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San Pedro College: Accounting & Financial Management

This document provides lessons and examples on capital budgeting techniques. It includes multiple choice questions covering topics like net present value (NPV), internal rate of return (IRR), payback period, and discount rates. It also includes practice problems calculating investment costs, cash flows, rates of return, and payback periods for sample capital budgeting projects. The key capital budgeting methods covered are NPV, IRR, payback period, accounting rate of return, and profitability index.

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Juan Frivaldo
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116 views

San Pedro College: Accounting & Financial Management

This document provides lessons and examples on capital budgeting techniques. It includes multiple choice questions covering topics like net present value (NPV), internal rate of return (IRR), payback period, and discount rates. It also includes practice problems calculating investment costs, cash flows, rates of return, and payback periods for sample capital budgeting projects. The key capital budgeting methods covered are NPV, IRR, payback period, accounting rate of return, and profitability index.

Uploaded by

Juan Frivaldo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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SAN PEDRO COLLEGE

12 C. Guzman Street, 8000 Davao City, Philippines

Master of Arts in Hospital Administration


Third Trimester, SY 2019-2020

ACCOUNTING & FINANCIAL MANAGEMENT

LESSON 5 – CAPITAL BUDGETING

ANSWER KEYS & SOLUTIONS:

Multiple Choice:

1. Which of the following is a common capital budgeting method?


a. Return on assets
b. Net present value
c. Inventory turnover
d. Debt-to-equity ratio

2. Which of the following is TRUE of discounted cash flow methods like NPV and IRR?
a. They use simple interest calculations.
b. They use net income amounts rather than cash flows.
c. They focus on the payback period.
d. They incorporate compound interest calculations.

3. Cash flows used in NPV and IRR analyses include all of the following EXCEPT:
a. future increased sales.
b. future cost savings.
c. depreciation expense.
d. residual value.

4. An investment would be considered a good prospect under which of the following


conditions?
a. The present value of the cash flows exceeds the initial investment.
b. The IRR is lower than the hurdle rate.
c. The cash inflows are greater than the initial investment.
d. It has a residual value.

5. Which of the following most accurately describes the discount rate used in NPV and IRR
analyses?
a. The rate of inflation
b. The rate of interest earned on a savings account
c. The required rate of return, also known as the "hurdle rate"
d. The rate of interest charged for debt financing of an investment

CASE PROBLEMS

1. The following data pertains to a project being proposed:


Cash purchase price of machinery and equipment P300,000
Freight in 3,000
Installation cost 4,000
Cost of labor and materials to be used in test runs 62,000
Working capital requirements 50,000

Required: Net cost of investment is _____________.

Answer: P419,000
Cash purchase price of machinery and equipment 300,000
Freight in 3,000
Installation cost 4,000
Cost of labor and materials to be used in test runs 62,000
Working capital requirements 50,000
Net cost of investment 419,000

2. The following data pertains to a project being proposed:


Investment P100,000
Cash returns Scrap
First year P40,000 P30,000
Second year 26,000 20,000

Third year 20,000 10,000


Fourth year 10,000 4,000
Fifth year 6,000 1,000

Required:
a. Payback period_________
b. Payback bail-out period___________

Answer: Payback = 4.67 years, Payback bailout = 4 years

Investment 100,000
First year (40,000)
Second year (26,000)
Third year (20,000)
Fourth year (10,000)
Fifth year (4,000/6,000=0.67) ( 4,000)

End of first year (40,000 + 30,000) 70,000


End of second year (40,000 + 26,000 + 20,000) 86,000
End of third year (40,000 + 26,000 + 20,000
+ 10,000) 96,000
End of fourth year (40,000 + 26,000 + 20,000
+ 10,000 + 4,000) 100,000

3. The following data pertains to a project being proposed:


Investment P60,000,000
Annual revenue 22,000,000
Annual out-of-pocket operating expenses 15,000,000
Income tax rate 30%
Economic life of asset 10 years

Required:
a. Compute the net accounting income____________
b. Compute the net cash inflows.____________
c. Compute the accounting rate of return.__________
d. Compute the payback period.___________

Answer: NI = 700,000; NCI 6,700,000; ARR = 11.67%; PP = 8.96 years


Revenue 22,000,000
Operating expenses (15,000,000)
Depreciation (60,000/ 10 years) ( 6,000,000)
Net income before tax 1,000,000
Income tax (30%) 300,000
Net income after tax 700,000

ARR = 700,000/ 60,000,000 11.67%


Net income after tax 700,000
Depreciation 6,000,000
Net cash inflows 6,700,000
Payback period (60,000,000/ 6,700,000) 8.96 years

4. The following are extracted for two investment projects:


Case A Case B
Investment P50,000,000 P65,000,000
Cash returns:
Year 1 30,000,000 40,000,000
Year 2 40,000,000 38,000,000
Year 3 35,000,000 26,000,000
Year 4 22,000,000 25,000,000
Cost of money 18% 20%

Required: Compute the discounted payback period._____________

Case A
Investment 50,000,000
Year 1 (30M x 0.8475) 25,425,000
Year 2 (40M x 0.7182) 24,575,000 (24,575/ 28,728)
DPP = 1.855 years

Case B
Investment 65,000,000
Year 1 (40M x 0.8333) 33,332,000
Year 2 (38M x 0.6944) 26,387,200
Year 3 (26M x 0.5787) 5,280,800 (5,280,800/ 15,046,200)

5. Brand Corporation is considering five different investment opportunities. The


company’s cost of capital is 12%. Data on these opportunities under consideration are
given below: Profitability
Project Investment PV at 12% NPV IRR Index
A P35,000,000 P39,325,000 P4,325,000 16% 1.12
B 20,000,000 22,930,000 2,930,000 15% 1.15
C 25,000,000 27,453,000 2,453,000 14% 1.10
D 10,000,000 10,854,000 854,000 18% 1.09
E 9,000,000 8,749,000 (251,000) 11% 0.97
Required:
1. Rank these five projects in order of preference, according to:
- Net present value
- Internal rate of return
- Profitability index

2. Which ranking would you prefer?

Order of preference
NPV IRR PI
A 1 2 2
B 2 3 1
C 3 4 3
D 4 1 4
E 5 5 5

The profitability index approach is generally considered the most dependable


method of ranking projects competing for limited funds. It is an index of relative
attractiveness, measured in terms of how much you get out for each peso
invested.

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