Our Lady of the Pillar College - San Manuel, Inc.

DISTRICT 3, SAN MANUEL, ISABELA, PHILIPPINES

E-mail: nuestrasenioradelpilar@gmail.com

Financial Management
Capital Budgeting

PROBLEM 1 For P 450,000, Copper Corp. purchased a new machine with an estimated useful
life of five years with no salvage value. The machine is expected to produce cash flows from
operations, net of 40% income taxes, as follows:

First year P160,000 Fourth year P120,000

Second year 140,000 Fifth year 100,000
Third year 180,000

Copper Corp. will use the sum-of-years-digits’ method to depreciate the new machine:
First year P150,000 Fourth year P60,000
Second year 120,000 Fifth year 30,000
Third year 90,000
The present value of P 1 for 5 periods at 12% is 3.60478. the present value of P 1 at 12% at end of
each period are: Period 1 – 0.8928, 2 – 0.79719, 3 – 0.71178, 4 – 0.63552, 5 – 0.56743. Had Copper
used the straight-line method of depreciation,

1. What is the difference in net present value provided by the machine at a discount rate
of 12%? Assume tax rate of 40%.

PROBLEM 2 A proposed investment is not expected to have any salvage value at the end of
its 5- year life. For present value purposes, cash flows are assumed to occur at the end of each
year. The company uses a 12% after-tax target rate of return.

Year Purchase Cost (Book Value) Net After-Tax Cash Accrual Income
Flows
0 P500,000 - -
1 336,000 240,000 70,000
2 200,000 216,000 78,000
3 100,000 192,000 86,000
4 36,000 168,000 94,000
5 - 144,000 102,000

Discount Factors for a 12% rate of return:

Year Present Value of P1 Present Value of an Annuity of P1
1 0.89 0.89
2 0.80 1.69
3 0.71 2.40
4 0.64 3.04
5 0.57 3.61
6 0.51 4.12
2. The accounting rate of return based on the average investment is?
3. The net present value is?
4. The traditional payback period is?
5. The benefit-cost ratio is?
6. What is the internal rate of return of the investment?

PROBLEM 3 MATTHEW CORP plans to invest in new technological equipment costing P188,640
to be depreciated using straight-line method over its useful life of 10 years. If the new equipment
will be bought the company will save P45,000 in cash operating costs per annum. The cut-off
rate is 14%. (Round-off present value factors in three decimal places)

7. What is the investment’s net present value?

8. What is the profitability index?
PROBLEM 4: An investment of P400,000, can bring in the following annual cash income, net of
tax:

First year P70,000

Second year 90,000
Third year 85,000
Fourth year 160,000
Fifth year 75,000
Sixth year 70,000
9. Determine the payback period.

PROBLEM 5: An equipment costing P1,000,000 is expected to yield the following net cash
inflows and salvage values:

Year Net Cash inflow Residual value, net of tax

01 P300,000 200,000
02 400,000 100,000
03 200,000 50,000
04 150,000 20,000
10. Determine the payback bailout period.

PROBLEM 6 The RT Company is considering the production of a new product line which will
require an investment of 1,000,000 with no scrap value. The investment will have a useful life of
ten years, during which annual net cash inflows before taxes of P200,000 are expected. The
income tax rate is 40%.

11. Determine the annual net income for the purposes of computing the accounting rate of
return.
12. Accounting rate of return based on original investment.
13. Accounting rate of return based on average investment.

PROBLEM 7 Silver Products Company is considering a new product that will sell for P100 and
has a variable cost of P60. Expected sales volume is 20,000 units. New equipment costing P
1,500,000 with a five-year useful life and no terminal salvage value is needed. The machine will
be depreciated using the straight-line method. The machine has cash operating costs of P
20,000 per year. The firm is in the 40 percent tax bracket and has cost of capital of 12 percent.
The present value of 1, end of five periods is 0.56743; present value of annuity of 1 for 5 periods is
3.60478.

14. Suppose the 20,000 estimated sales volume is sound, but the price is in doubt, what is the
selling price (rounded to nearest peso) needed to earn a 12 percent internal rate of return?

PROBLEM 8 On January 1, a company invested in an asset with a useful life of 3 years. The
company’s expected rate of return is 10%. The cash flow and present and future value factors
for the 3 years are as follows: Year 1 – 8,000, Year 2 – 9,000 and Year 3 – 10,000. All cash inflows
are assumed to occur at year-end.

15. If the asset generates a positive net present value of P 2,000, what was the amount of the
original investment?