The Cap Company is

considering the replacement of

Machine A with Machine B
that will cost P150,000 and will
result in annual savings of
P40,000 before income taxes
because of the expected
increase in operating efficiency.
Machine B has an estimated
useful life of 10 years and
salvage of P10,000. Machine A
has a book value of P16,000
and a disposal value of P20,000
now.
Straight line depreciation is
used and the company has an
average income tax rate
of 35%. The minimum desired
rate of return on this investment
is 20%. The present
value of an ordinary annuity of
P1 in arrears for 10 periods at
20% is 4.192. The present
value of P1 for 10 periods at
20% is 0.162
ADDITIONAL EXERCISES – CHAPTER 13

10. The Cap Company is considering the replacement of Machine A with Machine B that will
cost P160,000 and will result in annual savings of P40,000 before income taxes because of
the expected increase in operating efficiency. Machine B has an estimated useful life of 10
years and salvage of P10,000. Machine A has a book value of P16,000 and a disposal value
of P20,000 now.
Straight-line depreciation is used and the company has an average income tax rate of 35%.
The minimum desired rate of return on this investment is 20%. The present value of an
ordinary annuity of P1 in arrears for 10 periods at 20% is 4.192. The present value of P1 for
10 periods at 20% is 0.162.
 Required:
a. Determine the net investment.
b. Determine the annual cash flow net of income tax.
c. What is the net present value of the investment?

Solution:

a. Net Investment:
Cost of Machine B P160,000
Less: Disposal value of Machine A P20,000
Tax on gain 35% x (P20,000 – P16,000) 1,400 18,600
Net Investment P141,400

b. Annual Cash Flow Net of Tax:

Annual cash savings from Machine B P40,000 P40,000
Less: Annual Depreciation
(P160,000 – P10,000)/10 years 15,000
Taxable Net Income P25,000
Income Tax x 35% 8,750
Annual Cash Flow Net of Income Tax P31,250

c. Net Present Value:

Present Value of annual cash saving
Net of Tax (P31,250 x 4.192) P131,000
Present value of salvage value of Machine B
(P10,000 x 0.162) 1,620
Total Present Value P129,380
Net Investment (141,400)
Net Present Value – negative P(8,780)

11. Using the following data:

Cost of investment P 100,000
Net cash inflows:
Year 1 P 30,000
2 40,000
3 35,000
4 20,000
5 15,000
Cost of capital 6%

Required: Compute the discounted payback period.

 Solution:

Year Cashflow Present Value Factor at 6% Discounted Cash Flow Balance

0 P100,000 1 P100,000 P100,000

1 30,000 0.94340 28,302 71,698
2 40,000 0.8900 35,600 36,098
3 35,000 0.83962 29,386.7 6,711.3
4 20,000 0.79209 15,841.8 (9,130.5)
5 15,000 0.74726 11,208 .9 (20,339.4)

Discounted Payback Period = 3 + (*6,711.3/15,841.8)

= 3.42 years

*28,302 + 35,600 + 29,386.7 = 93,288.7 - 100,000 = (6,711.3)

12. Rizal Company is considering two alternative proposals:

Project X Project Y
Estimated net investment P575,000 P580,000
Annual cash inflow:
Year 1 P220,000 P420,000
2 200,000 325,000
3 450,000 200,000
Desired rate of return 20% 20%

Required: Compute the profitability index of each project and recommend what project
should be accepted by Rizal Company.

Solution:

Project X

Year Cashflow Present Value Factor at 20% Discounted Cash

Flow
1 P220,000 0.83333 P183,332.6
2 200,000 0.69444 138,888

3 450,000 0.57870 260,415

Profitability index of Project X

= P183,332.6 + P138,888 + 260,415/P575,000
= 1.0132

Project Y

Year Cashflow Present Value Factor at 20% Discounted Cash

Flow

1 P420,000 0.83333 P349,998.6

2 325,000 0.69444 225,693

3 200,000 0.57870 115,740

Profitability index of Project Y

= P349,998.6 + P225,693 + P115,740/P580,000
= 1.1921

- The project that Rizal Company should accept is Project Y.