CAPITAL BUDGETING THEORIES

1. The accounting area in which the only objective of depreciation accounting relates to the effect
of depreciation charges upon tax payments is
a. Capital budgeting
b. Cost volume profit analysis
c. Income determination
d. Responsibility accounting
A
2. The method of project selection which considers the time value of money in a capital budgeting
decision is accomplished by computing the
a. Accounting rate of return on average investment
b. Accounting rate of return initial investment
c. Discounted cash flow
d. Payback period
C
3. For a project such as a plant investment, the return that should leave the market price of the
firms stock unchanged is known as the
a. Cost of capital
b. Net present value
c. Payback period
d. Discounted rate of return
A
4. Which of the following capital expenditure planning and control techniques has been criticized
because, it might mistakenly imply the earnings are reinvested at the rate of return earned by
the investment?
a. Payback period
b. Accounting rate of return
c. Net present value method
d. Time adjusted rate of return
D
5. Which of the following capital expenditure planning and control techniques has been criticized
because it fails to consider investment profitability?
a. Payback method
b. Accounting rate of return
c. Net present value method
d. Time adjusted rate of return
A

6. An advantage of using payback method of evaluating capital budgeting alternatives is that

payback is
a. Precise in estimates of profitability
b. Easy to apply
c. Based on non-cash flow data
 d. Insensitive to the file of the project(s) considered
B
7. The minimum return that a project must earn for a company in order leave the value of the
company unchanged is the
a. Current borrowing rate
b. Discount rate
c. Cost of capital
d. Capitalization rate
C
8. The weighted average cost of capital approach to decision making is not directly affected by the
a. Value of the common stock
b. Current budget ton expansion
c. Cost of debt outstanding
d. Proposed mix of debt, equity, and existing funds used
B
9. If the sum of the present values of all future cash flows related to proposed capital expenditure
discounted at the companys cost of capital is positive, it indicates that the
a. Resultant amount is the maximum that should be paid for the asset
b. Return on the investment exceeds the companys cost of capital
c. Investment is the nest alternative
d. Discount rate used is the proper cost of capital
B
10. In order for a project to be acceptable to a company using the cost of capital method of analysis,
the return on invested capital must
a. At least equal the amount of cash to cover interests and principal payments for any debt
obtained to finance the project
b. Generate sufficient capital to pay for itself within the economic life of the assets committed
to the project
c. At least equal to the return on invested capital currently being generated by the company
d. Generate sufficient capital resources to justify any additional capital expenditures and
reduce idle capacity within the company.
C

11. What capital budgeting method assumes that funds are reinvested at the companys cost of
capital?
a. Payback method
b. Accounting rate of return
c. Net present value method
d. Time adjusted rate of return
C
12. Which capital budgeting methods require the use of present value table?
a. Net present value and Time adjusted rate of return
b. Payback and Accounting rate of return
 c. Accounting rate of return and Time adjusted rate of return
d. Accounting rate of return and Time adjusted rate of return and payback method
A
13. Which of the following best identifies the reason for using probabilities in capital budgeting
decisions?
a. Uncertainty
b. Cost of capital
c. Time value of money
d. Projects with unequal lives
A
14. The net present value of a proposed project represents the
a. Cash flow less the present value of the cash flows
b. Cash flow less the original investment
c. Present value of the cash flows plus the present value of the original investment
d. Present value of the cash flows less original investment
D
15. The effectiveness of the net present value, method has been questioned as an evaluation
technique for capital budgeting decisions on the basis that
a. Predicting future cash flows is often difficult and clouded with uncertainties
b. The accounting rate of return method is usually more accurate and useful
c. The payback technique is theoretically more reliable
d. The computation involves some difficult mathematical applications that most accountants
cannot perform
A
16. The payback method measures
a. How quickly investment pesos may be recovered
b. The cash flow from an investment
c. The economic life of an investment
d. The profitability of an investment
A

17. A capital budgeting technique that explicitly, incorporates an estimated interest rate into its basic
computations is the
a. Accounting book value method
b. Payback method
c. Net present value method
d. Average rate of return method
C
18. When using one of the discounted cash flow methods to evaluate the desirability of a capital
budgeting project, which of the following factors generally is not important?
a. The method of financing the project under consideration
b. The time of cash flows relating to the project
c. The impact of the project on income taxes to be paid
d. The amount of cash flows relating to the project
A
19. Sensitivity analysis is used in capital budgeting to quantify the
a. Amount that an assumed factor used in evaluating a project could be varied and still produce
acceptable results
b. Reaction within the marketplace to a new product
c. Type of capital that will have to be committed to an anticipated project
d. Relationship between the payback period and the economic lives of the assets used in a
project
A
20. How are the following used in the calculation of the net present value of a proposed project?
Ignore income tax considerations
DEPRECIATION EXPENSE SALVAGE VALUE
a. Include include
b. Include exclude
c. Exclude include
d. Exclude exclude
C
21. Which of the following capital budgeting techniques require the use of cash flows from period to
period?
INTERNAL RATE OF RETURN NPV
a. Yes yes
b. Yes no
c. No yes
d. No no
A

22. Which of the following is necessary in order to calculate the payback period of a project?
a. Useful life
b. Minimum desired rate of return
c. Net present value
d. Annual cash flow
D
23. On what basis is the cost of capital derived from bonds and preferred stock measured,
respectively?
a. Pre tax rate of interest for bond and stated annual dividend rate less the expected earnings
per share for preferred stock
b. Pre tax rate of interest for bond and stated annual dividend for preferred stock
c. After tax rate of interest for bonds and stated annual dividend rate less the expected
earnings per share for preferred stock
d. After tax rate of interest for bonds and stated annual dividend rate for preferred stock
D
24. On May 1, 2004, a company purchased a new machine that it does not have to pay until May 1,
2016. The total payment on May 1, 2006, will include both principal and interest. Assuming
 interest at a 10% rate, the cost of the machine would be the total payment multiplied by what
time value of money concept?
a. Future amount of annuity of 1
b. Future amount of 1
c. Present value of annuity of 1
d. Present value of 1
D
25. On May 1, 2004, a company sold some machinery to another company. The two companies
entered into an installment sales contract at a predetermined interest rate. The contract
required five equal annual payments with the first payment due on May 1, 2004. What present
value concept is appropriate for this situation?
a. Present value of annuity due of 1 for five periods
b. Present value of ordinary annuity of 1 for five periods
c. Future amount of annuity of 1 for five periods
d. Future amount of 1 for five periods
A
26. If 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
A
27. It is assumed that cash flows are reinvested at the rate earned by the investment in which of the
following capital budgeting techniques?
INTERNAL RATE OF RETURN NPV
a. Yes yes
b. Yes No
c. No No
d. No Yes
B
28. The discount rate (hurdle rate of return) must be determined advance for the
a. Internal rate of return method
b. Net present value method
c. Payback period method
d. Time adjusted rate of return
B
29. The present value capital budgeting technique can be used when cash flows from period to
period are
UNIFORM UNEVEN
a. No Yes
b. No No
c. Yes No
d. Yes Yes
D
30. If income tax considerations are ignored, how is depreciation expense used in the following
capital budgeting techniques?
INTERNAL RATE OF RETURN NPV
a. Excluded excluded
b. Excluded included
c. Included excluded
d. Included included
A

CAPITAL BUDGETING PROBLEMS

1.Kipping Company invested in an eight year project. It is expected that the annual cash flow from
the project net of income taxes will be 20, 000. Information on present value factors is as
follows:
Present value of 1 at 12% for eight periods 0. 404
Present value of an annuity of 1 in arrears at 12% for eight periods 4. 968

Assuming the Kipping based its investment decision on an interest rate of 12%, how
much did the project cost?
a. 60, 000
b. 99, 360
c. 80, 800
d. 64, 640
B. present value of cash flow net of income taxes: (20, 000 x 4. 968) = 99, 360
The cost of the investment is 99, 360

ITEMS 2 AND 3 ARE BASED ON THE FOLLOWING INFORMATION:

Hanley company purchase a machine for125, 000 which will be depreciated on the
straight line basis over a five year period with no salvage value. The related cash flow from
operations, net of income taxes, is expected to be 45, 000, a year. Assume that Hanleys effective
income tax rate is 40% for all years.

2.What is the payback period?

a. 2. 1 years
b. 2. 3 years
c. 2. 8 years
d. 4. 2 years
C. Payback period: (125, 000 / 5years) = 2. 8 years
 3.What is the accounting (book value) rate of return on the initial increase in required investment?
a. 16%
b. 24%
c. 28%
d. 36%
A. accounting rate of return = 45, 000 (125, 000/5 years) = 16%
4.On January 1, 2004, Stud Company purchased a new machine for 100, 000 with an estimated
useful life of five years and no salvage value. For book and tax purposes, the machine will be
depreciated using the straight line method and it is expected to produce annual cash flow from
operations, before income taxes, of 240, 000. Assume that Stud uses a time adjusted rate of 12%
and that its income tax rate will be 40% for all years. The present value of 1 at 12% for five
periods is 0. 57; and the present value of an ordinary annuity of 1 at 12% for five periods is 3. 61.
The net present value of the machine should be
a. 15, 520 positive
b. 15, 520 negative
c. 14, 000 positive
d. 13, 680 negative
A. annual cash flow before taxes 40, 000 40, 000
Less: depreciation : (100, 000 / 5) 20, 000
Taxable income 20, 000
Income tax x 40% (8, 000)
Annual cash flow after taxes 32, 000
Present value of cash flow after taxes (32, 000 x 3. 61) = 115, 520
Initial investment 100, 000
Net present value- positive 15, 520
5.Hamilton Company invested in a two year project having an internal rate of return of 12%. The
project is expected to produce cash flow from operations, net of income taxes, of 60, 000 in the
first year and 70, 000 in the second year. The present value of 1 for one period at 12% is 0.893
and for two periods at 12% is 0.797. How much will be the project cost?
a. 103, 610
b. 109, 370
c. 116, 090
d. 122, 510
B. total present value (60, 000 x 0.893) + (70, 000 x .797) = 109, 370
The cost of the project is 109, 370 based on an internal rate of return of 12%
6.Womack Company purchased a new machine on January 1, 2004 for 90, 000 with an estimated
useful life of five years and a salvage value of 10, 000. The machine will be depreciated using the
straight line method. The machine is expected to produce cash flow form operations, net of
income taxes, of 36, 000 a year in each of the next five years. The payback period would be
a. 2.2 years
b. 2. 5 years
 c. 4. 0 years
d. 4. 5 years
B. PAYBACK PERIOD = 90, 000 / 36, 000 = 2.5 years
7.An office equipment representative has a machine for sale or lease. If you buy the machine, the
cost amounts to 75, 960. If you lease the machine you will have to sign a non cancellable lease
and make 5 payments of 20, 000 each. The first payment will be paid on the first day of the
lease. At the time of the last payment you will receive title to the machine. The present value of
an ordinary annuity of 1 is as follows:
PRESENT VALUES AT
No. of periods 10% 12% 16%
1 0. 909 0.893 0.802
2 1. 736 1.690 1. 605
3 2. 487 2. 402 2. 246
4 3. 170 3. 037 2. 198
5 3. 791 3. 650 3. 274

The interest rate implicit in this lease is approximately

a. 10%
b. 12%
c. Between 10% and 12%
d. 16%
D. Annuity (payback) factor: 75, 960 / 20, 000 = 3. 798
The problem is based on annuity due because the first payment is made at the 1 st day.
Factor 3. 798 for five payments is based on ordinary annuity. To convert ordinary
annuity to annuity (due in advance), take one period less and add 1. 000. At 16% for 4
periods, the factor is 2. 798 add 1.000 = 3. 798. Therefore the interest rate is 16%.

ITEMS 8 AND 9 ARE BASED ON THE FOLLOWING INFORMATION:

Fleming inc. is planning to acquire a new machine at a total cost of 360, 000. The
estimated life of the machine is six years with no salvage value. The straight line method of depreciation
will be used. Fleming estimates that the annual cash flow from operations, before income taxes, from
using this machine amounts to 90, 000. Assume that Flemings cost of capital is 8% and the income tax
rate is 40%. The present value of 1 at 8% for six years is 0. 630. The present value of an annuity of 1 in
arrears at 8% for six years is 4. 623

8.What would be the payback period for the machine?

a. 4 years
b. 4. 6 years
c. 5. 7 year
d. 6.7 year
B. annual cash flow before taxes 90, 000 90, 000
 Less: depreciation : (100, 000 / 5) 60, 000
Taxable income 30, 000
Income tax x 40% (12, 000)
Annual cash flow after taxes 78, 000

Payback period 360, 000 / 78, 000 = 4. 6 years

9. What would be the net present value?

a. 590
b. 56, 070
c. 108, 000
d. 131, 400
A. present value of cash flow after taxes: (78, 000 x 4. 623) 360, 590
Cost of machine 360, 000
Net present value 590

10. Rosa Company is planning to invest 40, 000 in a three year project. Rosas expected rate
of return is 10%. The present value of 1 at 10% for one year is .909, for two years is .826, and the
three years is .751. the cash flow, net of income taxes, will be 15, 000 for the first year (present
value of 13, 635) and 18, 000 for the second year (present value of 14, 868). Assuming the rate is
exactly 10%. What would the cash flow, net of income taxes, be for the third year?
a. 8, 634
b. 11, 000
c. 11, 497
d. 15, 309
D. cost of investment 40, 000
Present value of cash flows, net of tax: year 1 13, 635
Year 2 14, 868 28, 503
Present value of cash flows year 3 11, 497
Present value of 1 for 3 years / 0. 751
Cash flow, net of income taxes- year 3 15, 309

11. The Jennings Company is planning to acquire a new machine. The payback period will be
six years. The cash flow from operations, net of income taxes, will be 20, 000 a year for each
of the first three years of the payback period and 30, 000 a year of the last three years of the
payback period. Depreciation of 15, 000 a year will be charged to income for each of the six
years of the payback period.
How much will the machine cost?
a. 150, 000
b. 120, 000
c. 90, 000
d. 60, 000
 A. cash flow, net of tax: year 1-3 (20, 000 x 3) 60, 000
Year 4 -6 (30, 000 x 3) 90, 000
Cost of machine 150, 000

12. The herb Company acquired a new machine for 160, 000, which will be depreciated on a
straight line basis over ten year period. A full years depreciation was taken in the year of
acquisition. The accounting (book value) rate of return is expected to be 12% on the initial increase
in required investment. If we assume a uniform cash inflow, the annual cash flow from operations,
net of income taxes, will be
a. 3, 200
b. 17, 280
c. 19, 200
d. 35, 200
D. accounting rate of return = *x (160, 000 / 10) = 12%
160, 000
*x 16, 000 = 19, 200
X = 35, 200 * annual cash flow

13. Fillmore, Inc. is planning a project that will cost 220, 000. The annual cash inflow net of
income taxes, will be 50, 000 a year for seven years. The present value of 1 at 12% is as
follows:
PERIOD PV OF P1 AT 12%
1 .893
2 .797
3 .712
4 .636
5 .567
6 .507
7 .452
Using a rate of return of 12%, what is the present value of the cash flow generated by
this project?
a. 226, 000
b. 228, 200
c. 341, 800
d. 350, 000
B. present value of cash flows net of tax: (50, 000 x 4. 564*) = 228, 200
(.893 +. 797 + .712 +.636 +.567 +.507 +.452) = 4.564*

14. Ludwig Inc. purchased a new machine on January 1, 1998 for 350, 000. The machine is expected
to have a useful life of 8years and no salvage value. Straight line depreciation is to be used. The
present value of the cash flow generated by the machine was calculated to be 371, 120 using a
 time adjusted rate of return of 14%. The present value of an ordinary annuity of 1 in arrears for 8
periods at 14% is 4. 639. The present value of 1 for 8 periods at 14% is 0. 351.
What was the annual cash flow, net of income taxes, that was used in the calculation of the
present value?
a. 122, 850
b.75, 447
c. 130, 263
d. 80, 000
D. PRESENT VALUE OF CASH FLOW AT 14% 371, 120
Present value of an annuity of 1 for 8 periods / 4. 639
Annual cash flow 80, 000

15. Maxwell Company has an opportunity to acquire a new machine to replace one of its present
machines. The new machine would cost 90, 000, have a five year life, and no Estimated salvage
value. Variable operating costs would be 100, 000 per year. The present machine has a book
value of 50, 000 and a remaining life of five years. Its disposal value now is 5, 000 but it would be
zero after five years. Variable operating costs would be 125, 000 per year. Ignore present value
calculations and income taxes.
Considering the five years in total, what would be the difference in profit before income
taxes by acquiring the new machine as opposed to retaining the present one?
a. 10, 000 decrease
b. 15, 000 decrease
c. 35, 000 increase
d. 40, 000 increase
D. net cost of new machine (90, 000 85, 000) 85, 000
Operating costs: (100, 000 x 5) 500, 000
Total 585, 000
Operating costs of old machine (125, 000 x 5) 625, 000
Increase in profit 40, 000

ITEMS 16 AND 17 ARE BASED ON THE FOLLOWING INFORMATION:

Heflin Inc. invested in a machine with a useful life of five years and no salvage value. The
machine was depreciated using the straight line method. The annual cash inflow from
operations, net of income taxes, amounts to 100, 000. The present value of an ordinary annuity
of 1 in arrears for five periods at 12% is 3. 605. The present value of 1 for five periods as 12% is
0. 567.

16. Assuming that Heflin used a time adjusted rate of return of 12%, what was the amount of the
original investment?
a. 283, 500
b. 360, 500
c. 440, 000
d. 567, 000
 B. original investment : (100, 000 x 3. 605) = 360, 500

17. Assuming that the minimum desired rate of return on this investment was 12% and the amount
of the original investment was 350, 000, what would be the net present value?
a. 0
b. 10, 500
c. 19, 800
d. 5, 670
B. present value of cash flows, net of taxes (100, 000 x 3. 605) 360, 500
Initial investment 350, 000
Net present value 10, 500

18. Coral, Inc. recently acquired a machine at a cost of 64, 000. It will be depreciated on a straight
line basis over eight years with no estimated salvage value. Coral estimates that this machine will
produce annual net cash flow (before income taxes) of P18,000. Assuming an income tax rate of 50%,
what is the approximate payback period on this investment?
a. 3.6 years b. 4.9 years c. 7.1 years d. 12.8 years
B. annual cash flow before taxes 18, 000 18, 000
Less: depreciation : (64, 000/ 8) 8, 000
Taxable income 10, 000
Income tax x 50% (5, 000)
Annual cash flow after taxes 13, 000

Payback period 64, 000 / 13, 000 = 4. 9 years

19. Freedom corporation acquired a fixed asset at a cost of P100,000. The estimated life was four
years and there was no estimated salvage value. Assume a relevant interest rate of 8% and an income
tax rate of 40%. The present value of 1 at 8% is as follows:
No. of periods Present value No. of periods Present value
1 .926 3 .794
2 .857 4 .735
What is the present value of the tax benefits resulting from using the sum of the years digits
depreciation as opposed to straight-line depreciation on this asset?
a. 0 b. 1908 c. 1272 d. 3180
C. Year syd s.line difference tax effect* pv factor p. value
1 40, 000 25, 000 15, 000 6, 000 .926 5556
2 30, 000 25, 000 5, 000 2, 000 .857 1714
3 20, 000 25, 000 (5, 000) (2, 000) . 794 (1, 588)
4 10, 000 25, 000 (15, 000) (6, 000) .735 (4, 410)
TAX BENEFITS SYD 1, 272
*DIFFERENCE X 40% TAX RATE
20. George Company is planning to acquire a new machine at a total cost of P306,,000. The
estimated life of the machine is 6 years and the estimated salvage value is P6,000.. George Company
estimates annual cash savings from using this machine will be P80,000. Assume the companys cost
of capital is 8% and its income tax rate is 40%. Present value of 1 for 6 years is .630. the present
value of an annuity of 1 in arrears at 8% for 6 years is 4.623. what are the annual after tax cash
benefits of this investment?
a. P30.000 b. P48,000 c. P54,000 d. P68,000
D. annual cash flow before taxes 80, 000 80, 000
Less: depreciation : (306, 000 6, 000/ 6) 50, 000
Taxable income 30, 000
Income tax x 40% (12, 000)
Cash savings after taxes 68, 000

21. Assuming the same information as in no.20, if the annual after tax net cash benefits of
investment were P50,000 what would the net present value of this investment be?
a. P74,850 negative c. P71,070 positive
b. P71,070 negative d. P74,850 positive
B. present value of annual cash savings (50, 000 x 4. 623) 231, 150
Present value of salvage value (6, 000x .630) 3, 780
Total present value 234, 930
Initial investment 306, 000
present value - negative (71, 070)

22. Assuming the same information in no.20, if the annual after tax net cash benefits of the
investment were P50,000, what would be the payback period?
a. 6 years b. 6.12 years c. 5.5 years d. 4.4 years
B. payback period ( 306, 000 / 50, 000) = 6. 12 years

23. Jarvis Inc., a calendar year company , purchased a new machine for P280,000 on January 1,
2004. The machine has an estimated useful life of 8 years with n o salvage value and is being
depreciated using the straight line method. The accounting (book value) rate of return is expected to
be 15% on the initial increase in required investment.

On the assumption of a uniform cash inflow, this investment is expected to provide annual cash
flow from operations, net of income taxes, of
a. 35, 000
b. 40, 250
c. 42, 000
d. 77, 000
D. Accounting rate of return : * x ( 80, 000/ 8) = 15%
280, 000
*x 35, 000 42, 000 x= 77, 000 annual cash flow
24. Energy company is planning to spend 840, 000 for a new machine which it will depreciate on the
straight line basis over ten years with no salvage value. The related cash flow operations, net of
income taxes, is expected to be 100, 000 a year for each of the first six years, and 120, 000 for each
of the next four years

What is the payback period?

a. .4.4 years b. 7. 6 years c. 7. 8 years d. 8 years
D. Cash flow net of tax; year 1-6 (100, 000 x 6) 600, 000
Year 7-8 (120, 000 x 2) 240, 000
Equal to initial investment 840, 000

Therefore the payback period is = 8 years

25. Hilltop Company invested 100, 000 in a two year project. Hilltops expected rate of return was
12%. The cash flow, net of income taxes, was 40, 000 for the first year. Information on present value
and future value factors is as follows:
PRESENT VALUE FUTURE VALUE
PERIOD OF 1 AT 12% OF 1 AT 12%
1 .8929 1.1200
2 .7972 1.2544

Assuming that the rate f return was exactly 12%, what was the cash flow, net of income
taxes, for the second year of the project?
a. 51, 247
b. 50, 000
c. 64, 284
d. 80, 638
D. initial investment 100, 000
Present value of cash flow year 1(40, 000 x .8929) 35, 716
Present value of cash flow year 2 64, 284
To convert to future value of year 2 cash flow x 1.2544
Cash flow year 3 80, 638

26. The bread company is planning to purchase a new machine that will depreciate on straight line
basis over a ten year period. A full years depreciation will be taken in the year of acquisition. The
machine is expected to produce cash flow net of income taxes 0f 30, 000 in each of the ten years.
The accounting (book value) rate of return is expected to be 10% on the initial increase in required
investment. The cost of the new machine will be
a. 120, 000
 b. 135, 000
c. 150, 000
d. 300, 000
C. Cost of machine: 30, 000 (x/ 10) = 10%
X*
.10x = 30, 000 (x / 10)
.20 x = 30, 000 x = 150, 000 *cost of machine

27. The Polar company is planning to purchase a new machine for P300,000. The payback period is
expected to be five years. The new machine is expected to produce cash flow from operations, net of
income taxes, of P70,000 a year in each of the next three years and P55,000 in the fourth year.
Depreciation of P50,000 a year will be charged to income for each of the five years of the payback
period.

What is the amount of cash flow from operations, net of taxes, that the new machine is expected to
produce in the last (fifth) year of the payback period?
a. P10,000 b. P35,000 c. P50,000 d. P85,000
B. initial investment 300, 000
Cash flows: year 1-3 (7,000 x 3) 210, 000
Year 4 55, 000 265, 000
CASH FLOW YEAR 5 35, 000

28. SM Supply is considering the purchase of a new machine. The expected after tax cash flows are
listed as follows:
Year Cash flows after taxes
1 P20,000
2 30,000
3 30,000
4 20,000
5 10,000

If SM requires a target rate of 18% on investment of this type, the maximum SM should pay for this
machine is
a. P110,000 b. P120,000 c. P65,660 d. P71,440
D. Year PV * AT 18% CASH FLOWS PRESENT VALUE
1 .847 20, 000 16, 940
2 .718 30, 000 21, 540
3 .609 30, 000 18, 270
4 .516 20, 000 10, 320
5 . 436 10, 000 4, 360
SM SHOULD PAY 71, 430
*REFER TO PRESENT VALUE TABLE:
29. Oriental Books is considering the purchase of a new binding equipment that will reduce
operating costs. The cost of the equipment will be P170,000, which will be depreciated straight-line
over five-years to a zero salvage value. Sales are expected to increase P65,000 per year, with an
expected cash flow earnings before depreciation and, taxes/sales ratio of 60%.

The tax rate is 40%, after-tax cash flows from the project are expected to be
a. P25,000 b. P15,000 c. P15,000 P29,000
D. annual cash flow before taxes(65, 000 X 60%) 18, 000 18, 000
Less: depreciation : (70, 000/ 5) 8, 000
Taxable income 10, 000
Income tax x 50% (5, 000)
Annual cash flow after taxes 13, 000

30. The Top Company is considering to purchase a new truck that will cost P700,000 and will be
depreciated over five years . The new truck will replace another that has a book value of P450,000
and five years useful life remaining. The old truck can be sold for P400,000. The current tax rate is
35%.

The net initial investment for the new truck is

a. P300,000 b. P250,000 c. P282,500 d. P317,500