Management Advisory Services

1. Kagitingan Industries is replacing a grinder purchased 5 years ago for P15,000 with a new one costing
P25,000 cash. The original grinder is being depreciated on a straight line basis over 15 years to a zero
salvage value. Kagitingan will sell this old equipment to a third party for P6,000 cash. The new
equipment will be depreciated on a straight line basis over 10 years to a zero salvage value.

Assuming a 40% marginal tax rate, Kagitingan’s net cash investment at the time of purchase if the old
grinder is sold and the new one purchased is
A. 19,000 C. 17,400
B. 15,000 D. 25,000

2. Lakeview Company is planning to purchase a new machine for P800,000. The installation of the new
machine costs and testing runs amount to P100,000. This new machine shall replace an old unit that
was acquired 2 years ago at a cost of P500,000 with an annual depreciation of P100,000.

The old unit can be sold at P200,000. If the new equipment is not purchased, extensive repairs on the
old machine will have to be made immediately at a cost of P50,000. The purchase of the new machine
will immediately require P250,000 working capital in order to support the operation.

The new machine will be depreciated for 3 years with a 10% salvage value. The company is subject to
40 percent income tax and require a discount rate of 8% for this type of asset.

Compute the new cost of investment for the new machine:

A. 880,000 C. 742,400
B. 808,000 D. 793,600

3. Hatchet Company is considering replacing a machine with a book value of P400,000, a remaining useful
life of 5 years, and annual straight line depreciation of P80,000. The existing machine has a current
market value of P400,000. The replacement machine would cost P550,000, have a 5-year life, and save
P75,000 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 the existing machine?
A. 90,000 C. 150,000
B. 330,000 D. 550,000

4. Diliman Republic Publishing, Inc. is considering replacing an old press that cost P800,000 six years ago
with a new one that would cost P2,250,000. Shipping and installation would cost an additional
P200,000. The old press has a book value of 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’s net initial investment for analyzing the acquisition of the net press assuming a 35% income
tax rate would be
A. 2,450,000 C. 2,425,000
B. 2,600,000 D. 2,250,000

5. Key Corporation plans to replace a production machine that was acquired several years ago.
Acquisition cost is P450,000 with salvage value of P50,000. The machine being considered is 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
A. 540,000 C. 610,000
B. 660,000 D. 800,000
Valuation and Methods by: John Bo S. Cayetano, CPA, MBA Page 1 of 4
6. 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 of the acquisition of the new machine can be
salvaged and sold for P3,000. The loss on retirement of these other asset 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 cost can be avoided by purchasing the new equipment. Additional gross working
capital of P12,000 will be needed to support operation planned with the new equipment.

The net investment assigned to the new machine for decision analysis is
A. 50,200 C. 52,600
B. 53,600 D. 57,600

7. 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 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 annual cash savings of P20,000 before
income tax. Income tax rate is 25%.

The net investment of the new car is

A. 108,000 C. 108,750
B. 107,250 D. 107,000

8. Billings Builders is purchasing a machine for P80,000. The machine will require an expenditure of
P12,000 for installation and P4,000 for training new operators. The new equipment will also require an
increase of P5,000 in inventory, P4,000 in accounts receivable, and P3,000 in accounts payable. What
is the net investment for this project?
A. 108,000 C. 102,000
B. 98,000 D. 99,000

9. A company is considering replacing a machine with one that will save P50,000 per year in cash
operating costs and has P20,000 more depreciation expense per year than the existing machine. The
tax rate is 40%. Buying the new machine will increase annual net cash flows of the company by
A. 38,000 C. 20,000
B. 30,000 D. 12,000

10. Old equipment with a book value of P15,000 will be replaced by new equipment with a purchase price
of P50,000, exclusive of freight charges of P2,000. The market value (selling price) of the old equipment
is P11,000. Repair costs of P2,000 can be avoided if the new machine is acquired. Assume a tax rate
of 35%. What is the initial (net) investment of the project?
A. 33,800 C. 39,700
B. 38,300 D. 52,000

11. Puting Kabayo, Inc. has purchase a new fleet of trucks to deliver its merchandise. The truck have a
useful life of 8 years and cost a total of P500,000. The company expects its net increase in after-tax
cash flow to be P150,000 in Year 1, P175,000 in Year 2, P125,000 in Year 3, and P100,000 in each of
the remaining years.

Ignoring the time value of money, how long will it take Putting Kabayo to recover the amount of
investment?
A. 5 years C. 4.2 years
B. 3.5 years D. 4.0 years

12. Seb Company is considering the acquisition of a new, more efficient press. The cost of the press is
P360,000, and the press has an estimated 6-year life with zero salvage value. Seb uses the straight
line depreciation for both financial reporting and income reporting purposes and has a 40% corporate
income tax rate. To meet Sub’s desired payback period, the press must produce a minimum annual
before-tax operating cash savings of:
A. 90,000 C. 114,000
B. 150,000 D. 110,000
13. Dou Company has a payback period goal of 3 years on a new equipment acquisitions. A new sorter is
being evaluated that cost P450,000 and has a 5-year life. Straight line depreciation will be used; no
salvage value is anticipated. Dou is subject to a 40% income tax rate. To meet the company’s payback
goal, the sorter must generate reductions in annual cash operating costs of:
A. 150,000 C. 190,000
B. 100,000 D. 60,000

14. David is considering the purchase of a new equipment that will cost P640,000 and have a life of five
years with no expected salvage value. The expected cash flows associated with the project are as
follows:

Year Cash revenue Cash expenses and depreciation

1 P 250,000 P 150,000
2 375,000 225,000
3 375,000 225,000
4 750,000 450,000
5 750,000 450,000
What is the accounting rate of return for the project?
A. 31.25% C. 43.75%
B. 37.50% D. 47.00%

15. Luv, Inc. is planning to purchase a new machine that will take six years to recover the cost. 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 for 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?
A. 12,000 C. 18,000
B. 24,000 D. 36,000

16. Iriga Company is considering a certain project with the following cash income after taxes for 4 years,
the life of the project:

Year 1 P 11,000
Year 2 9,000
Year 3 8,000
Year 4 7,000

If the project requires an investment of P25,000 with a salvage value of P5,000, what is the payback
period?
A. 2.265 years C. 2.526 years
B. 2.562 years D. 2.625 years

17. Bulan Company is planning to purchase a new machine. The payback period is estimated to be 6
years. The project’s after tax cash flow is estimated to be P2,000 yearly for the first three years and
P3,000 yearly for the next three years of the payback period. Annual depreciation of P1,000 will be
charged to income for each of the years of the payback period. The machine will cost:
A. 15,000 C. 9,000
B. 12,000 D. 6,000

18. Sabang Company purchased a new machine on January 1 of this year for P90,000, with an estimated
useful life of 5 years and a salvage value of P10,000. The machine will be depreciated using the straight
line method. The machine is expected to produce cash flow from operations, net of tax of P36,000 a
year in each of the next 5 years.

The new machine’s salvage value is P20,000 in year 1 and year 2, and P15,000 in years 3 and 4. What
will be the bailout payback period for this machine?
A. 1.4 years C. 1.9 years
 B. 2.2 years D. 3.4 years

19. Tigaon Company is considering the purchase of a P100,000 machine that is expected to reduce
operating cash expenses by P25,000 per year. This machine, which has no salvage value, has a useful
life of 10 years and will be depreciated on a straight line basis.

What would be the simple rate of return?

A. 10% C. 25%
B. 15% D. 35%

20. Lagonoy Inc. purchased a new machine for P60,000 on January 1. The machine is being depreciated
on the straight line basis over five years with no salvage value. The simple rate of return is expected to
be 15% on the initial investment. Assuming a uniform cash flow, this investment is expected to provide
annual cash flow from operation of
A. 7,200 C. 12,000
B. 13,800 D. 21,000