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REQUIRED:
A) Rank the projects in descending order of preference according to NPV, IRR and benefit/cost ratio.
B) If only a budget of P 55,000 is available, which projects should be chosen?
SOLUTION GUIDE
1. A projects salvage value, realizable at the end of life of the project, is considered in the computation of the net
investments for decision-making purposes.
FALSE
2. The payback period emphasizes the profitability of a capital project while the accounting rate of return, on the other
hand, emphasizes the projects liquidity.
FALSE
3. Annual cash inflows from the capital projects are measured in terms of
a. Income after depreciation and taxes
b. Income before depreciation and taxes
c. Income before depreciation but after taxes
d. Income after depreciation but before taxes
4. When computing for the accounting rate of return (ARR), which of the following is used?
a. Income after depreciation and taxes
b. Income before depreciation and taxes
c. Income before depreciation but after taxes
d. Income after depreciation but before taxes
5. What technique does not use cash flow for capital investment decisions?
a. Payback c. ARR
b. NPV d. IRR
6. Which of the following groups of capital budgeting techniques uses the time value of money?
a. Book rate of return, payback and profitability index
b. IRR, payback and NPC
c. IRR, ARR and profitability index
d. IRR, NPC and profitability index
CAPITAL BUDGETING
7. Cost of capital is 3%; economic life in years = 4 years; what is the simple PV factor for year 4?
a. 0.915 c. 0.455
b. 0.888 d. 0.350
8. Discount rate is 11%; economic life in years = 3 years; what is the PV annuity factor for 3 years?
a. 0.731 c. 2.444
b. 1.713 d. 3.102
9. As the discount rate increases,
a. Present value factors increase
b. Present value factors decrease
c. Present value factors remain constant
d. It is impossible to tell what happens to the factors
10. What is the PV factor of any amount at year zero or zero percent?
a. Zero
b. 0.50
c. 1.00
d. An amount that cannot be determined without more information
11. The present value of P 50,000 due in five years would be highest if discounted at a rate of
a. 0%
b. 10%
c. 15%
d. 20%
12. A capital project with a positive NPV also has
a. A profitability index of one
b. A positive profitability index
c. A profitability index less than one
d. A profitability index greater than one
13. A capital project that has a positive NPV based on a discount rate of 12% also has an IRR of
a. Zero
b. 12%
c. Less than 12%
d. Greater than 12%
14. Which of the following combinations is possible?
Profitability Index NPV IRR
a. Greater than 1 Positive Equals cost of capital
b. Greater than 1 Negative Less than cost of capital
c. Less than 1 Negative Less than cost of capital
d. Less than 1 Positive Less than cost of capital
15. The net present value method assume that the projects cash flows are reinvested at the
a. Internal rate of return
b. Simple rate of return
c. Cost of capital
d. Payback period
16. The internal rate of return method assumes that the projects cash flows are reinvested at the
a. Required rate of return
b. Internal rate of return
c. Simple rate of return
d. Payback period
17. Which of the methods is a project ranking method rather than a project screening method?
a. Net present value
b. Profitability index
c. Simple rate of return
d. Sophisticated rate of return
18. If the IRR on an investment is zero,
a. Its NPV is positive
b. It is generally a wise investment
c. Its cash fows decrease over its life
d. Its annual cash flows equal its required investment
CAPITAL BUDGETING
Depreciation is a non- cash expense. As such, it has no effect on Net Present Value since NPV is a discounted cash flow
technique; however, since depreciation expense reduces the income subject to tax, the tax savings (tax shield) of depreciation has as
effect on NPV. Consequently, higher depreciation means higher tax savings (effectively a cash inflow); therefore, the higher the
depreciation, the higher the NPV will be.
Depreciation
Year Straight-line* SYD Difference Tax Rate Tax Savings PV Factors NPV Effect
1 P 90,000 P 150,000 ( P 60,000 ) 40% ( P 24,000 ) 0.89280 ( P 21,427.20 )
2 P 90,000 P 120,000 ( P 30,000 ) 40% ( P 12,000 ) 0.79719 ( P 9,566.28 )
3 P 90,000 P 90,000 - 40% - 0.71178 -
4 P 90,000 P 60,000 P 30,000 40% P 12,000 0.63552 P 7,626.24
5 P 90,000 P 30,000 P 60,000 40% P 24,000 0.56743 P 13,618.32
*Based on the cost of P 450,000 divided evenly throughout 5-year life TOTAL ( P 9,748.92 )
Rounded off answer: ( P 9,750.00 )
Take note that the only effect of depreciation on NPB is the tax savings out of depreciation expense. Accordingly, computation shall
emphasize the tax savings effect on NPV.
Since depreciation will be lower in the early years of the project life under the straight- line method (as opposed to SYD method), then
the over-all NPV will be definitely lower based on time value of money, as represented by the present value factors. Consider this: lower
depreciation lower tax savings (shield) lower cash inflow lower NPV.
Alternative solution: Based on above computations. The difference in depreciation method in multiplied to a common 40% tax rate to
compute the tax shield for each year. This common factor (tax of 40%) being multiplied every year makes the calculation somewhat
inefficient. We could then initially ignore the common tax factor of 40% in the discounting process and shorten the computation as
follows:
Before tax: P 75,000 P 25,000 = P 50,000 After tax: P 50,000 x 60% = P 30,000
Alternative solution: Since the annual increase in returns is 10% and the discount rate is also 10%, the effect is somewhat offsetting.
Notice the last column of the solution, the investment is supposed to have a uniform cash flow every year: P 27,272.70. Hence,
P 27,272.20 x 5 years = P 136,364 (rounded) is the total present value of cash inflow. Apparently, choice A is based on this:
NPV = 136,364 99,300 = P 37,064.
Management Services
INSTRUCTIONS: Select the correct answer for each of the following questions. Mark only one answer for each item by shading the
box corresponding to the letter of your choice on the answer sheet provided.
STRICTLY NO ERASURES ALLOWED. Use pencil no. 2 only.
Set B
1. Monumento Company manufactures products LRT and MRT from a joint process. Product LRT has been allocated P 5,000
of total joint costs of P 40,000 for the 1,000 units produces. LRT can be sold at the split-off point for P 6 per unit, or it can be
processed further with additional costs of P 2,000 and sold for P 10 per unit.
2. North Avenue Company plans to replace an old machine with a new one. For capital budgeting purposes, which of the
following shall be considered in the calculation of initial cost of net investment?
a. Cost of the old machine and salvage value of the new machine
b. Cost of the new machine and salvage value of the old machine
c. Cost and salvage value of the old machine
d. Cost and salvage value of the new machine
3. Shaw Boulevard Companys present current ratio is 4 times. What transaction will most likely cause the current ratio of the
company to increase?
a. Purchase of inventory on credit
b. Collection of trade receivables
c. Payment of current tax obligations
d. Borrowing of cash based 12-month loan
4. Quezon Avenue Company is preparing its cash budget for November. Quezon Avenue expects 50% of credit sales to be paid
in the month of sale. 30% in the month following the sale. And the remainder paid two months after the month of sale.
Quezon Avenue expects the following cash and credit sales.
Cash Credit
November P 17,000 P 100,000
October ??? P 90,000
September P 15,000 P 80,000
August P 18,000 P 95,000
Assuming no bad debts and a projected total cash inflow of P 107,000 in October, what is Quezon Avenues expected
October cash sales?
a. P 20,000
b. P 19,000
c. P 16,000
d. P 14,000
5. In an income statement prepared as an internal report using the variable costing method, variable selling and administrative
expenses would:
6. Tayuman Company has average daily cash collections of P 3 million, based on a 360-day year. A new system is estimated to
reduce the average collection period by two days without affecting sales. The new systems annual cost is P 100,000 plus
0.01& of collections. Tayuman estimates that it would earn 6%on additional funds.
What is the estimated annual net benefit from the new system?
a. P 152,000
b. P 180,000
c. P 260,000
d. P 360,000
7. Two goods, Alpha and Beta, are substitutes. What will an increase in the price of Beta cause?
8. At 40% capacity, overhead cost if P 1,450; at 75% capacity, overhead cost is P 2,150. Determine the variable overhead cost
at 80% capacity.
a. P 20
b. P 650
c. P 1,600
d. P 2,250
10. The following information regarding a capital project was given for consideration:
a. 15.38%
b. 20.77%
c. 30.77%
d. Cannot be determined from the given information
11. What would a business most likely offer credit terms of 2/10, n/30?
a. The business can borrow funds only at a rate higher than the effective annual interest rate of these terms.
b. The business can borrow funds at a rate lower than the effective annual interest rate of these terms.
c. Competitors are offering the same terms and the business has a cash shortage.
d. Competitors are not offering terms and the business has a cash surplus.
12. Baclaran Corporation has preferred stock with a market value of P 107 per share, a face value of P 100 per share,
underwriting costs of P 5 per share, and annual dividends of P 10. Baclarans tax rate is 30%.
a. 6.9%
b. 9.3%
c. 9.8%
d. 10.5%
a. 11,000 units
b. 9,000 units
c. 7,000 units
d. 5,000 units
15. Assume a tax rate of 25%, how many more units shall be sold in year 2 to earn an after-tax profit of P 236,250?
a. 25,000 units
b. 21,500 units
c. 7,000 units
d. 3,500 units
Month of January
Cost of goods manufactured P 257,500
Factory overhead applied 75,000
Direct materials used 95,000
Actual factory overhead 72,000
18. What was the total amount of direct material purchases during January?
a. P 90,000
b. P 95,000
c. P 97,500
d. P 100,000
19. How much direct labor cost was incurred during January?
a. P 85,000
b. P 87,500
c. P 90,000
d. P 93,000
20. Why is equity capital generally more expensive than debt financing?
21. Libertad Company sells 500,000 bottles of condiments annually at P 3 per bottle. Variable costs are P 0.60 per bottle and
fixed costs are P 110,000 annually. Libertad has annual interest expense of P 60,000 and a 30% income tax rate. What is
Libertads approximate degree of financial leverage?
a. 1.04
b. 1.06
c. 1.08
d. 1.10
22. When a flexible budget is used, an increase in production levels within the relevant range would