ANSWER KEY FOR CAPITAL BUDGETING

TRUE OR MULTIPLE
FALSE CHOICE
1)F 1)A
2)T 2)C
3)F 3)A
4)F 4)D
5)F 5)A
6)F 6)B
7)T 7)D
8)T 8)A
9)T 9)D
10)F 10)B
11)T 11)A
12)F 12)B
13)F 13)C
14)F 14)A
15)T 15)C
16)T 16)A
17)F 17)C
18)T 18)A
19)F 19)B
20)T 20)B
21)T 21)A
22)T 22)C
23)F 23)C
24)F 24)D
25)T 25)B
26)F 26)B
27)T 27)A
28)F 28)B
29)T 29)C
30)T 30)B

PROBLEM 1

(a) Cash payback period = P240,000 P78,000 = 3.08 years

(b) Present value of cash inflows (P78,000 3.791) = P295,698

Capital investment 240,000
Net present value P 55,698

(c) Annual rate of return = P30,000 [(P240,000 + P0) 2] = 25%

PROBLEM 2

(a) Project Green Project Yellow

Annual net income P30,000 P50,000
Annual depreciation 50,000* 70,000**
Annual cash inflow P80,000 P120,000
*(P400,000 8) **(P560,000 8)

P400,000 P560,000
Cash payback period: = 5.0 years = 4.7 years
P80,000 P120,000

(b) Project Green Project Yellow

Present value of cash inflows: P459,760* P689,640**
Capital investment 400,000 560,000
Net present value P 59,760 P 129,640
*(P80,000 x 5.747) **(P120,000 x 5.747)

(c) Annual rate of return: Project Green Project Yellow

P30,000 P50,000
= 15% = 17.9%
(P400,000 + P0) 2 (P560,000 + P0) 2

(d) The company should select Project Yellow because it has a larger positive net present
value and a higher annual rate of return. In addition, Project Yellow has a slightly shorter
cash payback period.

PROBLEM 3

(a) Net present value of the investment:

Item Present Value Cash Flow Factor Present Value
Initial Investment (P630,000) 1.0000 (P630,000)
Revenue P329,000
Expense (212,500)* 116,500 5.9176 689,400
Net Present Value P 59,400
*P40,000 + P8,000 + P126,000 + P38,500

(b) Internal rate of return of the investment:

P630,000 P116,500 = 5.4077
Scanning the 12-year line, a factor of 5.4077 represents an IRR of approximately 15%.

(c) Cash payback period of the investment:

P630,000 P116,500 = 5.41 years.
PROBLEM 4
(a) Project Blue
Year Annual Cash Inflows Present Value of 1 Present Value
1 P38,000 .893 P33,935
2 42,000 .797 33,474
3 48,000 .712 34,176
P128,000 P101,584

Present value of cash inflows P101,584

Capital investment 90,000
Net present value P 11,584

Project Red
Present value of cash inflows (P42,000 2.402) P100,884
Capital investment 90,000
Net present value P 10,884

(b) Blue Red

Profitability index: P101,584 P90,000 = 1.13 (P100,884 P90,000) = 1.12

(c) Both projects are acceptable because both show a positive net present value. Project Blue
is the preferred project because its net present value is greater than project Hot's net
present value and it has a slightly higher profitability index.

PROBLEM 5
(a) (1) Present value of cash inflows (P20,000 3.791) P75,820
Capital investment 73,000
Net present value P 2,820

(2) Profitability index: P75,820 P73,000 = 1.04

(b) Capital Investment

= Internal Rate of Return Factor
Net Annual Cash Inflow

P73,000
= 3.65
P20,000

Since the calculated internal rate of return factor of 3.65 is very near the factor 3.605 for
five periods and 12% interest, this project has an approximate interest yield of 12%.

(c) The Company should invest in this project because it has a positive net present value, a
profitability index above 1, and its internal rate of return of 12% is greater than the
company's 10% required rate of return.
PROBLEM 6
(a) Machine X Machine Y
(1) Present value of net cash flows P157,010* P179,440**
Capital investment 152,000 170,000
Net present value P 5,010 P 9,440
*(P35,000 4.486) **(P40,000 4.486)

Machine X Machine Y
P157,010 P179,440
(2) Profitability index = 1.03 = 1.06
P152,000 P170,000

(3) Machine X Machine Y

Internal rate of return factor P152,000 P170,000
= 4.34 = 4.25
P35,000 P40,000

Internal rate of return 10% (4.355 factor) 11% (4.231 factor)

(b) Both machines are acceptable because both show a positive net present value, have a
profitability index above 1, and have an internal rate of return greater than the company's
minimum required rate of return. Machine 2 is preferred because its net present value,
profitability index, and internal rate of return are all greater than Machine X's amounts.

PROBLEM 7
(a) 1. Cash payback period: P320,000 P62,000 = 5.16 years
2. Present value of cash inflows (P62,000 5.535) P343,170
Capital investment 320,000
Net present value P 23,170
3. Profitability index: P343,170 P320,000 = 1.07
4. Internal rate of return factor: P320,000 P62,000 = 5.16
Internal rate of return = 11% (5.146 factor)
5. Annual rate of return: P22,000 [(P320,000 + P0) 2] = 13.75%

(b) The company should accept the investment, since its net present value is positive and its
internal rate of return of 11% is greater than the company's required rate of return of 9%.
In addition, its cash payback period of 5.16 years is significantly shorter than the
equipment's useful life of 8 years.
PROBLEM 8
(a) Present value of the estimated net cash inflows (P70,000 4.355) P304,850
Estimated capital investment 300,000
Net present value P 4,850

Yes, the company should have invested in the project based on the original estimates,
since the net present value is positive.

(b) Present value of the actual net cash inflows (P58,000 x 5.759) P334,022
Actual capital investment 340,000
Net present value (P 5,978)

The company should not have invested in the project based on the actual amounts, since
the net present value is negative. The decrease of P10,828 in net present value was
caused due to a decrease of P12,000 per year in net cash inflows and a P40,000 increase
in the cost of the capital investment. This more than offsets the 3-year increase in useful
life.

PROBLEM 9
(a) Present value of annual cash flows (P4,300 5.335) P22,941
Present value of salvage value (P3,000 .467) 1,401
P24,342
Capital investment 25,000
Net present value (P 658)
Based on the negative net present value of P658, the van should not be purchased.

(b) Present value of annual cash flows [(P4,300 + P500) 5.335] P25,608
Present value of salvage value (P3,000 .467) 1,401
P27,009
Capital investment 25,000
Net present value P 2,009
Incorporating the additional benefits of P500/year into the calculation produces a positive
net present value of P2,009. Therefore, the van should be purchased.

(c) The additional benefits would need to have a total present value of at least P658 in order
for the van to be purchased.

PROBLEM 10
(a) Present value of net cash flows (P270,000 8.514) P2,298,780
Present value of salvage value (P3,900,000 .149) 581,100
P2,879,880
Capital investment (P600,000 + P2,100,000) 2,700,000
Net present value P 179,880

(b) Present value of net cash flows (P2,100,000 8.514) P1,787,940

Present value of salvage value 581,100
P2,369,040
Capital investment 2,700,000
 Net present value (P330,960)

If the number of campers attending each week is only 80 instead of 100, the net present
value decreases by P510,840 (from a positive P179,880 to a negative P330,360). This
indicates that the camp should not be invested in unless the number attending is closer to
100.

(c) Present value of net cash flows (P270,000 7.469) P2,016,630

Present value of salvage value (P3,900,000 .104) 405,600
P2,422,230
Capital investment 2,700,000
Net present value (P 277,770)