CAPITAL BUDGETING

1. The management of Arleen Corporation is considering the purchase of a new

machine costing P400,000. It will be depreciated using straight line method for 5
years. The companys desired rate of return is 10%. The present value of P1 at
compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683,
and 0.621, respectively, and the present value of annuity of 1 for 5 periods at 10
percent is 3.79. In addition to the foregoing information, use the following data
in determining the acceptability in this situation:
Year
1
2
3
4
5

Income from Operations

P120,000
80,000
70,000
30,000
150,000

Net Cash Flow

P180,000
120,000
100,000
90,000
90,000

Compute the net present value.

A. Negative P 126800
B. Positive P 55,200

C.
D.

Negative P 99,600
Positive P 36,400

Answer and Solution:

Cash Flow
180,000
120,000
100,000
90,000
90,000
Total
Amount of
investment
Net Present
Value

PV Factor
0.909
0.826
0.751
0.683
0.621

PV of annual net cash

flows:
163,620
99,120
75,100
61,470
55,890
455,200
400,000
B. 55,200

2. . Baho Co. is considering the sale of a machine with the following characteristics.
Book value

P120,000

Remaining useful life

5 years

Annual straight-line depreciation

P24,000

Current market value

P 70,000

If the company sells the machine its cash operating expenses will increase by
P30,000 per year due to an operating lease. The tax rate is 40%.
Calculate the increase in annual net cash outflows as a result of selling the
machine.
A. 34,000

B. 43,000

C. 33,600

D. 27,600

Answer: D) increase in annual cash outflows: $27,600 ($30,000 pretax cost increase
- $2,400 decrease in income taxes; the $30,000 increase in cash costs is partially
offset by losing a $24,000 depreciation deduction)

3. The Stop Cheating Corporation is planning to invest in a four-year project that will
cost P750,000. Stop Cheatings cost of capital is 8% while the market rate at that
date was 9%. Additional information on the project is as follows:
Year
1
2
3
4

Cash Flow from Operations

P200,000
P220,000
P240,000
P260,000

Present value of P1
at 8%
at 9%
0.926
0.917
0.857
0.842
0.794
0.772
0.735
0.708

Should Stop Cheating accept or reject the project and what will be the advantage
or disadvantage of Powerful in continuing the project?
a) Accept, P5,400 advantage
b) Accept, P12,000 advantage
c) Reject, P5,400 disadvantage

d) Reject, P12,000 disadvantage

Answer: A) Accept, P5,400 advantage
Solution:
Present value of cash inflow after taxes at 8%:
Year
Amount
PV Factor
1
200,000
x
0.926
2
220,000
x
0.857
3
240,000
x
0.794
4
260,000
x
0.735
Total
Less: Net Investment
Net Present Value/ Advantage
4. Given:

=
=
=
=

Project's investment= P400,000

Present value of after tax CFs=P500,000
Outstanding shares= P100,000
Price=P40

Q: What is the project's effect on the stock price?

A. Increase by P2.
B. Decrease by P2.
C. Increase by P1.
D. Decrease by P1.

Asnwer:

C. Increase by P1
NPV= P100k (500k-400k)
MV(b4 project) = P4M (100k x 40)
MV(after project) =P4.1M (4M+100k)
Price after project =P41 (4.1M/100k)

PV
185,200
188,540
190,560
191,100
755,400
750,000
P5,400

RELEVANT COSTING
5. Dont Copy Enterprises, Inc. has an annual plant capacity to produce 2,500 units.
Its predicted operations for the year are:
Sales revenue (2,000 units at P40 each)
Manufacturing Costs:
Variable
Fixed
Selling and Administrative Costs:
Variable (commissions on sales)
Fixed

P80,000
P24 per unit
P17,000
P2.50 per unit
P2,500

Should Dont Copy accept a special order for 400 units at a selling price of P32
each, which is subject to half the usual commission rate per unit? Assume no
regular sales at regular prices.
a.
b.
c.
d.

No. The company will lose P920.

Yes. The company will have incremental profits of P2700.
Either way.
No. The company will lose P1200.

Answer & Solution:

The special order should be accepted.
Incremental revenue from special order
(400 x P32)
Less: Incremental costs
Manufacturing (400 x P24)
Sales commission (400 x P1.25)
Total
Incremental profit

12,800
9,600
500
10,100
2,700

6. Bae Curry sells product Duck at a price of P21 per unit. Bae's cost per unit based
on the full capacity of 200,000 units is as follows:
Direct Materials
Direct Labor
Overhead (2/3 of which is fixed)

P4
5
6

A special order offering to buy 20,000 units was received from a foreign
distributor. The only selling costs that would be incurred on this order would be
P3 per unit for shipping. Bae has sufficient existing capacity to manufacture the

additional units. To achieve an increase in operating income of P40,000, Bae

should charge a selling price of:
A. 14

B. 16

C. 15

D.18

Answer and Solution:

DM
4
DL
5
VOH
2
Selling
3
Total cost
14
Multiply by:
Offer in units
20,000
Total cost
280,000
Operating Income
40,000
Total cost
320,000
Divide by:
Offer in units
20,000
Price
B. 16
7. Rey Company has two sales territories-South and North. Financial Information
for the two territories are:

Sales
Direct costs
Variable
Fixed
Allocated Common Costs
Net Income(Loss)

South
P 980,000
(343,000)
(450,000)
(275,000)
P(88,000)

North
P750,000
(225,000)
(325,000)
(175,000)
P25,000

Because the company is in a start-up stage, corporate management feels that

the South territory is creating too much of a cash drain on the company and it
should be eliminated. If the South territory is discontinued, one sales manager
(whose salary is P40,000 per year) will be relocated to the North territory. By how
much would Rey's income change if South territory will be eliminated?
A.
B.
C.
D.

increase by P 88,000
increase by P 48,000
decrease by P267,000
decrease by P227,000

Answer: D. Decrease by P227,000

Sales forgone

P(980,000)

Variable cost avoided

343,000

Fixed cost avoided

410,000

Decrease in income

P227,000

8. Lucian Inc. estimates that 60,000 components will be used in manufacturing a

specialty steel window for the next year. Its supplier quoted a price of P60 per
component. Lucian prefers to purchase 5,000 units per month, but its supplier
could not guarantee this delivery schedule. In order to ensure availability of these
components, Lucian is considering the purchase of all the 60,000 units at the
beginning of the year. Assuming Lucian can invest cash at 8%, the company's
opportunity cost of purchasing all the 60,000 units at the beginning of the year is

A. P150000

B. P132000

Answer: B. P132,000

Inventory at beginning
if all purchased at the
beginning
(60,000 x 60)
Inventory purchase
monthly
(5000 x 60)
Excess inventory
Multiply: Average Factor
Average Excess inventory
Rate of possible earnings
Income lost

3,600,0
00
(300,00
0)
3,300,0
00

1,650,0
00
8%
132,000

c. P144000

d. P264000