MAS 2a

General Review – Capital Budgeting

September 20, 2018

1. Flores Company is planning to purchase a new machine costing P200,000, with freight and
installation cost of P6,000. The old unit will be traded in for a trade in value of P30,000. Other
assets can be salvaged and sold for P12,000 with loss on sale of P4,000. If the new equipment is
not purchased, the old unit will undergo repair by P12,000. This cost can be avoided by
purchasing the new equipment. Additional working capital of P48,000 is needed to support the
operation planned. Compute the net cost of investment.

2. Agalin Company is planning to buy a new machine that can produce additional 20,000 units of
product per year. The product sells for P50 each. The cost associated with the product per year
is P30 per unit, exclusive of depreciation on the new machine. The new machine which is
expected to last for 10 years will cost P500,000. No salvage value is expected to be recovered at
the end of its life. Compute for the following.
a. Accounting net income
b. Annual net cash inflow

3. Carl Company wants to compute its weighted average cost of capital for use in evaluating capital
investment projects. The following data were provided by the company’s accountant.
Income after tax P 50,000
Income tax rate 30%
Capital structures:
Bonds payable, 12%, 8 years P 180,000
10% Preference shares, P 100 par value 200,000
Ordinary shares, P 10 par value 100,000
Retained Earnings 50,000
Additional information:
Preference shares current market price P 125
Ordinary shares current market price 30
Compute the weighted average cost of capital.

4. Management at The Daily Grind wants to install an espresso bar in its restaurant. The espresso
bar costs P140,000 and has a 10-year life and will generate net annual cash inflow of P35,000.
Management requires a payback period of 5 years or less on all investments. What is the
payback period for the espresso bar?

5. Management at The Daily Grind wants to install an espresso bar in its restaurant. The espresso
bar costs P140,000 and has a 10-year life and will generate incremental revenues of P100,000
and incremental expenses of P65,000 including depreciation. What is the simple/accounting rate
of return on the investment project?

6. Martina Company has been offering a five year contract to provide component parts of a large
manufacturer.
Cost of special equipment 160,000
Working capital required 100,000
Relining equipment in 3 years 30,000
Salvage value of equipment in 5 years 5,000
Annual cash revenue and costs:
Sales revenue from parts 750,000
Cost of parts sold 400,000
Salaries, shipping, etc. 270,000
Additional information:
 At the end of five years, the working capital will be released and may be used elsewhere
by Lester.
 Martina Company uses a discount rate of 10%
Compute for the net present value.
7. Consider the following proposals:
X Y
Cost of investment 40,000 100,000
Annual NCI 16,000 32,000
Economic life 5 years 5 years
Cost of capital (10%)
a. Compute the NPV of each project
b. Compute the Profitability index
c. Compute the Net Present Value index
d. Formulate decisions in every method of evaluation.

8. The expected annual net cash inflow form a project is P22,000 over the next 5 years. The
required investment now in the project is P79,310. What is the internal rate of return on the
project?

9. Management at The Daily Grind wants to install an espresso bar in its restaurant. The espresso
bar costs P140,000 and has a 10-year life and will generate net annual cash inflows of P35,000.
Management requires a payback period of 5 years or less on all investments.
The PV of P1 for 10 years Rate
4.833 16%
4.494 18%
4.192 20%
3.923 22%
Compute the DCFRR.

10. Home Furniture Company is trying to decide whether to overhaul an old delivery truck now or
purchase a new one. The company uses a discount rate of 10%. Here is the information about
the trucks.

Old Truck
New Truck
Overhaul cost now 4,500
Purchase price 21,000
Annual operating costs 10,000
Annual operating costs 6,000
Salvage value in 5 years 250
Salvage value in 5 years 3,000
Salvage value now 9,000

Decide based on your computation.

“Do something that your future self will thank you for.”