Capital Budgeting
Capital Budgeting
Capital Budgeting
GUIA
Required: Compute the net investment cost of the company to the new equipment.
Problem 2: It was estimated by the company that the equipment will be able to produce an
additional 100,000 units of its only product, which can all be sold by the company at P 10.00
each. Information about the production and other operating costs follow:
The equipment was estimated to have a useful life of 5 years and the company uses the
straight-line method of depreciation. Income tax rate is still 30%.
OPERATING PERIOD
LESS: ANNUAL
EXPENSES
CASH EXPENSES
NON-CASH EXPENSES
Depreciation (56,000)
Problem 3: After five years, the company expects the equipment to have a salvage value of
P 5,000, but for tax purposes, such equipment will be depreciated down to zero. Disposal
cost of removing the equipment is estimated at P 15,000. All current assets invested are
likewise expected to be recovered.
Required:
56,700
ROI = 200,000
= 28.35%
200,000
PBP = 95,700
= 2.09 years
Year 2
Year 3
Required: Compute the Payback Period.
P 200,000
Year 1 2 3
P 150,000
4 20,000 50,000
Investment
Cost 150000
=(80,000-60,000)/25,000
= 0.8 + 2
_________________________________________________________________________
Tax Rate
ANSWER:
1. 35,000/200,000 = 17.50%
2. 35,000 .
(200,000 + 50,000) / 2 = 28%
_________________________________________________________________________
Problem 8: Calvin Inc. is considering the purchase of a new state-of-art machine to replace
its hand-operated machine. Calvin’s effective tax rate is 40%, and its cost of capital is 12%.
Data regarding the existing and new machines are presented below.
Original Cost
Installation Costs
Freight and Insurance Expected end salvage value Depreciation Method Expected useful life
The existing machine has been in service for seven years and could be sold currently for
P25,000. Calvin expects to realize a before-tax annual reduction in labor costs of P 30,000 if
the new machine is purchased and placed in service.
Required:
Problem 9: Olson Industries needs to add a small plant to accommodate a special contract
to supply building materials over a five year period. The required initial cash outlays at Time
0 are as follows.
Land
New Building Equipment
Olson uses straight-line depreciation for tax purposes and will depreciate the building over
10 years and the equipment over 5 years. Olson’s effective tax rate is 40% and its cost of
capital is 14%. Revenues from the special contract are estimated at P 1.2 million annually,
and cash expenses are estimated at P 300,000 annually. At the end of the fifth year, the
assumed sales values of the land and building are P 800,000 and P 500,000, respectively. It
is further assumed the equipment will be removed at a cost of P 50,000 and sold for P
300,000.
Required:
Problem 10: Kell Inc. is analyzing an investment for a new product expected to have annual
sales of 100,000 units for the next 5 years and then be discontinued. New equipment will be
purchased for P1,200,000 and cost P 300,000 to install. The equipment will be depreciated
on a straight-line basis over 5 years for financial reporting purposes and 3 years for tax
purposes. At
the end of the fifth year, it will cost P 100,000 to remove the equipment, which can be sold
for P300,000. Additional working capital of P 400,000 will be required immediately and
needed for the life of the product. The product will sell for P80, with direct labor and material
costs of P65 per unit. Annual indirect costs will increase by P 500,000. Kell’s effective tax
rate is 40% and cost of capital of 15%
Required:
Purchase Price (1 200 000) Depreciation 160 000 Equipment 180 000
* Sale [300k x (1 - 40%)]
proceeds
Installment Cost ( 300 000) Sales** 520 000 Removal (60 000)
Cost [100k x (1 - 40%)]
= 160 000
= 0..3357 or 33.57%
= 1.3357 (1.34*)
Problem 11: Allstar Company invests in a project with expected cash inflows of P9,000 per
year for four years. All cash flows occur at year-end. The required return on investment is
9%. Required: If the project generates a net present value (NPV) of P 3,000, what is the
amount of the initial investment in the project?
Another method
Problem 12: Jenson Copying Company is planning to buy a coping machine costing
P25,310. The net present values (NPV) of this investment, at various discount rates, are as
follows.
Discount Rate 4%
6%
8%
10%
ANSWER:
4% P 2,440
6% 1,420
8% 460
10% (440)