Elements

Net amount of Operating cash Minimum

the investment flows / Return acceptable rate
from the of return on the

investment investment /
Cost of capital
 Net Investment
It is the initial cost of the capital investment project. It
represents the initial cash outlay that is required to obtain
future returns or the net cash outflows to support a capital
investment project. In some instances, the net investment is
the sacrifice of an inflow of cash, that is, the opportunity
cost that arises when a benefit is rejected
 Net investment
Initial cash outlay Pxx
Add: Additional cash outlay related to the asset Pxx
Additional working capital xx xx
Total Pxx
Less: Cash inflow arising from the sale of
old asset being replaced Pxx
Avoidable costs xx xx
Net investment Pxx
Net investment
 Net investment - illustration
The management of Maingat company plans to replace a sorting machine that
was acquired several years ago at a cost of P60,000. The machine has been
depreciated to its residual value of P10,000. A new sorter can be purchased
for P96,000. The dealer will grant a trade-in allowance of P16,000 on the old
machine. If a new machine is not purchased, Maingat Company will spend
P10,000 to repair the old machine. Gains and losses on trade-in transactions
are not subject to income taxes. The cost to repair the old machine can be
deducted in computing income taxes. Income taxes are estimated at 40% of the
income subject to tax. Additional working capital required is P50,000.
Net investment - illustration
 Net income
The excess of revenues over the expenses related to the investment,

Net cash inflows

The amount of cash inflows expected from the investment reduced
by the cash outflows directly attributable to the investment.

Depreciation tax shield

The tax savings arising from allowable deduction of depreciation
expense in computing income tax. (DTS = depreciation expense x tax
rate)
 Net cash returns
This refer to the net benefit that can be derived from the
investment.
 Net
Cash
Returns
 Net returns - illustration
Alalay Company is considering the acquisition of a machine which will cost
P120,000. It has an expected useful life of five years at the end of which its
scrap value will be P20,000. The company expects to be able to generate
annual cash flow before taxes of P40,000. Estimated income tax rate is 30%.
What is the annual cashflow after taxes on this investment?
Net returns - illustration
 Net returns - illustration
Arlen Inc. is considering the purchase of a new machine costing P1,200,000 that
would generate annual cash revenues of P2,900,000 and annual operating
costs (including depreciation) of P2,050,000. The machine would be
depreciated over 5 year useful life with residual value of P100,000. The firm is
subject to 35% income tax rate.
Required: Annual net returns from acquiring and operating the new machine.
Net returns - illustration
 Minimum or Lowest
Acceptable Rate of Return
Equal to the average rate of return that the company will
earn from alternative investment opportunities or the cost of
capital which is the average rate of return that the firm must
pay to attract investment fund.
 Minimum or Lowest Acceptable
The cost of capital may be computed according to
source or the weighted average
Rate of Return
 Minimum or Lowest Acceptable
The cost of capital may be computed according to
source or the weighted average
Rate of Return
Cost of capital
illustration
Net returns - illustration
Net returns - illustration
Quiz Time!
1) If there were no income taxes,
A. depreciation would be ignored in capital
budgeting.
B. the NPV method would not work.
C. income would be discounted instead of cash
flow.
D. all potential investments would be desirable.
Answer:
Answer:
2) Which of the follow ing is not a
typical cash inflow in capital
investment decisions?
A. Incremental revenues
B. Cost reductions
C. Salvage value
D. Additional working capital
Answer:
Answer:
 3) The net benefit that can be
derived from the investment is the
A. Net returns
B. Net investment
C. Net income
D. Net cash inflows
Answer:
Answer:
4) The follow ing are elements of
capital budgeting except:
A. Net amount of investment
B. Net returns
C. Cost of capital
D. None of the above
Answer:
Answer:
5) Bruell Company is considering to replace its old equipment
with a new one. The old equipment had a net book value of
P100,000, 4 remaining useful life with P25,000 depreciation
each year. The old equipment can be sold at P80,000. The
new equipment costs P160,000, have a 4-year life. Cash
savings on operating expenses before 40% taxes amount to
P50,000 per year. What is the amount of investment in the
new equipment?

A. P160,000 B. P 72,000 C. P 80,000 D. P 68,000

Answer:
Answer:
6) KTA Inc. is considering a project that will generate cash
sales of P50,000 per year. Annual costs related to the
project are as follows:
Fixed costs P10,000 Depreciation expense P5,000
Variable costs 40% of sales Income tax rate 35%
Required: Annual net returns from acquiring and operating
the new machine.

A. P 9,750 B. P 14,750 C. P 16,250 D. P 11,250

Answer:
Answer:
Thank
you