return
A. Acquisition of new aircraft by a cargo company. 8. The following statements refer to the accounting rate of return (ARR)
B. Trade for a star quarterback by a football team. 1. The ARR is based on the accrual basis, not cash basis.
C. Design and implementation of a major advertising program. 2. The ARR does not consider the time value of money.
D. Adoption of a new method of allocating non-traceable costs to product lines. 3. The profitability of the project is considered.
From the above statements, which are considered limitations of the ARR concept?
2. The “inflation element” refers to the A. Statements 1 and 2 only. C. Statements 3 and 1 only.
A. Future increases in the general purchasing power of the monetary unit. B. Statements 2 and 3 only. D. All the 3 statements.
B. Future deterioration of the general purchasing power of the monetary unit.
C. Fact that the real purchasing power of a monetary unit usually increases over time. Payback Period
D. Impact that future price increases will have on the original cost of a capital expenditure. 9. The payback method assumes that all cash inflows are reinvested to yield a return equal to
A. the discount rate. C. the internal rate of return.
3. Which of the following best identifies the reason for using probabilities in capital budgeting is B. the hurdle rate. D. zero.
A. Cost of capital. C. Time value of money.
B. Different life of projects. D. Uncertainty.
10. As a capital budgeting technique, the payback period considers depreciation expenses (DE) and time value of money (TVM) as
4. In capital budgeting decisions, the following items are considered among others: follows:
1. Cash outflow for the investment. A. B. C. D.
2. Increase in working capital requirements. DE relevant relevant Irrelevant irrelevant
3. Profit on sale of old asset TVM relevant irrelevant Relevant irrelevant
4. Loss on write-off of old asset.
For which of the above items would taxes be relevant? Bailout Payback
A. Items 1 and 3 only. C. Items 3 and 4 only. 11. The bailout payback period is
B. Items 1, 3 and 4 only. D. All items. A. The payback period used by firms with government insured loans.
B. The length of time for payback using cash flows plus the salvage value to recover the original investment
Net Investments C. (A) and (B)
5. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient. This equipment has an estimated D. None of the above.
useful life of six years. As part of this acquisition, a P150,000 investment in working capital is required. In a discounted cash flow
analysis, this investment in working capital should be Discounted Cash Flow Method
A. Disregarded because no cash is involved. 12. Which of the following methods measures the cash flows and outflows of a project as if they occurred at a single point in time?
B. Amortized over the useful life of the equipment. A. Capital budgeting. C. Discounted cash flow.
C. Treated as an immediate cash outflow that is recovered at the end of six years. B. Cash flow based payback period. D. Payback method.
D. Treated as a recurring annual cash flow that is recovered at the end of six years.
13. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital budgeting project, which of the
Operating Cash Flows After Tax following factors generally is not important?
6. To approximate annual cash inflow, depreciation is A. The timing of cash flows relating to the project.
A. Subtracted from net income because it is an expense. B. The amount of cash flows relating to the project.
B. Added back to net income because it is an inflow of cash. C. The impact of the project on income taxes to be paid.
C. Subtracted from net income because it is an outflow of cash. D. The method of financing the project under consideration.
D. Added back to net income because it is not an outflow of cash.
14. Your company is purchasing a transport equipment as part of its territorial expansion strategy. The technical services department
7. In capital expenditures decisions, the following are relevant in estimating operating costs except indicated that this equipment needs overhauling in year 4 or year 5 of its useful life. The overhauling cost will be expected during
A. Cash costs. C. Future costs.
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the year the overhauling is done. The finance officer insists that the overhauling be done in year 4, not in year 5. A. Hurdle rate. C. Opportunity cost of capital.
The most likely reason is B. Opportunity cost. D. Required rate of return.
A. There is lower tax rate in year 5. C. The time value of money is considered.
B. There is higher tax rate in year 5. D. Due to statements A and C above. 22. The excess present value method is anchored on the theory that the future returns, expressed in terms of present value, must at
least be
15. In an investment in plant the return that should keep the market price of the firm stock unchanged is A. Equal to the amount of investment C. More than the amount of investment
A. Cost of capital C. Net present value B. Less than the amount of investment D. Cannot be determined
B. Discounted rate of return D. Payback
23. An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the
16. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost, the value of the firm and the price net present value method
of its common stock will <List B> A. Computes a desired rate of return for capital projects.
A. B. C. D. C. Uses a discount rate that equates the discounted cash inflows with the outflows.
List A Equal to Equal to Greater than Greater than D. Uses discounted cash flows whereas the internal rate of return model does not.
List B Decrease Increase Decrease Increase B. Can be used when there is no constant rate of return required for each year of the project.

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 more or less continuously during those years
A. Results in understated estimates of NPV. 24. When using the net present value method for capital budgeting analysis, the required rate of return is called all of the following
B. Results in higher estimate for the IRR on the investment. except the
C. Is done because present value tables for continuous flows cannot be constructed. A. Cost of capital. C. Discount rate.
D. Will result in inconsistent errors being made on estimating NPVs such that project cannot be evaluated reliably. B. Cutoff rate. D. Risk-free rate.

18. Polo Co. requires higher rates of return for projects with a life span greater than 5 years. Projects extending beyond 5 years must 25. A project’s net present value, ignoring income tax considerations, is normally affected by the
earn a higher specified rate of return. Which of the following capital budgeting techniques can readily accommodate this A. Proceeds from the sale of the asset to be replaced.
requirement? B. Carrying amount of the asset to be replaced by the project.
C. Amount of annual depreciation on the asset to be replaced.
A. B. C. D. D. Amount of annual depreciation on fixed assets used directly on the project.
Internal Rate of Return Yes Yes No No
Net Present Value Yes No Yes No 26. You have determined the profitability of a planned project by finding the present value of all the cash flows from that project.
Which of the following would cause the project to look less appealing, that is, have a lower present value?
A. The discount rate increases.
19. Payback period (PP), profitability index (PI), and simple accounting rate of return (SARR) are some of the capital budgeting B. The cash flows are extended over a longer period of time.
techniques. What is the effect of an increase in the cost of capital on these techniques? C. The cash flows are accelerated and the project life is correspondingly shortened.
A. B. C. D. D. The investment cost decreases without affecting the expected income and life of the project.
PP Decrease Increase No change No change
PI No change Decrease Decrease Increase 27. Which of the following is always true with regard to the net present value (NPV) approach?
SARR No change Increase No change Decrease A. The NPV and the IRR approaches will always rank projects in the same order.
B. The NPV and payback approaches will always rank projects in the same order.
Net Present Value C. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the payback approach.
20. A company had made the decision to finance next year’s capital projects through debt rather than additional equity. The D. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal rate of return
benchmark cost of capital for these projects should be (IRR) approach.
A. The after-tax cost of new-debt financing. C. The cost of equity financing.
B. The before-tax cost of new-debt financing. D. The weighted-average cost of capital. 28. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present value of P450,000. The project has
a life of 7 years with salvage value of P200,000. The company uses a discount rate of 12%. Which of the following would
21. All of the following refer to the discount rate used by a firm in capital budgeting except decrease the net present value?
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A. Increase the salvage value.
B. Increase discount rate to 15%. Investment Decisions – Independent Projects
C. Extend the project life and associated cash inflows. 35. A company is evaluating three possible investments. Information relating to the company and the investments follow:
D. Decrease the initial investment amount to P9.0 million. Fisher rate for the three projects 7%
Cost of capital 8%
Profitability Index Based on this information, we know that
29. What is the effect of changes in cash inflows, investment cost and cash outflows on profitability (present value) index (PI) A. all three projects are acceptable.
A. PI will increase with an increase in cash inflows, a decrease in investment cost, or a decrease in cash outflows. B. none of the projects are acceptable.
B. PI will increase with an increase in cash inflows, an increase in investment cost, or an increase in cash outflows. C. the net present value method will provide a ranking of the projects that is superior to the ranking obtained using the internal
C. PI will decrease with an increase in cash inflows, a decrease in investment cost, or a decrease in cash outflows. rate of return method.
D. PI will decrease with an increase in cash outflows, an increase in investment cost, or an increase in cash inflows. D. the capital budgeting evaluation techniques profitability index, net present value, and internal rate of return will provide a
consistent ranking of the projects.
Internal Rate of Return
30. Which of the following characteristics represent an advantage of the internal rate of return techniques over the accounting rate of Investment Decisions – Mutually Exclusive Projects
return technique in evaluating a project? 36. When ranking two mutually exclusive investments with different initial amounts, management should give first priority to the project
I Recognition of the project’s salvage value. A. That has the greater profitability index.
II Emphasis on cash flows. B. That has the greater accounting rate of return.
III Recognition of the time value of money. C. Whose net after-tax flows equal the initial investment.
A. I only. C. II and III. D. That generates cash flows for the longer period of time.
B. I and II. D. I, II, and III.
37. Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15%; Project A with three
31. How are the following used in the calculation of the internal rate of return of a proposed project? Ignore income tax annual cash flows of $1,000, or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?
considerations. A. Project A.
A. B. C. D. B. Project B.
Residual sales value of project Include Include Exclude Exclude C. The IRRs are equal, hence you are indifferent.
Depreciation expense Include Exclude Include Exclude D. The NPVs are equal, hence you are indifferent.

32. The discount rate that equates the present value of the expected cash flows with the cost of the investment is the Investment Decisions – Capital Rationing
A. Accounting rate of return C. Net present value 38. Capital budgeting methods are often divided into two classifications: project screening and project ranking. Which one of the
B. Internal rate of return D. Payback period. following is considered a ranking method rather than a screening method?
A. Accounting rate of return. C. Profitability index.
33. A company has analyzed seven new projects, each of which has its own internal rate of return. It should consider each project B. Net present value. D. Time-adjusted rate of return.
whose internal rate of return is _____ its marginal cost of capital and accept those projects in _____ order of their internal rate of
return. 39. Several proposed capital projects which are economically acceptable may have to be ranked due to constraints in financial
A. Above; decreasing. C. Below; decreasing. resources. In ranking these projects, the least pertinent is this statement.
B. Above; increasing. D. Below; increasing. A. If the internal rate of return method is used in the capital rationing problem, the higher the rate, the better the project.
B. If the net present value method is used, the profitability index is calculated to rank the projects. The lower the index, the
Relationship of NPV, PI & IRR better the project.
34. Which of the following combinations is NOT possible? C. In selecting the required rate of return, one may either calculate the organization’s cost of capital or use a rate generally
acceptable in the industry.
Profitability Index NPV IRR D. A ranking procedure on the basis of quantitative criteria may be established by specifying a minimum desired rate of return,
A. Equals 1 Zero Equals cost of capital which rate is used in calculating the net present value of each project.
B. Greater than 1 Positive More than cost of capital
C. Less than 1 Negative Less than cost of capital Optimal Capital Budget
D. Less than 1 Positive Less than cost of capital 40. An optimal capital budget is determined by the point where the marginal cost of capital is
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A. Minimized. at an estimated cost of P4,000. This cost can be avoided by purchasing the new equipment. Additional gross working capital of
B. Equal to the average cost of capital. P12,000 will be needed to support operation planned with the new equipment.
C. Equal to the rate of return on total assets. The net investment assigned to the new machine for decision analysis is
D. Equal to the marginal rate of return on investment. A. P50,200 C. P53,600
B. P52,600 D. P57,600

6. It is the start of the year and St. Tropez Co. plans to replace its old sing-along equipment. These information are available:
Old New
PROBLEMS Equipment cost P70,000 P120,000
Net Investments Current salvage value 10,000 -
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 Salvage value, end of useful life 2,000 16,000
depreciation of $25,000 annually is available. The machine has a current market value of $100,000. What is the cash flow from Annual operating costs 56,000 38,000
selling the machine if the tax rate 40%. Accumulated depreciation 55,300 -
A. $25,000 C. $92,000 Estimated useful life 10 years 10 years
B. $80,000 D. $100,000 The company’s income tax rate is 35% and its cost of capital is 12%. What is the present value of all the relevant cash flows at
time zero?
2 Hatchet Company is considering replacing a machine with a book value of $400,000, a remaining useful life of 5 years, and A. (P54,000) C. (P120,000)
annual straight-line depreciation of $80,000. The existing machine has a current market value of $400,000. The replacement B. (P110,000) D. (P124,700)
machine would cost $550,000, have a 5-year life, and save $75,000 per year in cash operating costs. If the replacement machine
would be depreciated using the straight-line method and the tax rate is 40%, what would be the net investment required to replace Operating Cash Flows After Tax
the existing machine? 7. C Corp. faces a marginal tax rate of 35 percent. One project that is currently under evaluation has a cash flow in the fourth year of
A. $90,000. C. $330,000 its life that has a present value of $10,000 (after-tax). C Corp. assumes that all cash flows occur at the end of the year and the
B. $150,000 D. $550,000 company uses 11 percent as its discount rate. What is the pre-tax amount of the cash flow in year 4? (Round to the nearest
dollar.)
3. Diliman Republic Publishers, Inc. is considering replacing an old press that cost P800,000 six years ago with a new one that A. $9,868 C. $23,356
would cost P2,250,000. Shipping and installation would cost an additional P200,000. The old press has a book value of B. $15,181 D. $43,375
P150,000 and could be sold currently for P50,000. The increased production of the new press would increase inventories by
P40,000, accounts receivable by P160,000 and accounts payable by P140,000. Diliman Republic’s net initial investment for 8. Maxwell Company has an opportunity to acquire a new machine to replace one of its present machines. The new machine would
analyzing the acquisition of the new press assuming a 35% income tax rate would be cost $90,000, have a 5-year life, and no estimated salvage value. Variable operating costs would be $100,000 per year. The
A. P2,250,000 C. P2,450,000 present machine has a book value of $50,000 and a remaining life of 5 years. Its disposal value now is $5,000, but it would be
B. P2,425,000 D. P2,600,000 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?
4. Key Corp. plans to replace a production machine that was acquired several years ago. Acquisition cost is P450,000 with salvage A. $10,000 decrease C. $35,000 increase
value of P50,000. The machine being considered is worth P800,000 and the supplier is willing to accept the old machine at a B. $15,000 decrease D. $40,000 increase
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 End-of-Life Cash Flows
P200,000. Tax-wise, the trade-in transaction will not have any implication but the cost to repair is tax-deductible. The effective 9. Lor Industries is analyzing a capital investment proposal for new machinery to produce a new product over the next ten years. At
corporate tax rate is 35% of net income subject to tax. For purposes of capital budgeting, the net investment in the new machine the end of the ten years, the machinery must be disposed of with a zero net book value but with a scrap salvage value of P20,000.
is It will require some P30,000 to remove the machinery. The applicable tax rate is 35%. The appropriate “end-of-life” cash flow
A. P540,000 C. P660,000 based on the foregoing information is
B. P610,000 D. P800,000 A. Inflow of P30,000. C. Outflow of P10,000.
B. Outflow of P6,500. D. Outflow of P17,000.
5. Great Value Company is planning to purchase a new machine costing P50,000 with freight and installation costs amounting to
P1,500. The old unit is to be traded-in will be given a trade-in allowance of P7,500. Other assets that are to be retired as a result 10. A project under consideration by the White Corp. would require a working capital investment of $200,000. The working capital
of the acquisition of the new machine can be salvaged and sold for P3,000. The loss on retirement of these other assets is would be liquidated at the end of the project's 10-year life. If White Corp. has an after-tax cost of capital of 10 percent and a
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
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marginal tax rate of 30 percent, what is the present value of the working capital cash flow expected to be received in year 10? B. No, since the payback period is 4 years or 80% of the useful life of the project.
A. $23,130 C. $53,970 C. Yes, since the payback period is 3.55 years or 71% of the useful life of the project.
B. $36,868 D. $77,100 D. Yes, since the payback period is 4 years and still shorter than the useful life of the project.
Bailout Payback
Accounting Rate of Return 15. Womark Company purchased a new machine on January 1 of this year for $90,000, with an estimated useful life of 5 years and a
11. Lyben Inc. is planning to produce a new product. To do this, it is necessary to acquire a new equipment that will cost the salvage value of $10,000. The machine will be depreciated using the straight-line method. The machine is expected to produce
company P100,000. The estimated life of the new equipment is five years with no salvage value. The estimated income and cash flow from operations, net of income taxes, of $36,000 a year in each of the next 5 years. The new machine’s salvage value
costs based on expected sales of 10,000 units per year are: is $20,000 in years 1 and 2, and $15,0000 in years 3 and 4. What will be the bailout period (rounded) for the new machine?
Sales @ P10.00 per unit P100,000 A. 1.4 years. C. 2.2 years.
Costs @ P8.00 per unit 80,000 B. 1.9 years. D. 3.4 years.
Net income P 20,000
The accounting rate of return based on initial investment is 20% Net Present Value
What will be the accounting rate of return based on initial investment of P100,000 if management decrease its selling price of the 16. The McNally Co. is considering an investment in a project that generates a profitability index of 1.3. The present value of the cash
new product by 10%? inflows on the project is $44,000. What is the net present value of this project?
A. 5% C. 15% A. $10,154 C. $33,846
B. 10% D. 20% B. $13,200 D. $57,200

17. The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $950,000. The investment is
12. Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. Data on the equipment are as follows: expected to generate $350,000 in annual cash flows for a period of four years. The required rate of return is 14%. The old
Original investment $30,000 machine can be sold for $50,000. The machine is expected to have zero value at the end of the four-year period. What is the net
Net annual cash inflow $12,000 present value of the investment? Would the company want to purchase the new machine? Income taxes are not considered.
Expected economic life in years 5 A. $69,550; no C. $326,750; no
Salvage value at the end of five years $3,000 B. $119,550; yes D. $1,019,550; yes
The company uses the straight-line method of depreciation with no mid-year convention.
What is the accounting rate of return on original investment rounded off to the nearest percent, assuming no taxes are paid? 18. Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The investment required is $80 million
A. 20.0% C. 24.0% for a plant with a capacity of 15,000 units a year for 5 years. The device will be sold for a price of $12,000 per unit. Sales are
B. 22.0% D. 40.0% expected to be 12,000 units per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million per year.
Assume Drillers employs straight-line depreciation on all depreciable assets, and assume that they are taxed at a rate of 36%.
Payback Period If the required rate of return is 12%, what is the approximate NPV of the project?
13. APJ, Inc. is planning to purchase a new machine that will take six years to recover the cost. The new machine is expected to A. $17,225,000 C. $26,780,000
produce cash flow from operations, net of income taxes, of P4,500 a year for the first three years of the payback period and B. $21,511,000 D. $56,117,000
P3,500 a year of the last three years of the payback period. Depreciation of P3,000 a year shall be charged to income of the six
years of the payback period. How much shall the machine cost? 19. JJ Corp. is considering the purchase of a new machine that will cost P320,000. It has an estimated useful life of 3 years. Assume
A. P12,000 C. P24,000 that 30% of the depreciable base will be depreciated in the first year, 40% in the second year, and 30% in the third year. It has a
B. P18,000 D. P36,000 resale value of 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% as hurdle rate in evaluating capital projects. Should the
14. Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash outlay. Below are the projected after-tax cash company proceed with the P320,000 capital investment?
inflow for the five year period covering the useful life. The company’s tax rate is 35%. Year Present Value of P1 Present Value of an Ordinary Annuity of P1
Year 1 2 3 4 5 1 0.862 0.862
P’000 600 700 480 400 400 2 0.743 1.605
The founder and president of the candy company believes that the best gauge for capital expenditure is cash payback period and 3 0.641 2.246
that the recovery period should not be more than 75% of the useful life of the project or the asset. Should the company undertake A. Yes, due to NPV of P6,556. C. Yes, due to NPV of P61,820.
the project? B. Yes, due to NPV of P11,684. D. No, due to negative NPV of P1,136
A. No, since the payback period extends beyond the life of the project.

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20. The following forecasts have been prepared for a new investment by Oxford Industries of $20 million with an 8-year life: B. 10% D. 12%
Pessimistic Expected Optimistic
Market size 60,000 90,000 140,000 Internal Rate of Return
Market share, % 25 30 35 25. Smoot Automotive has implemented a new project that has an initial cost, and then generates inflows of $10,000 a year for the
Unit price $750 $800 $875 next seven (7) years. The project has a payback period of 4.0 years. What is the project's internal rate of return (IRR)?
Unit variable cost $500 $400 $350 A. 14.79% C. 16.33%
Fixed cost, millions $7 $4 $3.5 B. 15.61% D. 18.54%
Assume that Oxford employs straight-line depreciation, and that they are taxed at 35%. Assuming an opportunity cost of capital of
14%, what is the NPV of this project, based on expected outcomes? 26. MLF Corporation is evaluating the purchase of a P500,000 die attach machine. The cash inflows expected from the investment is
A. $2,626,415 C. $6,722,109 P145,000 per year for five years with no equipment salvage value. The cost of capital is 12%. The net present value factor for
B. $4,563,505 D. $8,055,722 five (5) years at 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%
21. Cramden Armored Car Co. is considering the acquisition of a new armored truck. The truck is expected to cost $300,000. The B. 3.45% D. 15.48%
company's discount rate is 12 percent. The firm has determined that the truck generates a positive net present value of $17,022.
However, the firm is uncertain as to whether it has determined a reasonable estimate of the salvage value of the truck. In 27. The Zeron Corporation recently purchased a new machine for its factory operations at a cost of $921,250. The investment is
computing the net present value, the company assumed that the truck would be salvaged at the end of the fifth year for $60,000. expected to generate $250,000 in annual cash flows for a period of six years. The required rate of return is 14%. The old machine
What expected salvage value for the truck would cause the investment to generate a net present value of $0? Ignore taxes. has a remaining life of six years. The new machine is expected to have zero value at the end of the six-year period. The disposal
A. $0 C. $42,978 value of the old machine at the time of replacement is zero. What is the internal rate of return?
B. $30,000 D. $55,278 A. 15% C. 17%
B. 16% D. 18%
22. Rohan Transport is considering two alternative buses to transport people between cities that are in the Southeastern U.S., such 28. A tax-exempt foundation, Sincerely Foundation, Inc. intends to invest P1 million in a five-year project. The foundation estimates
as Baton Rouge and Gainesville. A gas-powered bus has a cost of $55,000, and will produce end-of-year net cash flows of that the annual savings from the project will amount to P325,000. The P1 million asset is depreciable over five (5) years on a
$22,000 per year for 4 years. A new electric bus will cost $90,000, and will produce cash flows of $28,000 per year for 8 years. straight-line basis. The foundation’s hurdle rate is 12% and as a consultant of the foundation, you are asked to determine the
The company must provide bus service for 8 years, after which it plans to give up its franchise and to cease operating the route. internal rate of return and advise if the project should be pursued.
Inflation is not expected to affect either costs or revenues during the next 8 years. If Rohan Transport's cost of capital is 17 To facilitate computations, below are present value factors:
percent, by what amount will the better project increase the company's value? N=5 12% 14% 16%
A. -$17,441 C. $10,701 Present value of P1 0.57 0.52 0.48
B. $5,350 D. $27,801 Present value of an annuity of P1 3.60 3.40 3.30
Your advice is
23. Union Electric Company must clean up the water released from its generating plant. The company's cost of capital is 11 percent A. To proceed due to an estimated IRR of more than 16%.
for average projects, and that rate is normally adjusted up or down by 2 percentage points for high- and low-risk projects. Clean- B. Not to proceed due to an estimated IRR of less than 12%.
Up Plan A, which is of average risk, has an initial cost of $10 million, and its operating cost will be $1 million per year for its 10- C. To proceed due to an estimated IRR of less than 14% but not more than 12%.
year life. Plan B, which is a high-risk project, has an initial cost of $5 million, and its annual operating cost over Years 1 to 10 will D. To proceed due to an estimated IRR of less than 16% but not more than 14%.
be $2 million. What is the approximate PV of costs for the better project? (VD)
A. -$5.9 million. C. -$16.8 million. 29. Para Co. is reviewing the following data relating to an energy saving investment proposal:
B. -$15.9 million. D. -$17.8 million. Cost $50,000
Residual value at the end of 5 years 10,000
Fisher rate Present value of an annuity of 1 at 12% for 5 years 3.60
24. Berry Products is considering two pieces of machinery. The first machine costs P50,000 more than the second machine. During Present value of 1 due in 5 years at 12% 0.57
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 What would be the annual savings needed to make the investment realize a 12% yield?
flow in year two than the second machine. All cash flows occur at year-end. The present value of 1 at 15% end of 1 period and 2 A. $8,189 C. $12,306
periods are 0.86957 and 0.75614, respectively. The present value of 1 at 8% end of period 1 is 0.92593 and period 2 is 0.85734. B. $11,111 D. $13,889
At what discount rate would Machine 1 equally acceptable as machine 2?
A. 9% C. 11% 30. Payback Company is considering the purchase of a copier machine for P42,825. The copier machine will be expected to be

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economically productive for 4 years. The salvage value at the end of 4 years is negligible. The machine is expected to provide Present Value of Cash Flows
15% internal rate of return. The company is subject to 40% income tax rate. The present value of an ordinary annuity of 1 for 4 Period Project A Project B
periods is 2.85498. In order to realize the IRR of 15%, how much is the estimated before-tax cash inflow to be provided by the 0 $(10,000) $(30,000)
machine? 1 4,550 13,650
A. P15,000 C. P25,000 2 4,150 12,450
B. P17,860 D. P35,700 3 3,750 11,250
31. Salvage Co. is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by Which of the projects will be selected using the profitability index (PI) approach and the NPV approach?
a considerable margin. The new ship would cost $500,000 and would be fully depreciated by the straight-line method over 10
A. B. C. D.
years. At the end of 10 years, the ship will have no value and will be sunk in some already polluted harbor. The Salvage Co.'s cost
of capital is 12 percent, and its marginal tax rate is 40 percent. If the ship produces equal annual labor cost savings over its 10- PI B Either Either B
year life, how much do the annual savings in labor costs need to be to generate a net present value of $0 on the project? (Round NPV A B A B
to the nearest dollar.)
A. $68,492 C. $114,154 Project Screening – Mutually Exclusive Projects
B. $88,492 D. $147,487 36. Five mutually exclusive projects had the following information:
A B C D
32. A company is considering putting up P50,000 in a three-year project. The company’s expected rate of return is 12%. The present NPV $500 $(200) $200 $1,000
value of P1.00 at 12% for one year is 0.893, for two years is 0.797, and for three years is 0.712. The cash flow, net of income IRR 12% 8% 13% 10%
taxes will be P18,000 (present value of P16,074) for the first year and P22,000 (present value of P17,534) for the second year.
Assuming that the rate of return is exactly 12%, the cash flow, net of income taxes, for the third year would be Which project is preferred?
A. P7,120 C. P16,392 A. A C. C
B. P10,000 D. P23,022 B. B D. D

33. The following data pertain to Sunlight Corp., whose management is planning to purchase an automated tanning equipment. Capital Rationing & Optimal Capital Budget
1. Economic life of equipment – 8 years. 37. Information on three (3) investment projects is given below:
2. Disposal value after 8 years – nil. Project Investment Required Net Present Value
3. Estimated net annual cash inflows for each of the 8 years – P81,000.
X P150,000 P34,005
4. Time-adjusted internal rate of return – 14%
G 100,000 22,670
5. Cost of capital of Sunlight Corp – 16%
W 60,000 13,602
6. The table of present values of P1 received annually for 8 years has these factors: at 14% = 4.639, at 16% = 4.344
7. Depreciation is approximately P46,970 annually. Rank the projects in terms of preference:
A. 1st W; 2nd G; 3rd X. C. 1st X; 2nd G; 3rd W.
B. 1st G; 2nd W; 3rd X. D. The ranking is the same.
Find the required increase in annual cash inflows in order to have the time-adjusted rate of return approximately equal the cost of
capital. 38. Telephone Corp. is contemplating four projects: L, M, N, and O. The capital costs for the initiation of each mutually-exclusive
A. P4,344 C. P5,871 project and its estimated after-tax, net cash flow are listed below. The company’s desired after-tax opportunity costs is 12%. It
B. P5,501 D. P6,501 has P900,000 capital budget for the year. Idle funds cannot be reinvested at greater than 12%.
In Thousand Pesos
34. Booker Steel Inc. is considering an investment that would require an initial cash outlay of $400,000 and would have no salvage L M N O
value. The project would generate annual cash inflows of $75,000. The firm's discount rate is 8 percent. How many years must the Initial cost 400 470 380 420
annual cash flows be generated for the project to generate a net present value of $0? Annual cash flows
A. between 5 and 6 years C. between 7 and 8 years Year 1 113 180 90 80
B. between 6 and 7 years D. between 8 and 9 years 2 113 170 110 100
3 113 150 130 120
Project Screening – Independent Projects 4 113 110 140 130
35. The following data relate to two capital-budgeting projects of equal risk: 5 113 100 150 150

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flotation costs associated with issuing new equity are $2 per share. Mulva's earnings are expected to continue to grow at 5
Net present value P7,540 P59,654 P54,666 P(15,708) percent per year. Next year's dividend (D1) is forecasted to be $2.50. The firm faces a 40 percent tax rate. What is the size of
Internal rate of return 12.7% 17.6% 17.2% 10.6% Mulva's capital budget?
Excess present value index 1.02 1.13 1.14 0.96 A. $800,000 C. $1,750,000
B. $1,200,000 D. $2,400,000
The company will choose
A. Projects L & M. C. Projects M & N. Comprehensive
B. Projects L & N. D. Projects M, N & O. Problem 42 and 43 are based on the following information.
Daneche’s, a tax-exempt entity, plans to purchase a new machine which they project to depreciate over a ten-year period without
39. The Nativity Corporation has the following investment opportunities: salvage value. The new machine will cost P200,000 and is expected to generate cash savings of P60,000 per year in operating costs.
Proposal Profitability Index Initial Cash Outlay Daneche's cost of capital is 12%.
1 1.15 P200,000 For ten periods at 12%, the present value of P1 is P0.3220, while the present value of an ordinary annuity of P1 is P5.650.
2 1.13 125,000
3 1.11 175,000 42. What is the net present value of the proposed investment, assuming Daneche uses a 12% discount rate?
4 1.08 150,000 A. P69,980 C. P185,640
The firm has a budget constraint of P300,000. B. P139,000 D. None of the above.
What proposal(s) should be accepted?
A. Proposal 4 because it has the lowest profitability index. 43. With the company’s initial investment on the new machine, the accounting rate of return is
B. Proposal 1 because it has the highest profitability index. A. 15% C. 25%
C. Proposals 1 and 2 because their total net present values are the highest among all possible proposal combinations. B. 20% D. None of the above.
D. Proposals 2 and 3 because their total net present values are the highest among all possible proposal combinations. Questions 43 and 44 are based on the following information.
The construction of a waste treatment plant was arrived at after a careful cost-benefit analysis. During the construction period a status
40. A company's marginal cost of new capital (MCC) is 10% up to $600,000. MCC increases .5% for the next $400,000 and another report was presented for your review:
.5% thereafter. Several proposed capital projects are under consideration, with projected cost and internal rates of return (IRR) as  completed cost as originally estimated, P5 million
follows:  % of actual completion to date, 65%
Project Cost IRR  actual cost to date, P3.75 million
A $100,000 10.5%
44. Assuming cost is evenly distributed throughout the construction period, how much will the completion cost be most likely?
B $300,000 14.0%
A. The original cost estimate of P5 million.
C $450,000 10.8%
B. P5 million plus a cost overrun of about P769,000
D $350,000 13.5%
C. P500,000 less than the original cost at completion.
E $400,000 12.0%
D. About P100,000 above the original cost at completion.
What should the company's capital budget be?
A. $0 C. $1,500,000 45. What would be an appropriate action to take considering the situation in number 28?
B. $1,050,000 D. $1,600,000 A. No need to take any action.
B. Immediately stop further work on the project.
41. Mulva Inc. is considering the following five independent projects: C. Wait for the next quarterly status report on the project.
Project Required Amount of Capital IRR D. Recommend immediate review with the project implementation team to determine the cause of overrun and the corrective
A $300,000 25.35% actions to be taken.
B 500,000 23.22%
C 400,000 19.10% Questions 46 and 47 are based on the following information.
D 550,000 9.25% Beta Company plans to replace its company car with a new one. The new car costs P120,000 and its estimated useful life is five years
E 650,000 8.50% without scrap value. The old car has a book value of P15,000 and can be sold at P12,000. The acquisition of the new car will yield
The company has a target capital structure which is 40 percent debt and 60 percent equity. The company can issue bonds with a annual cash savings of P20,000 before income tax. Income tax rate is 25%. (M)
yield to maturity of 10 percent. The company has $900,000 in retained earnings, and the current stock price is $40 per share. The
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46. The net investment of the new car is A. 0.96 C. 1.02
A. P107,000 C. P108,000 B. 0.98 D. 1.05
B. P107,250 D. P108,750
55. The project would be accepted on the basis of the
A. Payback and present value results.
47. The payback period of the investment is (M) B. Accounting rate of return and profitability index results.
A. 5.095 years C. 5.14 years C. Payback results only
B. 5.11 years D. 5.18 years D. A and B combined

Questions 48 through 55 are based on the following information.

The Burgos Corporation is considering investing in a project. It requires an immediate cash outlay of P100,000. It has a life of four
years and will be depreciated on a straight-line basis (no salvage value). The firm’s tax rate is 25% and requires a return of 10%.
Income before depreciation is projected to be:
YEAR 1 2 3 4
Income before depreciation P30,000 P30,000 P40,000 P40,000
The present value factors for P1 at 10% is
Year 1 2 3 4
Present Value Factor 0.909 0.826 0.751 0.683

48. The net cash flow for year 1 is

A. P25,850 C. P31,250
B. P28,750 D. P34,450

49. The net cash flow for year 4 is

A. P30,150 C. P35,950
B. P35,850 D. P36,250

50. The payback period for the project is

A. 3 years C. 3.5 years
B. 3.17 years D. 4 years.

51. The accounting rate of return of the project is

A. 7% C. 12%
B. 9% D. 15%

52. The present value of year two’s cash flow is

A. P23,747.50 C. P26,100.75
B. P25,856.25 D. P29,750.75

53. The present value of the project’s net cash flow is

A. P95,650.15 C. P101,863.75
B. P98,151.25 D. P104,750.25

54. The profitability index of the project (rounded to the nearest hundredth) is
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Theory Problem
1. D 21. B 1. C 21. B 41. C
2. B 22. A 2. B 22. D 42. B
3. D 23. B 3. B 23. B 43. B
4. C 24. D 4. B 24. B 44. B
5. C 25. A 5. A 25. C 45. D
6. D 26. A 6. B 26. C 46. B
7. D 27. D 7. C 27. B 47. B
8. A 28. B 8. D 28. A 48. B
9. D 29. A 9. B 29. C 49. D
10. D 30. C 10. D 30. B 50. B
11. B 31. B 11. B 31. C 51. D
12. C 32. B 12. B 32. D 52. A
13. D 33. A 13. C 33. B 53. C
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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