CAPITAL BUDGETING

QUIZ 1
MULTIPLE CHOICE

1. The consulting firm of Magaling Corporation is considering the replacement of

their computer system. Taking into account the income tax effect and
considering the carrying value of the old system (CVOS) and the salvage
value of the new system (SVNS), which combination below applies to the
decision making process?
a. CVOS, irrelevant and SVNS irrelevant.
b. CVOS, irrelevant and SVNS relevant.
c. CVOS, relevant and SVNS irrelevant.
d. CVOS, relevant and SVNS relevant.

2. As a capital budgeting technique, the payback period considers depreciation

expense (DE) and time value of money (TVM) as follows:
a. DE, relevant and TVM irrelevant
b. DE, irrelevant and TVM irrelevant
c. DE, irrelevant and TVM relevant
d. DE, relevant and TVM irrelevant

3. Mahlin Movers, Inc. is planning to purchase equipment to make its operations

more efficient. This equipment has an estimated useful life of six years. As
part of this acquisition, a P150,000 investment in working capital is required.
In a discounted cash flow analysis, this investment in working capital
a. Should be amortized over the useful life of the equipment
b. Should be disregarded because no cash is involved
c. Should be treated as a recurring annual cash flow that is recovered at the
end of six years.
d. Should be treated as an immediate cash outflow that is recovered at the
end of six years.

4. If income tax considerations are ignored, how is depreciation used in the

following capital budgeting techniques?
a. Internal Rate of Return, Included; Acctg. Rate of Return, Excluded.
b. Internal Rate of Return, Excluded; Acctg. Rate of Return, Included.
c. Internal Rate of Return, Excluded; Acctg. Rate of Return, Excluded
d. Internal Rate of Return, Included; Acctg. Rate of Return, Included.

5. KAREN company is considering replacing an old machine with a new

machine. Which of the following items is economically relevant to KAREN’s
decisions? Ignore income tax considerations.
 a. Carrying amount of old machine – Yes
Disposal value of new machine – Yes
b. Carrying amount of old machine – Yes
Disposal value of old machine – No
c. Carrying amount of old machine – No
Disposal value of old machine – Yes
d. Carrying amount of old machine – No
Disposal value of old machine – No

6. Key Corp. plans to replace a production machine that was acquired several
years ago. Acquisition cost is P450,000 with residual value of P50,000. The
machine being considered is worth P800,000 and the supplier is willing to
accept the old machine at a trade-in value of P60,000. Should the company
decide not to acquire the new machine, it needs to repair the old one at a cost
of P200,000. Tax wise, the trade-in transaction will not have any implication
but the cost to repair is tax deductible. The effective corporate tax rate is 35%
of net income subject to tax. For purposes of capital budgeting, the net
investment in the new machine is
a. P540,000
b. P610,000
c. P660,000
d. P800,000

7. Diliman Republic Publishers, Inc. is considering replacing an old press that

cost P800,000 six years ago with a new one that would cost P2,250,000.
Shipping and installation would cost an additional P200,000. The old press
has a book value of P150,000 and could be sold currently for P50,000. The
increased production of the new press would increase inventories by
P40,000, accounts receivable by P160,000 and accounts payable by
P140,000. Diliman Republic’s net initial investment for analyzing the
acquisition of the new press assuming a 35% income tax rate would be
a. P2,450,000
b. P2,425,000
c. P2,600,000
d. P2,250,000

8. Lawson Inc. is expanding its manufacturing plant, which requires an

investment of P4 million in new equipment and plant modifications. Lawson’s
sales are expected to increase by 3Million per year as are result of the
expansion. Cash investments in current assets average 30% of sales;
accounts payable and other current liabilities are 10% sales. What is the
estimated total investment for this expansion?
a. P3.4 million
b. P4.3 million
c. P4.6 million
d. P5.2 million

9. Regal industries is replacing a grinder purchased 5 years ago for P15,000

 with a new one costing P25,000 cash. The original grinder is being
depreciated on a straight-line basis over 15 years to a zero residual value.
Regal will sell this old equipment to a third party for P6,000 cash. The new
equipment will be depreciated on a straight-line basis over 10 years to a zero
salvage value. Assuming a 40% marginal tax rate, Regal’s net cash
investment at the time of purchased if the old grinder is sold and the new one
purchased is:
a. P19,000
b. P15,000
c. P17,400
d. P25,000

10. A company considers a project that will generate cash sales of P50,000 per
year. Fixed costs will be P10,000 per year, variable costs will be 40% of
sales, and depreciation of the equipment in the project will be P5,000 per
year. Taxes are 40%. The expected annual cash flow to the company
resulting from the project is
a. P15,000
b. P9,000
c. P19,000
d. P14,000

11. Whatney Co. is considering the acquisition of a new, more efficient press. The
cost of the press is P360,000, and the press has an estimated 6-year life with
zero residual value. Whatney uses straight-line depreciation for both financial
reporting and income tax reporting purposes and has 40% corporate income
tax. In evaluating equipment acquisitions of this type, whatney uses goal of a
4-year payback period. To meet Whatney’s desired payback period, the press
must produce a minimum annual before tax operating cash saving of
a. P90,000
b. P110,000
c. P114,000
d. P150,000

12. Garfield, Inc. is considering a 10-year capital investment project with

forecasted revenues of P40,000 per year and forecasted cash operating
expenses of P29,000 per year. The initial cost of the equipment for the project
is P23,000, and Garfield expects to sell the equipment’s for P9,000 at the end
of the tenth year. The equipment’s will be depreciated over 7 years. The
project requires working capital investments of P7,000 at its inception and
another P5,000 at the end of year 5. Assuming a 40% marginal tax rate, the
expected net cash flow from the project in the tenth year is
a. P32,000
b. P24,000
c. P20,000
d. P11,000
13. The payback capital budgeting technique considers
Income over entire Time value
Life of project of money
a. No No
b. No Yes
c. Yes Yes
d. Yes No

14. A machine costing P1,000 produces total cash inflows of P1,400 over 4
years. Determine the payback period given the following cash flows:
YEAR After-Tax Cash Flows Cumulative Cash Flows
1 400 400
2 300 700
3 500 1,200
4 200 1,400
a. 2 years
b. 2.60 years
c. 2.86 years
d. 3 years

15. Nonoy Company is planning to purchase a new machine for P500,000. The
new machine is expected to produce cash flow from operations, before
income taxes, of P135,000 a year in each of the next five years. Depreciation
of P100,000 a year will be charged to income for each of the next five years.
Assume that the income tax rate is 40%. The payback period would be
approximately
a. 2.2 years
b. 3.4 years
c. 3.7 years
d. 4.1 years

16. The Folk Company is planning to purchase a new machine which will
depreciate on a straight-line basis over a ten-year period with no residual
value and a full year’s depreciation in the year of acquisition. The new
machine is expected to produce cash flow from operations, net of income
taxes, of P66,000 a year in each of the next ten years. The accounting (book
value) rate of return on the initial investment is expected to be 12%. How
much will the new machine cost?
a. P300,000
b. P550,000
c. P660,000
d. P792,000
17. Jasper Company has a payback goal of 3 years new equipment acquisitions.
A new sorter is being evaluated that the costs of P450,000 and has a 5-year
life. Straight-line depreciation will be used; no residual value is anticipated.
Jasper is subject to a 40% income tax rate. To meet the company’s payback
goal , the sorter must generate reductions in annual cash operating costs of
a. P60,000
b. P100,000
c. P150,000
d. P190,000

18. The following statements refer to the accounting rate of return (ARR)
1. The ARR is based on the accrual basis, not the cash basis
2. The ARR does not consider the time value of money
3. The profitability of the project is not considered

From the above statements, which are considered limitations of the ARR
concept?
a. Statements 2 and 3 only
b. Statements 3 and 1 only
c. All the 3 statements
d. Statements 1 and 2 only

19. The method of project selection which considers the time value of money in
capital budgeting decision is accomplished by computing the
a. Accounting rate of return
b. Payback period
c. Accounting rate of return on average investment
d. Discounted cash flow

20. Anton Corporation is planning to buy a new machine with the expectation that
this investment should earn a discount rate of return of at least 15%. This
machine, which costs P150,000, woluld yield an estimated net cash flow of
P30,000 a year for 10 years, after income taxes. In order to determine the net
present value of buying the new machine. Anon should first multiply tne
P30,000 by what amount of the following factors?
a. 20.304 (Future amount of an ordinary annuity of P1)
b. 5.019 (Present value of an annuity of P1)
c. 4.046 (Future amount of P1)
d. 247 (Present value of P1)                                     (aicpa)

21. In income tax considerations are ignored, how is depreciation expense used
in the following capital budgeting techniques?
    Internal rate
    of return                    Payback
a. Excluded                   Excluded
b. Excluded                   Included
c. Included                    Excluded
d. Included                    Included                    
22. Garfield Company purchased which will be depreciated on he straight line
basis over an estimated useful life of seven years and no residual value. The
machine is expected to generate cash flow from operations, net of income
taxes, of P80,000 in each o seven years. Garfield's expected rate of return is
12%. Information on preent value factrs is as follows:
    Present value of P1 at 12% for seven periods                     0.452
    Present value of an ordinary annuity of P1 at 12% for 7 periods          
4.564
Aassuming a positive net present value of P12,720, what was the cost of
machine?
a. P240,000                    c. P352,400
b. P253,120                    d. P377,840          

23.   It is the start of the year and St. Tropez Co. plans to replace its old sing-
along equipment. These information are available
                         Old              New
Equipment cost                 P70,000        P120,000
Current salvage value                  10,000
Residual value, end of useful life           2,000          16,000
Annual operating costs               56,000           38,000
Accumulated depreciation               55,300            
Estimated useful life                    10 years         10 years

The company's income tax rate is 35% and its cost of capital is 12%. What i
the present value of all the relevant cash flows at time zero?
a.(P54,000)                         c.(P120,00)
b.(P110,000)                         d. (P124,000)      

24. McIndon Corporation bought a major equipment which is depreciable over 7

years on a straight line basis without residual value. It is estimated that it
would generate cash flow from operations, net of income taxes, of P800,000
in each of seven years. The company's expected rate of return is 12%. Based
on estimates, the project has a net present value of P127,200. What is the
cost of the equipment?

a. P3,651,200                    c. P2,404,000

b. P3,524,000                     d. P3,778,400                 (rpcpa)

25. FTG Corporation is evaluating the purchase of P500,000 dir attach

machine. The cash inflows expected from the investment is P145,000 per
year for five years with no equipment salvage value. The cost of capital is
12%.. The internal rate of return for this investment is
a. 9%-10%                     c.13%-14%
b. 11%-12%                     d. 15%-16%
 26.GUTZY Corporation is planning to invest P80,000 in a three-year project.
GUTZY's expected rate of return is 10%. The cash flow, net of income taxes,
will be P30,000 for the first year and P36,000 for the second year. Assuming
the rate of return is exactly 10%, what will the cash flow, net of income taxes,
be for the third year? (Round off the PV factor to 3 decimal places)
a. P17,268                         c, P22,994
b. P22,000                         d. P30,618       

27. Mr. Al Yu is an entrepreneur who contemplates to buy a machine to increase

the capacity of his manufacturing operations. He consults you for advise on
the alternatives of leasing or buying the equipment. If purchased, the straight
line depreciation expense will be {18,700 annually over its life of 5 years.
The annual lease payment will amount to P29,000 payable at the end of
each of the 5 years. Cost of money is 18%. Tax rate is 35%. There is no
salvage value. Presents value of P1 received annually for 5 years at 18% is
3.127. present value of P1 due in 5 years at 18% is .437.
What will you recommend and why?
a. Lease the machine because leasing saves P2,817.
b. Lease the machine because leasing saves P27,138.
c. Buy the machine because depreciation saves P10,300 each year.
d. Lease the machine because outlay is less by P51,500.

Questions 28 through 30 are based on the following information. A company

purchased a new machine to stamp the company logo on its products. The cost of
the machine was P250,000 and it has an estimated useful life of 5 years with an
expected salvage value at the end of its useful life P50,000. The company uses the
straight –line depreciation method.
The machine is expected to save P125,000 annually in operating costs. The
company’s tax rate is 40% and it uses a 10% discount rate to evaluate capital
expenditures. (Round off the PV factor to 3 decimal places)

28. .What is the traditional payback period for the new stamping machine?
a.2.00 years c. 2.75 years
b.2.63 years d. 2.94 years

29. What is the accounting rate of return based on the average investment in the
new stamping machine?

a.20.4% c. 40.8%
b.34.0% d. 51%

30. What is the net present value (NPV) of the new stamping machine
a.P125,940 c. P250,000
b.P200,000 d. 375, 940

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