Finance I Capital Budgeting

January 26, 2011

I. Payback Period. May Company is evaluating an investment proposal to acquire two new machines to be used in its manufacturing operations. The machines cost P60,000 each, inclusive of the value added tax of 10%. There is a P3,000 total installation cost for the machines. The useful life of the machines is 5 years, no salvage value. Annual net cash inflow from the two machines is P20,000. Required: Determine the payback period for the machines. II. Accounting Rate of Return. Sisa Company is evaluating a plan to expand its store space due to the expected increase in volume of activities in the next few months. The expansion would cost P200,000 and would have a useful life of 20 years, with no salvage value. The expected increase in sales revenue is P55,000 a year, and cash expenses are P20,000 a year. The income tax rate is 30%. Required: a. Compute the accounting rate of return b. If Sisas cost of capital is 15%, Should the project be accepted? III. Consider the following project proposal: Project A Cost of investment Annual net cash inflows Economic life Discount rate is at 10% Compute the following: a. Net Present Value (NPV) b. Profitability Index (PI) P 20,000 8,000 5 years 3.791 Project B P 40,000 16,000 5 years 3.791

Finance I Capital Budgeting

January 26, 2011

I. Payback Period. May Company is evaluating an investment proposal to acquire two new machines to be used in its manufacturing operations. The machines cost P60,000 each, inclusive of the value added tax of 10%. There is a P3,000 total installation cost for the machines. The useful life of the machines is 5 years, no salvage value. Annual net cash inflow from the two machines is P20,000. Required: Determine the payback period for the machines. Payback period = cash outflow = (60,000 x 2) +3,000 Net Cash inflow 20,000 = 6.15 years II. Accounting Rate of Return. Sisa Company is evaluating a plan to expand its store space due to the expected increase in volume of activities in the next few months. The expansion would coast P200,000 and would have a useful life of 20 years, with no salvage value. The expected increase in sales revenue is P55,000 a year, and cash expenses are P20,000 a year. The income tax rate is 30%. Required: c. Compute the accounting rate of return d. If Sisas cost of capital is 15%, Should the project be accepted? ARR = Average annual net income after taxes Cash outlay (investment) Sales Less: Expenses Depreciation (P 200,000/20) Net Income before Tax Less: Income tax @ 30% Net Income after Tax ARR = P 17,500 = 8.75% 200,000 P 55,000 20,000 10,000 25,000 7,500 P 17,500

III. Consider the following project proposal: Project A Cost of investment Annual net cash inflows Economic life Discount rate is at 10% Compute the following: a. Net Present Value (NPV) b. Profitability Index (PI) A. NPV PV of cash inflow (8,000 x 3.791) Less: cost if investment NPV B. PI Profitability Index = PV of cash inflow Investment Project A 30,328 20,000 10,328 Project A 30,328 20,000 =1.52 Project B (16,000 x 3.791) 60,656 40,000 20,656 Project B 60,565 40,000 = 1.52 P 20,000 8,000 5 years 3.791 Project B P 40,000 16,000 5 years 3.791