Cap Budge and Cash F Exercise
Cap Budge and Cash F Exercise
Cap Budge and Cash F Exercise
EXERCISE
True or False
Choose the best answer or response by placing the identifying letter in the space provided.
____ 2. All of the following are limiting assumptions when dealing with discounted cash flows,
except:
a. cash flows are assumed to occur at the end of a period
b. cash flows are assumed to be reinvested immediately in another investment
project
c. cash flows are assumed to occur evenly during a period
d. reinvested cash flows are assumed to earn a rate of return at least as great as
the current discount rate
e. all of these responses are limiting assumptions
Peters Company is considering the purchase of a machine to further automate its production
line. The machine would costs P30,000, and have a ten-year life with no salvage value. It
would save P8,000 per year in labor costs, but would increase power costs by P1,000
annually. The cost of capital is 12%.
____ 3. The present value of the net annual cost savings would be:
a. P39,550
b. P45,200
c. P5,650
d. None of these
____ 4. The net present value of the proposed machine would be:
a. P(15,200)
b. P5,650
c. P9,550
d. None of these
____ 5. Acme Company is considering investing in a new machine which costs P84,900, and
which has a useful life of 12 years witch no salvage value. The machine will generate
P15,000 annually in net cash inflows. The time-adjusted rate of return on the
machine is
a. 8%
b. 10%
c. 12%
d. 14%
e. None of these
____ 6. White Company’s cost of capital is 12%. The company is considering an investment
opportunity that would yield a return of P10,000 in 5 years. What is the most that the
company would be willing to invest in this project?
a. P36,050
b. P 5,670
c. P17,637
d. P 2,774
e. None of these
____ 7. If a company uses its cost of capital to discount the cash flows associated with an
investment project, and if the resulting net present value is positive, then it can be
concluded that:
a. the company will earn a profit on a project equal to the net present value
b. the return on the investment exceeds the company’s cost of capital
c. the discount rate used is not the company’s true cost of capital
d. this project is clearly more desirable than the other possible uses of the
investment funds
e. none of these
9. An investment opportunity costing P200,000 is expected to yield net cash flows of P39,000
annually for eight years. The IRR of the investment is between
a. 10 and 12%.
b. 12 and 14%.
c. 14 and 16%.
d. 16 and 18%.
10. An investment opportunity costing P80,000 is expected to yield net cash flows of
P25,000 annually for four years. The cost of capital is 10%. The book rate of return
would be
a. 10.0%.
b. 12.5%.
c. 21.3%.
d. 32.0%.
Complete the Statements
True or False
1. T A commitment of funds for the purposes indicated represents an investment, since a
return is expected from the funds committed.
2. T When discounting a single sum, the shorter the time period, the greater the present
value.
3. F The process of computing present value is called discounting.
4. T This point is illustrated in Exhibit 14-1.
5. T This point is illustrated in Exhibit 14-6.
6. F if the present value of an investment project is zero, then it is providing a return equal
to the discount rate.
7. F Discounted cash flow methods automatically provide for recovery of original
investment, as illustrated in Exhibit 14-5.
8. T The cash flow occurs when equipment is purchased; depreciation is a bookkeeping
adjustment and involves no cash flow.
9. F A cash outlay for a working capital item represents an investment, the same as a cash
outlay for a machine; thus, it would be considered in a capital budgeting analysis.
10. T This statement is true by definition.
11. F Cash flows are assumed to occur at the end of a period.
12. T This statement is true by definition; the principle involved is illustrated in Exhibit 14-7.
13. F The project’s time-adjusted rate of return can still be computed, but it must be done by
trial and error process.
14. F Depreciation is not an out-of-pocket cost, since an out-of-pocket cost involves a cash
outflow such as for salaries or rent.
15. T This statement is true by definition; the cost of capital represents the “cutoff” or
“hurdle” rate.
Multiple Choice
1. c To be acceptable, all projects must provide a return on the original investment. In the
case of depreciable assets, the asset will be used up at the end of its life; therefore,
the returns provided must be great enough to provide a return of the original
investment in the asset as well as a return on this investment.
2. c As stated in response (a), cash flows are assumed to occur at the end of the period.
P84,900.00 = 5.660
P15,000.00
A factor of 5.660 is equals a return of 14% from the 12-year row in Table 4
7. b If the net present value of a project is positive, then the return promised by that project
is greater than the discount rate that has been used in the present value
computations. Since in the case at hand the discount rate was the company’s cost of
capital, the return promised by the project exceeds the cost of capital.
Year 18%
Item (s) Amount Factor Present Value
Working capital invested now (P30,000.00) 1.000 (P30,000.00)
Cash inflow 1-6 10,000.00 3.498 34,980.000
Working capital
released 6 30,000.00 0.370 11,100.000
Net present value 16,080.000
9. a
10. b
1. Compute the net income = P25,000-(80,000/4) = P5,000
2. Ave, capital = P80,000/2 = P40,000
3. Book Rate of Return = NI/Ave. Capital = 5,000/40,000 = 12.5%