MAS-12: CAPITAL BUDGETING Example.

Cash income 25,000 Cash

Capital Budgeting
Investment 100,000
❖ planning for future capital
Depreciation (5,000) Sale of
➢ expenditure (no income, only benefits for
Asset (20,000)
several periods)
Accounting Net
➢ investment (income generating outlay;
Income 20,000 Investment 80,000
expect something in return)
▪ revenue increasing project
Payback Period
▪ cost reduction project
= Cash income/ net investment
❖ including the manner of financing (Ordinary
= 25,000/80,000
share, preference share, long-term borrowing,
= 31.25%
retained earning)
Accounting Rate of return
= Accounting income/ Cash investment
Methods of Evaluation
= 20,000/100,000
1) Cash Flow Methods – use cash income
= 20%
a) Non-discounted (ND) – money is not
invested
Exercise 1. Below is the information for a cost
i) Payback – measure recovery period
reduction investment.
ii) Payback Reciprocal – inverted payback
Project JUN Project ZON
iii) Bail Out Payback – considers salvage
Cost of Machine 50,000 100,000
value
Annual Cash Savings for end of:
b) Discounted (D) – money can be invested
i) Net Present Value (NPV) with index Year 1 23,000 40,000
ii) Internal Rate of Return (IRR) aka Year 2 23,000 50,000
discounted rate of return Year 3 23,000 60,000
iii) Present Value Payback (PVV) aka Salvage Value 5,000 10,000
discounted payback Income Tax = 20%
2) Accounting Method (AM) – use accounting Desired ROI: cash basis 23%
income accounting basis 18%
a) Accounting Rate of Return Compute for the following for both projects:
i) Original Cost 4. Tax shield
ii) Average Cost 5. Payback Period
6. Payback Reciprocal
Objectives 7. Bail out Payback
1) Recovery Period 8. Accounting Rate of Return on Original Cost
a) ND; Payback – if it will last its estimated life (ARROC)
b) ND; Bail Out Payback - if it will last its 9. Accounting Rate of Return on Average Cost
estimated life (ARRAC)
c) D; Present Value Payback
2) Return on Investment Exercise 2.
a) ND; Payback Reciprocal = ROI Project J Project V
b) D; Internal Rate of Return Cost of Machine 40,000 100,000
c) AM; Accounting Rate of Return ACIAT for end of:
3) Present Value of Cash Flows Year 1 22,000 45,000
a) PV of Inflow Year 2 22,000 50,000
b) PV of Outflow Year 3 22,000 60,000
Salvage Value - 10,000
Factors: Cost of Capital is 23%.
Pre-tax Compute for the following for both projects:
After Tax 1. NPV (Net Present Value)
1. Amount of investment (Outflow) 2. Index
2. Annual Return (Inflow) 3. Discounted rate of return
3. Desired ROI – basis for accepting or rejecting 4. Present Value Payback
decision. Use Cost of Capital if there’s no desire
ROI.

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MAS 12 Capital Budgeting
1. A company is considering replacing a machine with one that will save P 50,000 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 flow of
the company by
a. P 38,000 c. P 20,000
b. P 30,000 d. P 12,000
2. Daet Inc.’s depreciation deduction last year was P50, 000 and its tax rate was 30%. The company’s tax savings from the depreciation tax
shield for the year was
a. P 15,000 c. P 50,000
b. P 35,000 d. P 30,000
3. Iriga Company Is considering a certain project with the following projected cash income after taxes for 4 years, the life of the project: year 1, P
11, 000; year 2, P 9,000; year 3, P 8,000; year 4, P 7,000. If the projects requires an investment of P 25,000 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
4. Albay Inc. recently acquired a machine at a cost of P 64, 000. It will be depreciated on a straight-line basis over 8 years, with no salvage value.
Albay expects that this machine will produce P 18, 000 annual net cash flow before income tax. Assuming an income taxrate of 50%. The
appropriate payback period on this investment is:
a. 3.6 years c. 7.1 years
b. 4.9 years d. 12.8 years
5. A Project costing P180, 000 will produce the following annual cash benefits and salvage value:
End of the year Cash Benefits Salvage value
1 P 50,000 P 70,000
2 P 50, 000 P 60,000
3 P 50,000 P 50,000
What is the bailout payback?
a. 3 years c. 2.4 years
b. 2.6 years d. 2 years
6. Sabang Company purchased a new machine on January 1 of this year for P 90,000, with an estimated useful life of 5 years and a salvage value
of P 10, 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 P 36, 000 a year in each of the next 5 years. The new machine’s salvage value is P 20,000 in years 1 and 2, and P15,000 in years
3 and 4. What will be the bailout payback period for this machine?
a. 14 years c. 1.9 years
b. 2.2 years d. 3.4 years
7. The techniques that does not use cash flow for capital investment decisions.
a. Payback c. ARR
b. NPV d. IRR
8. San Jose Company is considering the acquisition of a personal computer that costs P 120, 000 with an economic life of 12 years and a terminal
salvage value of P 12, 000. It is estimate that the increase in net income before taxes as a result from this investment will amount to P 7, 000
annually. Income taxes are 35%. The company uses the straight-line method of depreciation. What is the accounting rate of return on the
average costs of investment?
a. 3.79% c. 6.68%
b. 5.83% d. 6.98%
9. Lagonoy Inc. purchased a new machine for P 60, 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. P 7, 200 c. P 12,000
b. P 13, 800 d. P 21, 000
10. The Camalig Company has invested in a machine that cost P 70,000, that has a useful life of seven years, and that has no salvage values at the
end of its useful life. The machine is being depreciated by the straight-line method, based on its useful life. It will have a payback period of
four years. Given these data, the simple rate of return on the machine is closest to:
a. 7.1% c. 10.7%
b. 8.2% d. 39.3%
11. Which of the following methods is a discounted cash flow method for evaluating capital investment?
a. a. Payback c. PV payback
b. b. Bail-out payback d. Payback reciprocal
12. A project costing P 28,715 will produce the following cash benefits after taxes:
End of year After-tax cash benefits
1 P 11,000
2 15,000
3 18,000
The company’s cost of capital is 16%. The PV of P 1 for one year at 16% is 0.862; for two years is 0.743; for three years 0.641.
What is the discounted (PV) payback period?
a. 1.7 years c. 2.3 years
b. 2 years d. 2.7 years
13. Which of these cash flow methods of evaluating capital investment ignores the time value of money?
a. IRR c. Profitability index
b. ARR d. NPV
14. Net present value (NPV) is
a. The sum of discounted cash inflows
b. The sum of discounted cash outflows
c. The sum of discounted cash inflows less the sum of the discounted cash outflows
d. The sum of discounted cash inflows plus discounted cash outflows
15. An investment opportunity costing P 110,000 is expected to yield net cash flows of P 28,000 annually for six years. The NPV of the investment
at a cutoff rate of 12% would be (Round off PV factors based on three decimal places)
a. (P 5,108) c. P 110,000
b. P 5,108 d. P 115,108
16. A project requires an investment of P 40,000 and has a net present value of P 10,000. The project’s profitability index would be.
a. 0.80 c. 4.0
b. 1.25 d. 1.0
17. Consider an investment with the following cash flows:
Year Cash flows PV of P 1 at 14%
0 (P 31,000) 1.000
1 10,000 0.877
2 20,000 0.770
3 10,000 0.675
4 10,000 0.592
Salvage Value: P 5,000
What is the profitability index?
a. 1.824 c. 1.482
b. 1.284 d. 1.842
18. The internal rate of return (IRR) is the
a. Hurdle rate
b. Rate of interest at which the net present value is greater than 1.0
c. Rate of return generated from the operational cash flows
d. Rate of interest at which the net present value is equal to zero
19. The discount rate that equates the PV of expected cash flows with the cost of investments is the
a. Net present value c. Accounting rate of return
b. Internal rate of return d. Payback period
20. Bula Corporation is planning to invest P80,000 in a three-year project. Bula’s expected rate of return is 10%. The present value of P 1 at 10%
for 1 year is 0.909, for two years is 0.826 and for three years is 0.751. The cash flows, net of income taxes, will be P 30,000 for the first year
(present value: P 27,270) and P 36,000 for the second year (present value: P 29,736). Assuming the rate of return is exactly 10%, what will be
the net cash flow, net of income taxes, for the third year?
a. P 17,260 c. P 22,904
b. P 22,000 d. P 30,618
21. If an investment of P 14,760 now is to yield P 18,000 at the end of one year, then the internal rate of return for this investment to the nearest
whole percentage is:
A. 14% B. 18%
C. 22% D. 28%

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