CAPITAL BUDGETING

Net Investments
1. Maxwell Company has an opportunity to acquire a new machine to replace one of
its present machines. The new machine would cost $90,000, have a 5-year life, and
no estimated salvage value. Variable operating costs would be $100,000 per year.
The 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 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?
A. $10,000 decrease C. $35,000 increase
B. $15,000 decrease D. $40,000 increase
End-of-Life Cash Flows
2. A project under consideration by the White Corp. would require a working capital
investment of $200,000. The working capital 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 marginal tax rate of 30 percent, what is the present value of the working capital
cash flow expected to be received in year 10?

A. $23,130 C. $53,970
B. $36,868 D. $77,100
Accounting Rate of Return
3. Hooker Oak Furniture Company is considering the purchase of wood cutting
equipment. Data on the equipment are as follows:
Original investment $30,000
Net annual cash inflow $12,000
Expected economic life in years 5
Salvage value at the end of five years $3,000
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?
Payback Period
4. APJ, 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 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?
A. P12,000 C. P24,000
B. P18,000 D. P36,000
Bailout Payback
5. 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 salvage value of $10,000. The
machine will be depreciated using the straight-line method. The machine is
expected to produce 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 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?
A. 1.4 years. C. 2.2 years.
B. 1.9 years. D. 3.4 years.
Net Present Value
6. Rohan Transport is considering two alternative buses to transport people
between cities that are in the Southeastern U.S., such 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 $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. The company must
provide bus service for 8 years, after which it plans to give up its franchise and to
cease operating the route. Inflation is not expected to affect either costs or
revenues during the next 8 years. If Rohan Transport's cost of capital is 17 percent,
by what amount will the better project increase the company's value?
A. -$17,441 C. $10,701
B. $5,350 D. $27,801
Internal Rate of Return
7. Smoot Automotive has implemented a new project that has an initial cost, and
then generates inflows of $10,000 a year for the next seven (7) years. The project
has a payback period of 4.0 years. What is the project's internal rate of return (IRR)?
A. 14.79% C. 16.33%
B. 15.61% D. 18.54%
8. A company is considering putting up P50,000 in a three-year project. The
company’s expected rate of return is 12%. The present 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 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
A. P7,120 C. P16,392
B. P10,000 D. P23,022
Project Screening – Mutually Exclusive
Projects
9. Five mutually exclusive projects had the following information:
A B C D
NPV $500 $(200) $200 $1,000
IRR 12% 8% 13% 10%

Which project is preferred?

A. A C. C
B. B D. D
Comprehensive
Questions 10 through 17 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
10. The net cash flow for year 1 is
A. P25,850 C. P31,250
B. P28,750 D. P34,450

11. The net cash flow for year 4 is

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

12. The payback period for the project is

A. 3 years C. 3.5 years
B. 3.17 years D. 4 years.
13. The accounting rate of return of the project is
A. 7% C. 12%
B. 9% D. 15%

14. 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

15. 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
16. The profitability index of the project (rounded to the nearest hundredth) is
A. 0.96 C. 1.02
B. 0.98 D. 1.05

17. The project would be accepted on the basis of the

A. Payback and present value results.
B. Accounting rate of return and profitability index results.
C. Payback results only
D. A and B combined