Capital Budgeting

1. Net Investment for Decision-making

SAMSUNG Co. plans to replace a unit of equipment with a new one:
a. The old unit as acquired three years ago and is now recorded at a carrying value of 65,000; it can be sold now at
75,000. Tax Rate is 25%
b. The new unit can be acquired at a list price of 200,000. A 2% cash discount is available if the equipment is paid for
within 30days from acquisition date. Shipping, installation, and testing charges to be paid are estimated at 14,000.
c. Other assets with a book value 12,000 that are to be retired as a result of the acquisition of the new machine can be
salvaged and sold for 10,000.
d. Additional working capital of 23,000 will be needed to support operations planned with the new equipment.
e. The annual cash flow from operation of the new equipment has been estimated at 50,000. The equipment is expected
to have a useful life of 5 years with a salvage value of 4,000 at the end of year 5.
Required: What is the initial cost of net investments for decision making purposes?

2. Net Returns (Increase in Revenues)

STARBUCKS Co. plans to install coffee vending machine costing 200,000. Annual Sales of coffee are estimated
100,000 cups at 15.00 per cup. Variable costs are estimated at 6.00 per cup, while incremental fixed cash cost, excluding
depreciation, at 20,000 per year. The machines are expected to have a service life of 5 years, with no salvage value.
Depreciation will be computed on a straight line basis. The company’s tax rate is 30%.
Required: Determine the following
a. Increase in Annual net income
b. Annual cash inflows that will be generated by the project

3. Net Returns (Cost Savings)

NOKIA Co. is planning to buy a high-tech machine that can reduce cash expenses by an average of
70,000 per year. The new machine will cost 100,000 and will be depreciated for 5 years on a straight line basis. No
salvage value is expected at the end of the machine’s life. Income tax rate is 20% of income. Determine the net
cash inflows that will be generated by the project.

4. Payback Period and ARR (with even cashflows)

HUAWEI Co. considers replacement of some old equipment. The cost of the new equipment is 90,000
with useful life estimate of 8 years and a salvage value of 10,000. The annual pre-tax cash savings from the use
of the new equipment is 40,000. The old equipment has zero market value and is fully depreciated. The
company uses a cost of capital of 25%.
Required: Assume that the income tax rate is 40%. Compute the following items
a. Payback period
b. Accounting Rate of return on Original Investment
c. Accounting Rate of return on Average Investment

5. Payback period and ARR (with uneven cashflows)

MOTOROLA Co. has an investment opportunity costing 90,000 that is expected to yield the following
cash flows over the next five years: (assume the hurdle rate of 30%)
Year Amount
1 40,000
2 35,000
3 30,000
4 20,000
5 10,000
Total 135,000
Required: a. Payback period in months b. Book rate of return
6. Bailout payback period
APPLE Co. has a project costing 180,000 that will produce the following annual cash flows and salvage
values:
Year Cash Flows Salvage Values
1 50,000 65,000
2 50,000 50,000
3 50,000 35,000
4 50,000 20,000
Required: What is the bail-out payback period?

7. Net Present Value (with uniform cash flows)

VIVO Co. plans to buy a new machine costing 28,000. The new machine is expected to have a salvage
value of 4,000 at the end of its economic life of 4 years. The annual cash inflows before income tax from this
machine are estimated at 11,000. The tax rate is 20%. The company desires a minimum rate of return of 25% on
invested capital. Determine the net present value