POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

Sta. Mesa, Manila

MANAGEMENT ACCOUNTING PART 2

Quiz 2 Final Term – Capital Budgeting
September 2018

NAME: _________________________________________ SECTION _______________ SCORE: _______

For Multiple-Choice-Questions, kindly ENCIRCLE the letter of the best answer.

THEORIES (1 point each)

1. Qualitative issues could increase the acceptability of a project under which of the following conditions?
a. The IRR is less than the company’s rate of return.
b. The project has a negative NPV.
c. The payback period is longer than the company’s cutoff period
d. All of the above.

2. Which of the following capital budgeting techniques does not routinely rely on the assumption that all
cash flows occur at the end of the period?
a. Internal rate of return c. Profitability index
b. Net present value d. Payback period

3. The technique most concerned with the liquidity is:

a. NPV c. Accounting Rate of Return
b. IRR d. Payback

4. If there were no income taxes,

a. depreciation would be ignored in capital budgeting
b. the NPV method would not work
c. income would be discounted instead of cash flow
d. all potential investments would be desirable

5. If income tax considerations are ignored, how is depreciation handled by the following capital
budgeting technique?
IRR ARR Payback
a. Excluded Excluded Included
b. Excluded Included Excluded
c. Included Excluded Included
d. Included Included Included

6. The discount rate that equates the present value of the expected cash flows with the cost of the
investment is the
a. Payback Period and Internal Rate of Return
b. Net Present Value and Internal Rate of Return
c. Internal Rate of Return and Modified Internal Rate of Return
d. Accounting and Internal Rate of Return and Modified Internal Rate of Return

7. Statement 1: Both the net present value method and the internal rate of return method can be used
as a screening tool in capital budgeting decisions
Statement 2: When considering a number of investment projects, the project that has the best
payback period will also always have the highest net present value.

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 a. True, True c. False, False
b. True, False d. False, True

8. Some investment projects require that a company increase its working capital. Under the net present
value method, the investment and eventual recovery of working capital should be treated as:
a. a future cash inflow
b. an initial cash outflow
c. irrelevant to the net present value analysis
d. both an initial cash outflow and a future cash inflow

9. Statement 1: In calculating payback where new equipment is replacing old equipment, any
salvage value to be received on disposal of the old equipment should be deducted from the cost of the
new equipment.
Statement 2: When cash flows are uneven and vary from year to year, the internal rate of return
method is easier to use than the net present value method
a. True, True c. False, False
b. True, False d. False, True

10. Many firms use the payback method as a guideline in capital investment decisions. Reasons they do
so include all of the following except
a. it gives an implicit consideration to the timing of cash flows
b. it recognizes cash flows which occur after the payback period
c. it is a measure of risk exposure
d. it is easy to calculate

11. The payback method assumes that all cash inflows are reinvested to yield a return equal to
a. The discount rate. c. The internal rate of return.
b. The hurdle rate. d. Zero.

12. As to a capital investment, net cash inflow is equal to the

a. Cost savings resulting from the investment.
b. Sum of all future revenues from the investment.
c. Net increase in cash receipts over cash payments.
d. Net increase in cash payments over cash receipts.

13. The time value of money is considered in long-range investment decisions by

a. Investing only in short-term projects.
b. Assuming equal annual cash flow patterns.
c. Assigning greater value to more immediate cash flows.
d. Ignoring depreciation and tax implications of the investment.

14. Which of the following is true of an investment?

a. The lower the cost of capital, the higher the NPV
b. The lower the cost of capital, the higher the IRR
c. The longer the project's life, the shorter its payback period
d. The higher the project's NPV, the shorter its life

15. I will become a CPA

a. in God’s time
b. on May 2019
c. if I will focus and give my best
d. all of the above

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PROBLEMS (2 points each)

16. An investment opportunity costing P150,000 is expected to yield net cash flows of P45,000 annually for
five years. The cost of capital is 10%. The book rate of return would be
a. 10% b. 20% c. 30% d. 33%

17. An investment opportunity costing P150,000 is expected to yield net cash flows of P36,000 annually for
six years. The NPV of the investment at a cutoff rate of 12% would be
a. P(2,004) c. P150,000
b. P2,004 d. P147,996

18. An investment opportunity costing $100,000 is expected to yield net cash flows of $22,000 annually for
seven years. The payback period of the investment is
a. 0.22 years c. 4.55 years
b. 3.08 years d. some other number

19. Evaluate the following projects using the payback method assuming a rule of 3 years for payback

Year Project A Project B

0 -10,000 -10,000
1 4,000 4,000
2 4,000 3,000
3 4,000 2,000
4 0 1,000,000

a. Both projects can be accepted because the payback is less than 3 years.
b. Project B should be accepted because you get more money paid back in the long run.
c. Project A can be accepted because the payback period is 2.5 years but Project B cannot be accepted
because its payback period is longer than 3 years
d. Project B should be accepted because even though the payback period is 2.5 years for project A
and 3.001 project B, there is a P1,000,000 payoff in the 4th year in Project B

20. Should ABC Mining company accept a new project if its maximum payback is 3 years and its initial
after tax cost is P5,000,000 and it is expected to provide after-tax operating cash inflows of P1,800,000
in year 1, P1,900,000 in year 2, P700,000 in year 3 and P1,800,000 in year 4?
a. Yes, payback period is 3.33 years
b. No, payback period is less than 3 years
c. Yes, payback period is less than 3 years
d. No, payback period is more than 3 years

A firm must choose from six capital budgeting proposals outlined below. The firm is subject
to capital rationing and has a capital budget of P1,000,000; the firm's cost of capital is 15 percent
Project Initial Investment IRR (%) NPV
1 P 200,000 19 P 100,000
2 400,000 17 20,000
3 250,000 16 60,000
4 200,000 12 (5,000)
5 150,000 20 50,000
6 400,000 15 150,000

21. Using the internal rate of return approach to ranking projects, which projects should the firm accept?
a. 1, 2, and 5 c. 1, 2, 3, 5, and 6
b. 1, 2, 3, and 5 d. 1, 2, 3, 4, 5, and 6

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22. Using the net present value approach to ranking projects, which projects should the firm accept?
a. 1, 3, and 6 c. 1, 2, 3, 5, and 6
b. 1, 3, 5, and 6 d. 1, 2, 3, 4, 5 and 6

23. What is the profitability index of Project 4?

a. -1.025 c. 0.975
b. 0.025 d. 1.025

24. Using profitability index to rank, which project would be the most preferred?
a. Project 1 c. Project 4
b. Project 2 d. Project 6

Projects are mutually exclusive.

Project A Project B
Initial End of Year Initial End of Year
Investment Cash Flows Investment Cash Flows

400,000 200,000 900,000 400,000

200,000 400,000
200,000 800,000

25. The new financial analyst does not like the payback approach and determines that the firm's required
rate of return is 15 percent. Using NPV approach, his recommendation would be to
a. reject both c. accept project A and reject B
b. accept projects A and B d. reject project A and accept B

26. Using profitability index, what would be his recommendation?

a. reject both c. accept project A and reject B
b. accept projects A and B d. reject project A and accept B

27. If the firm has a required discounted payback of two (2) years, it should
a. accept both c. accept project A and reject B
b. reject both d. reject project A and accept B

Porky, Inc. bought a piece of machinery with the following data:

Useful life 6 years

Yearly net cash inflow P45,000
Salvage value –0–
Internal rate of return 18%
Cost of capital 14%

28. The initial cost of the machinery was

a. P157,392.
b. P165,812.
c. P174,992.
d. Impossible to determine from the information given.

29. Adidas Co. is considering the purchase of a new ocean-going vessel that could potentially reduce labor
costs of its operation by a considerable margin. The new ship would cost P500,000 and would be fully
depreciated by the straight-line method over ten years. At the end of ten years, the ship will have no
value and will be sunk in some already polluted harbor. Adidas Co.’s cost of capital is 12%, and its
marginal tax rate is 40%. If the ship produces equal annual labor cost savings over its ten-year life,

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 how much do the annual savings in labor costs need to be to generate a net present value of P0 on the
project? (Note: Round to the nearest peso.)
a. P68,492 c. P114,154
b. P88,492 d. P147,487

30. Toyota Co. is considering an investment in a machine that would reduce annual labor costs by
P30,000. The machine has an expected life of ten years with no salvage value. The machine would be
depreciated according to the straight-line method over its useful life. Assume the company pays
P250,000 for the machine. What is the expected internal rate of return on the machine?
a. Less than 1% d. Between 17% and 18%
b. Between 3% and 4%
c. Between 8% and 9%

CASES (2 points each)

Norcio plans to purchase a piece of equipment which amounts to P300,000 in accordance with an
investment proposal from a member of his staff. If the equipment is bought, it is expected to generate an
annual cash inflow of P70,000 throughout the useful life of 10 years. A five year payback period is acceptable to
Norcio.

Payback:
1. What is the payback reciprocal? _____________________
2. After 3 years, how much, in percent of investment, would already be recovered? Ignore time value of
money. _____________________

3. What is the accounting rate of return? _____________________

Discounted Payback:
4. If the cost of capital is 10%, what is the discounted payback period (DPB)? _____________________
5. If the cost of capital is 8%, what is the Net Present Value? _____________________
6. If the cost of capital is 9%, profitability index? _____________________

Mr. Lo plans to purchase a piece of equipment which amounts to P400,000 in accordance with an
investment proposal from a member of his staff. If the equipment is bought, during the useful life of 10 years, it
is expected to generate cash inflow as shown below. A five year payback period is acceptable to Mr Lo.

Year Cash Inflow

1 P70,000
2 80,000
3 90,000
4 90,000
5 80,000
6 80,000
7 – 10 70,000

7. What is the payback period? _____________________

8. What is the average or accounting rate of return? _____________________
9. If the cost of capital is 12%, what is the discounted payback period (DPB)? _____________________
10. If the cost of capital is 10%, what is the Net Present Value? _____________________
11. If the cost of capital is 8%, profitability index? _____________________

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Internal Rate of Return and MIRR

Assume the following information from Kam’s Korner:

Initial Investment P220,000
Estimated life 10 years
Annual cash inflows P40,000
Cost of capital 12.0%

12. What is the IRR? Make sure to use 1% increment _____________________

If the IRR is 12.5% and the expected cash flow would be P20,000 each year, compute for the following.
(Use 4 decimal places for the present value factor)
13. The amount of initial investment is ______________________
14. What is its MIRR if WACC is 10%? ______________________
15. What is its MIRR if WACC is 15%? ______________________
16. What is its MIRR if WACC is 12.5%? ______________________

Mutually exclusive projects

Assume the following cash returns for Projects A and B with the cost of capital of 10%
Year Project A Project B ProjectC
0 (200,000) (250,000) (80,000)
1 30,000 40,000 40,000
2 40,000 60,000 30,000
3 50,000 80,000 20,000
4 70,000 100,000 10,000
5 80,000 100,000 10,000

17. Using Payback Period, which project would be most preferred? _____________________
18. What is the discounted payback period for Project B? _____________________
19. What is the NPV of Project A? _____________________
20. Using Profitability Index, which project would be least preferred? _____________________