Chapter 14 MAS agamata answer key.

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CHAPTER 14 CAPITAL BUDGETING [Problem 1] Purchase price Trade-in allowance Saving from repairs Additional tax on savings (P25,000 x 40%) Net cost of investment for decision analysis

P140,000 ( 7,000) ( 25,000) 10,000 P118,000

[Problem 2] Purchase price P4,800,000 Freight and installation 45,000 Trade-in allowance ( 200,000) Salvage value of other assets 12,000 Tax savings – other assets ( 8,000) Savings from repairs ( 400,000) Add’l tax on savings from repairs (P400,000 x 40%) 160,000 Additional working capital 350,000 Net cost of investment for decision analysis P4,759,000 [Problem 3] Purchase price Freight charge Installation costs Special attachment Add’l working capital Proceeds from sale of old assets Tax savings (P38,000 x 25%) Savings from repairs

P900,000 25,000 22,000 55,000 110,000 ( 22,000) ( 9,500) ( 120,000) Add’l tax on savings from repairs (P120,000 x 25%) 30,000 Net cost of investment for decision analysis P990,500

[Problem 4] Furnishing and equipment Rental deposits Accounts receivable (P9M x 1/3 x 2/3) Inventory Cash Net cost of investment for decision analysis

P 500,000 200,000 2,000 000 400,000 120,000 P5,020,000


[Problem 5] 1. Sales Materials Labor Factory overhead Selling and administrative expenses Depreciation expense (P1,200,000  5 yrs) Income before income tax Tax (30%) Net income Add back: Depreciation expense 2. Annual net cash flows

P6,000,000 ( 800,000) ( 1,200,000) ( 540,000) ( 700,000) ( 240,000) 2,520,000 ( 756,000) 1,764,000 240,000 P2,004,000

[Problem 6]

1.

Weighted Average Cost of Capital (WACOC) = ?

Sources of capital

Market values

Individual Cost of Capital

Capital Mix

WACOC

Fraction

Mortgage bonds

(P300,000 x 105%) = P315,000

(10% x 55%) = 5.5%

Preferred equity

(2000 sh x P96)

=

192,000

(P12 / P96) = 12.5

192 / 1.007

2.38%

Common equity

(50,000 sh x P10)

=

500,000

P1.50 / P10 = 15.0

500 / 1.007

7.45%

Total

315 / 1.007

P1,007,000

11.55%

Preferred dividends = 12% x P100 = P12 / sh Earnings per share = P75,000 / 50,000 sh = P1.50

2. Proposed Investment A B C

ROI 7% 10% 14%

WACOC 11.55% 11.55% 11.55%

1.72%

Advise Reject Reject Accept

Investments are to be accepted if the WACOC is higher than the ROI.


[Problem 7]

1.

New WACOC = ? Cost of

Sources of Money Long-term debt Preferred equity Common equity

Package 1

Capital 6%

Amount P10,000,000

11%

Amount

3%

P 2,000 000

7,000,000 4.90% P20,000,000

2.

WACOC

3,000,000 1.65%

14%

Total

Package 2

9.55%

Package 3

WACOC

11,000 000 7,000, 000

Amount

WACOC

0.60% P 6,000,000

1.80%

6.05%

5,000,000

2.75%

4.90%

9,000,000

P20,000,000 11.55% P20,000,000

6.30% 10.85%

Package 1 gives the invest WACOC at 9.55%.

[Problem 8] Before Bonds Retirement Amount Bonds Preferred equity Common equity

After Bonds Retirement

WACOC

Amount

WACOC

P 5,000,000 (8% x 60% x 5/10) = 2.4% 1,000,000 (9% x 1/10) 4,000,000 (12.5% x 4/10)

Lease Totals

P10,000,000

P4,000,000 (8% x 60% x 4/10) = 1.92% 1, = 0.9% 000,000 (9% x 1/10) = 0.90% 4, = 5% 000,000 (12.5% x 4/10) = 5.0% 1, 000,000 10% x 60% x 1/10) = 0.60% P 8.30% 10,000,000 8.42%

[Problem 9]

a.

WACOC = ? Funds

Mortgage bonds Common stock Ret earnings Total

Amount P20,000,000 25,000,000 55,000,000 P100,000,000

Individual Cost of Capital

WACOC

[(6.5% x 50%) / 95%] 3.42% 0.684% [(P4 x 105%) /P94 + 5%] 9.47 2.3675% 9.47 5.2085% 8.26%

b. The weighted average cost of capital is used as a benchmark in evaluating the acceptability or rejection of proposed investment because it measures the point of expected return where the minimum required return of each class of investor is met by reason of cross-subsidizing from one class of security to another. [Problem 10]


a. WACOC under each alternative

Debt Equity WACOC

b.

Alternative A (9% x 50% x 2/6) = 1.5% {[(P1/P20) + 7%] x 4/6} = 8.0% 9.5%

Alternative B (12% x 50% x 4/6) = 4.0% {[(P0.90/P20) + 12%] x 2/6} = 5.5% 9.5%

In alternative B, the amount of debt increases thereby increasing the debt equity ratio signalling the firm is highly leveraged and more risky for investment. This tends to increase the nominal rate of the bonds.

c. Yes; it is logical for stockholders to expect a higher dividend growth rate under alternative B to compensate the higher rate implied by an increase in the debt exposure of the firm and to validate the theory that the more debt is used in the financing portfolio, the higher the profitability rate of the firm, thereby, the higher the growth rate. [Problem 11] 1. Marginal Cost of Capital for each fund 2. WACOC = ? Capital [a] Mix [b] Sources Individual COC Rate WACOC Mortgage bonds (14% x60%) = 8.4% 15.00% 1.26% Debentures (145% x 60%) = 8.7% 25.00% 2.175% Preferred stock (P13.50/ P99.25) = 13.60% 10.00% 1.36% Common stock 16.67% 2.11% (P1.80 / P67.50 + 10%)=12.67% Retained earnings 33.33% 4.22% = 12.67% 100.00% 11.125% 3. Maximum point of expansion for retained earnings: Net income (P4.50 x 15 million shares) P67,500,000 Common dividends (P67,000,000 x 40% or P1.80 x 15 million) ( 27,000,000) Preferred stock dividends ( 6,750,000) Retained earnings available for expansion P33,750,000 Common equity = 50% of total capitalization Maximum point of expansion before common stock shares are issued = P33,750,000 / 50% = P67.5M 4.

The WACOC varies among firms in the industry even if the basic business risk is similar for all firms in the industry. This is true because


each firm selects the degree of financial leverage it desires. This financial leverage affects the capital mix structure of a firm that affects the determination of the weighted average cost of capital. [Problem 12] 1. WACOC before and after bond retirement: [1] Before Bond Retirement Capital

Amount

[2] After Bond retirement

WACOC

Amount

Lease

WACOC

P1,000,000 (10% x 60% x 1/10) = 0.6%

8% Debentures 9% Preferred stock Common stock Retained earnings

P5,000,000 8% x 60% x 5/10) = 2.4%

4,000,000

(8% 60% x 4/10) = 1.92%

1,000,000

(9% x 1/10) = 0.9%

1,000,000

{same} 0.9%

2,000,000

(13% x 2/10) = 2.6%

2,000,000

{same} 2.6%

2,000,000

(13% x 2/10) = 2.4%

2,000,000

{same} 2.4%

8.30% P10,000,000

8.42%

P10,000,000

2.

The component costs and the weighting used to calculate the WACOC in a-1 is different in a-2 because P1 M of debentures are replaced by lease which is more expensive (from 8% to 10% nominal rate). This brings up the WACOC to 8.42%. 3. Market values should be used in calculating the WACOC because COC calculation is used to estimate the current marginal cost of capital for the company. The use of market values a. recognizes the current investor attitudes regarding the company’s risk position and will reflect current rates for capital. b. recognizes better the capital proportions the company must consider in the capital sources decision; and c. ignores the influence of past values which are not relevant to future decision. [Problem 13] 1. The board member’s agreement is incorrect because the facts seem to indicate that Kia Corporation’s capitalization is not in optimum mix (i.e., equilibrium). The issuance of new debt will increase the financial leverage of the firm, increases the risk, increases the note’s nominal rate, and decreases the earnings multiple. While the marginal cost of capital is a combination of explicit interest cost on the notes and the additional cost of earnings that must occur to compensate the common stockholders for the decline in the earnings multiple. The 14% return in


this project should be compared with the new weighted average cost of capital if the issuance of note is undertaken. 2. New level of annual earnings of the earnings multiple declines to 9 =? 1.

Present market price per share = 10(P2.70) = P27.00 Required EPS (new) = P27/9 = P3.00 Required earnings before tax (P3.00 x 10,000,000 shares / 50%) P 60,000,000 Interest expense [(P10 M x 8%) + (P50M x 10%)] 5,800,000 Required earnings before interest and taxes 65,800,000 Less: Old earnings before interest and taxes {[(P2.70 x 10,000,000 shares) / 50%] + P800,000} 54,800,000 Additional earnings before interest and taxes P 11,000,000

Additional informational analysis: If the earnings multiple declines to 9, the additional earnings provided by the new assets to maintain the same market price per share of P27 shall be: X = additional earnings (new P/E) (new EPS) = P27 9 ( P2.70 + X) = P27 2.70 + X = P3 X = P0.30 [Problem14] 1. Breaks = ? Breaks or increases in weighted marginal cost of capital will recur as follows: For Debt = Debt / Debt Ratio = P100,000 / 40% = P250,000 For Equity = Equity / Equity Ratio = P150,000 / 60% = P350,000 2. WACOC = ? a. Before the break (P1 – P250,000 amount of financing) i. Debt = 7% x 40% = 3.2% ii. Equity = 18% x 60% = 10.8% iii. WACOC 14.0% b. After the break (P250,001 – above amount of financing) Debt = 10% x 40% = 4.0% Equity = 22% x 60% = 13.2% WACOC 17.2%


3. Graph of marginal cost of capital (MCC) schedule and investment opportunities schedule (IOC): 26 24 IRR ( ) 22 A MCC (------) 20 18 B MCC 16 14 12 C 10 8 6 4 2 0 100

200 225 300

400 450 500 (new financing, thousands of pesos)

4. Projects are to be accepted as long as the IRR is greater than the MCC. Projects A and B are acceptable; based on the following: Project A B C

IRR 19% 15% 12%

MCC 14% 14% 17.20%

Advise Accept Accept Reject

[Problem15] 1. EPS and market price per share = ? a. Raise P100,000 by issuing 10-year, 12% bonds Case 1 Sales P 400,000 - Costs and operating expenses (90%) 360,000 EBIT 40,000 -Interest charges [P2,000 + (12% x P100,000)] 14,000 IBIT 26,000 - Tax (50%) 13,000 Net Income P 13,000 P1.30 Earnings per share

Case 2 P 600,000 540,000 60,000

Case 3 P 800,000 720,000 80,000

14,000 46,000 23,000 P 23,000 P2.30

14,000 66,000 33,000 P 33,000 P3.30


(NI / 10,000 shares) Price / earnings rates Market price per share EPS (old) = P36 / 12 = No. of shares = P30,000 / P3 = b.

10x P13

10x P23

10x P33

Case 1 P 400,000 360,000 40,000 2,000 38,000 19,000 P 19,000

Case 2 P 600,000 540,000 60,000 2,000 58,000 29,000 P 29,000

Case 3 P 800,000 720,000 80,000 2,000 78,000 39,000 P 39,000

P1.46 12x P17.52

P2.23 12x P26.76

P3.00 12x P36

13,000

13,000

13,000

3 10,000 sh

Raise P100,000 by issuing new column stock Sales - Costs and D Exp (90%) EBIT -Interest expense IBIT - Tax (50%) Net Income Earnings per share (NI / 13,000Shares) Price / earnings rates Market price per share No. of shares (P100,000 / P33.33 + 10,000)

2. Recommended proposal = ? The recommendation shall be based on the following criteria:  Brief desorption of the criteria

 The proposal chosen

Wealth Maximization  Wealth maximization is primordial among shareholders in as much as this is the end objective of business. This wealth maximization principle is represented by the market price per share.  The total sales of the firm should be higher than P600,000, since its sales last year was already at P600,000. At this level and more, the

Profit Maximization  Profit maximization is a short-run strategy to satisfy the interest of shareholders. This profit maximization strategy is .best represented by the earnings per share.


market price per share is higher by issuing a new share of stock. Wealth maximization is a strategic reason of managing a business, hence, at guides organization in its longterm decisions, such as financing decision. 3.

No, the financing package chosen would be the same. The higher the level of sales in excess of P600,000, the more favorable it is on the part of the business!

4.

The investment banker would rationalize that issuance of more debt securities would mean a greater variability in earnings and higher risk of bankruptcy created by the fixed commitment to pay debt interest and principal. This would bring restrain by diminishing the earnings multiple to compensate the increased risk in leverage.

[Problem 16] 1. Sales P600,000 Out-of-pocket costs ( 450,000) Depreciation expense (P500,000/5) ( 100,000) IBIT 50,000 Tax (40%) ( 20,000) Net income 30,000 Depreciation expense 100,000 Annual cash inflows P130,000 Payback period = P500,000 / P130,000 =

3.85 yrs

2. 3. 4.

25.97% 6% 12%

Payback reciprocal ARR (original) ARR (average)

= 1 / 3.85 = P30,000/P500,000 = [P30,000 / (P500,000/2)[

[Problem 17]

Year

Annual Cash Income, Net of Tax

Cash to Date

Payback Period

= = =


1 2 3 4

P 70,000 90,000 85,000 160,000 Total

P 70,000 160,000 245,000 400,000

1 1 1 0.97 3.97

(155,000/160,000) yrs.

[Problem 18] Net Cash Cash to Inflows Date P300,000 P300,000 400,000 700,000 200,000 900,000 150,000 1,000,000

Year 1 2 3 4

Salvage Total Value Cash P200,000 P500,000 100,00 800,000 50,000 950,000 20,000 1,000,000

Total

Payback Period 1 1 1 0.53 3.53

[Problem 19] 1. Cash flows before tax Depreciation expense (P1,000,000/ 10) IBIT Tax (40%) Net income 2.

ARR (original) = P60,000 / P1 million = ARR (average) = [P60,000 / (P1 million/2)] =

(100,000 - 20,000 150,000 yrs.

P200,000 ( 100,000) 100,000 ( 40,000) P 60,000 6% 12%

[Problem 20] 1. Sales P4,000,000 Out-of-pocket costs ( 3,100,000) Depreciation expense [(P2M x 80%)/5] ( 320,000) IBIT 580,000 Tax (40%) ( 232,000) Net income 348,000 Add: Depreciation expense 320,000 Annual net cash inflows P 668,000 Payback period = P 2 million / P668,000 = 2.99 yrs. 2. Payback reciprocal = 1 / 2.99 = 33.44% 3. Payback bailout period = [(P4 4M x 80%) / P668,000] = 4.79 yrs. 4. ARR (original) = P348,000 / P4 M = 8.7% 5. ARR (average) = [(P348,000 / (P4 M + P800,000) / 2] = 14.5%


[Problem 21] 1. Cash flows before tax - Tax [(P15,000 – P5,000) 40%] Cash flows after tax Payback period (P40,000 / P11,000) 2.

P15,000 4,000 P11,000 3.64 yrs.

Cash flows after tax P11,000 Less: Depreciation expense 5,000 Net income P 6,000 ARR (original) = P6,000 / P40,000 = 15%

[Problem 22] 1. PVCI: Annual cash inflows (P300,000 x 3.127) P938,100 Salvage value (P20,000 x 0.437) 8,740 P946,840 Less: COI 800,000 Net present value P146,840 2. Profitability index = P946,840 / P800,000 = 1.184 3. NPV index = P146,840 / P800,000 = 0.184 [Problem 23] 1. Year 1 2 3 4 5 SV

2. 3.

Annual Cash PVF at 12% PVCI Inflows P350,000 0.893 P312,550 250,000 0.797 199,250 150,000 0.712 106,800 100,000 0.636 63,600 50,000 0.567 28,350 30,000 0.567 17,010 Total 727,560 Less: Cost of investment 600,000 Net present value P 127,560

Profitability index = (P727,560/P600,000) = 1.21 NPV index = P127,560 / P600,000 = 0.21

[Problem 24]


PVF at Year 14% Proj. 1 Proj. 2 Proj. 3 1 0.877 P2,104,800 P4,823,500 P175,400 2 0.769 1,691,800 1,999,400 461,400 3 0.675 1,215,000 472,500 675,000 4 0.592 651,200 118,400 473,600 SV 0.592 118,400 118,400 47,360 Total PVCI P5,781,200 P7,532,200 P1,832,760 COI P5,000,000 P8,000,000 P1,400,000 Profitability index 1.16 0.94 1.31 The company should make investments on the following projects: Rank 1 Proj. 3 P 1,400,000 Rank 2 Proj. 1 5,000,000 Total investment P 6,400,000

[Problem25] 1.

Annual cash inflows: (P500,000 x 3.889) (P400,000 x 3.889) Salvage value (P100,000 x 0.456) Recovery of working capital (P200,000 x 0.456) (P1,400,000 x 0.456) Total PV of cash inflows Less: COI (P1,400,000 + P200,000) (P200,000 + P1,400,000) Net present value

2. 3.

Profitability index (PVCI / COI)

Produce Wooden Toy

Distribute an Imported Product

P 1,944,500 P

1,555,600

45,600 91,200 638,400 2,194,000

2,081,300 1,600,000 P

481,300

1.30

P

1,600,000 594,000

1.37

The net advantage of investing in distributing an imported product is P112,700 (i.e., P534,000 – P481,300).


{Problem 26] Year 1 2 3 4

Project X Project Y Cash to Cash to PVFC 14% PVCI PVCI Date Date 0.887 P 1,754,000 P 1,754,000 P 3,069,500 P 3,069,500 0.769 1,538,000 3,292,000 1,922,500 4,992,000 0.675 1,350,000 4,642,000 1,012,500 5,000,000 0.592 1,184,000 5,000,000

Payback period – Proj X Payback period – Proj Y

[3 yrs. + (P358,000/P1,184,000)] 3.30 yrs. [2 yrs. + (P8,000/P1,012,500)] 2.01 yrs.

[Problem 27] a. PVF Annuity =

b.

P520,000 = 2.6 P200,000 Using Table 2 (PVFA Table), the IRR is computed as follows: 18%

2.690

?

2.600

0.090 2%

0.102 0.012

20% IRR

=

18%

[Problem 28] a. PVF Annuity =

2.588 +

0.090 x 2% 0.102

P800,000 P234,000 *

= 19.75%

= 3.419

* (P234,000 = [(Total cash inflows + SV)  5] b.

Using Table 2, the PVF of 3.419 is between 14% and 16%

b.1.

Using 16% and 18% discount rates we have: PVCI @ 16%

Year 1 2 3 4 5

Cash Inflows P

350,000 300,000 250,000 150,000 80,000

PVF 0.862 P 0.743 0.641 0.552 0.476

Amount 301,700 222,900 160,250 82,800 38,080

PVCI @ 18% PVF 0.847 P 0.718 0.609 0.516 0.437

Amount 296,450 215,400 152,250 77,400 34,960


SV Totals

b.2.

40,000

0.476

19,040 824,770

P

0.437 P

17,480 793,940

Since the cost of investment of P800,000 is found the present value of cash inflows (PVCI) of 16% and 18%, then by interpolation, the IRR, could be determined as: Discount rate 16%

PVCI P824,770

?

800,000

24,770 2%

30,830 6,060

18% IRR

=

16%

793,940 +

24,770 x 2% 30,830

= 17.61%

[Problem 29] 1. PV of cash dividends (1,400 shares x P20 x 3.791) PV of stock sales (P200,000 x 0.621) PV of the shares of stock Less: Cost of the share of stock Net present value 2

P106,148 124,200 230,348 203,000 P 27,348

a) PV Annuity b)

=

P230,000 P203,000 = = 2.988 {[(1,400 x P20) x 5 + P200,000] + 5} P68,000

Using Table 2 (PVFA Table), we have: 20%

2.991 0.006

2%

2.985 ? 22%

IRR

=

[Problem 30] Background analysis:

20%

0.127 0.121

2.864 +

0.006 0.127

x 2%

= 20.09%


Cash savings before depreciation (P138,600 - P91,300) P47,300 Less: Depreciation expense 20,000 Income before income tax 27,300 Less: Tax (40%) 10,920 Net Income 16,380 Add: Depreciation expense 20,000 Annual Cash Inflows P36,380 1. Payback period = P160,000/P36380 = 4.40 yrs. 2. Payback reciprocal = 1/.P4.40 = 22.73% 3. ARR (original) = P16,380/P160,000 = 10.24% ARR (average) = P16,380/(P160,000/2) = 20.48% 4. PVCI (P36,380 x 5.747) P209,076 Less: Cost of Investment 160,000 Net Present Value P 49,076 5. Profitability index = P209,076/P160,000 = 1.31 6. NPV index = P49,076/P160,000 = 0.31 7. a. PVF annuity = P160,000/P36,380 = 4.398 b. Using Table 2, we have: 14%

4.639 0.241

2%

?

4.398

0.295 0.054

16% IRR

=

14%

4.344 +

0.241 0.295

x 2%

= 15.63%

[Problem 31] Depreciation Expense Year 1 2 3 4

SY P3.2M 2.4M 1.6M 0.8M Total

Tax Effect

PV of Tax PVF at SL 8% Savings P(444,480 P2.0M P1.2M P(480,000) 0.926 ) 2.0M 0.4M (160,000) 0.857 (137,120) 2.0M (0.4M) 160,000 0.794 127,040 2.0M (1.2M) 480,000 0.735 352,800 P101,760


[Problem 32] Cash

Net Cash

Flows

Straight Line Method (P2,400,000 P1,430,000) Sum-of-theyears-digit method

1.a.

b.

Inflows

Before

Dep.

Tax

Expense

IBIT

Tax (30%)

Net

Dep.

After

Income

Expense

Tax

P970,000

P360,000

P610,000

P183,000 P427,000 P360,000

Year 1

P970,000

640,000

330,000

99,000

231,000

640,000

871,000

Year 2

P970,000

560,000

410,000

123,000

287,000

560,000

847,000

Year 3

P970,000

480,000

490,000

147,000

343,000

480,000

823,000

Year 4

P970,000

400,000

570,000

171,000

399,000

400,000

799,000

Year 5

P970,000

320,000

650,000

195,000

455,000

320,000

775,000

Year 6

P970,000

240,000

730,000

219,000

511,000

240,000

751,000

Year 7

P970,000

160,000

810,000

243,000

567,000

160,000

727,000

Year 8

P970,000

80,000

890,000

267,000

623,000

80,000

703,000

Annual cash inflows after tax: Alternately, cash inflows after tax may be computed by deducting the corresponding income tax from the cash flows before tax. The tax expense equals cash flows before tax less depreciation expense. Net present values, straight-line method and SYD method PVCI: Regular(P787,000 x 5.747) Y1 (P871,000 x 0.926) Y2 (P847,000 x 0.857) Y3 (P823,000 X 0.794) Y4 (P799,000 X 0.735) Y5 (P775,000 X 0.681) Y6 (P751,000 X 0.630) Y7 (P727,000 X 0.583) Y8 (P703,000 X 0.540) SV (P120,000 X 0.540) Recovery of working capital

Straight-line P4,523,889

64,800

SYD P806,546 725,879 653,462 587,265 527,775 473,130 423,841 379,620 64,800

P787,000


(P400,000 x 0.540) Cost of investment(P3M + P400,000) Net present value

216,000 (3,40 0,000) P1,403.689

Advantage of the SYD method 2.

216,000 (3,400,000) P1,458,328

P

54,639

The tax benefit using SYD method instead of the straight-line method is P54,639 (i.e., P1,458,328 - P1,403,689).

[Problem 33] 1. Purchase price PV of lease payments (P30,000 x 5.650) PV of salvage value (P200,000 x 0.322/64,400) PV of tax savings on depreciation expense (P200,00 x 35% x 5.650) PV of tax savings on lease payments (P300,000 x 35% x 4.65) PV of relevant costs

2.

Buy P2,200,000 (

64,400)

(

395,500)

P1,740,100

Net Advantage of leasing PV of annual savings (P638,350/5.65)

Lease P1,695,000 ( 64,400)

( 93,250) P1,101,750

P638,350 P112,982

[Problem 34] 1. Payback period = P35,000/P10,000 = 3.5 yrs. 2.

PVCI (P10,000 x 3.785) Less: Cost of investment Net present value

3.

Amount of investment six years ago

P37,850 35,000 P 2,850 =

= =

P35,000 Future Value Factor @ 15%, n = 6 P35,000 2.313 P15.132

[Problem 35] 1. PV of cash dividends (20,000 shares x P4 x 3.605) P288,400 PV of stock sales (P500,000 x 115% x 0.567) 326,025 PV of shares of stock 614,425 Less: cost of investment 500,000


2.

Net present value – common stock

P114,425

PV of interest receipts (P500,000 x 14% x 3.605) PV of bond redemption (P500,000 x 150% x 0.567) PV of bonds Less: Cost of investment Net present value – bonds

P252,350 425,250 677,600 500,000 P177,600

3. The investment in bonds is more advantageous by P63,175 (i.e., P177,600 – P114,425) than the investment in stock. [Problem 36] 1. Cost of investment Less: Present values of inflows: Y1 (P120,000 x 0.893) Y2 (P240,000 x 0.797) Y3 (P360,000 x 0.712) Present value of year 4 inflows  PVFC 12%, year 4 Cash inflows, year 4

P681,960 (107,160) (191,280) (256,320) 127,200 0.636 P200,000

2.

PV of savings (P700,000 x 5.197) Less: Cost of investment Net present value of intangible benefits

3.

PVF Annuity = P1,027,750 = 4.11* P250,000

P3,637,900 3,000,000 P 637,900

*Using table 2, 4.11 at 12% = 6 yrs.

[Problem 37] 1. . Savings from labor and materials Increase in maintenance (P6,000 x 12)

Annual cash savings 2.

Y1 - Y3 P 820,000

Y4 - Y5 P 820,000

(72,000) P 784,000

(72,000) P 784,000

PVCI Regular cash (P784,000 x 3.433) P2,567,884 Salvage value (P180,000 x 0.579) 93,420 Less: Cost of investment (P2,700,000 – P70,000)

P2,661,304 2,630,000


Net present value

P

(31,304)

3. Annual cash savings Depreciation expense

P

P2,700,000 - P180,000 5 yrs.

Y1 - Y3 748,000

Y4 - Y5 P 748,000

(504,000)

[P504,000 + (P150,000/2)]

Income before income tax Less: Tax (40%) Net income Add: Depreciation expense Annual cash inflows P

244,000 97,600 146,400 504,000 650,400

(579,000) 169,000 67,600 101,400 579,000 P 680,400

PVCI Y1 – Y3 (P650,400 x 2.322) P1,510,229 Y4 (P680,400 x 0.592) 402,797 Y5 (P680,400 x 0.519) 353,128 Salvage value – new (P150,000 x 0.519) 77,850 Less: Cost of investment (P2,700,000 – P70,000 Net present value

P2,344,004 2,630,000 P (285,996)

[Problem 38]

1. Make

Buy

Relevant cost to buy / make Year 1 (50,000 x P22 x 0.893)

982,300 P

1,294,850 (50,000 x P29 x 0.893)

Year 2 (50,000 x P22 x 0.797)

P

876,700

1,155,650 (50,000 x P29 x 0.797)

Year 3 (52,000 x P22 x 0.712)

814,528

1,032,400 (50,000 x P29 x 0.712)

Year 4 (55,000 x P22 x 0.636)

769,560

1,014,400 (55,000 x P29 x 0.636)

Year 5 (55,000 x P22 x 0.567)

686,070

904,365 (55,000 x P29 x 0.567)

Avoidable fixed overhead (P45,000 x 3.605)

162,225

Salvage value - old asset

(1,500)

Salvage value - new (P12,000 x 0.567)

(6,804)

Tax savings on depreciation expense Year 1 (P384,000 x 40% x 9.893)

(137,165)


Year 2 (P230,400 x 40% x 0.797)

(73,452)

Year 3 (P138,240 x 40% x 0.712)

(39,371)

Year 4 (P82,944 x 40% x 0.636)

(21,101)

Year 5 (P 124,416 x 40% x 0.567)

(28,218)

PV of relevant costs - 5 yrs.

P

3,883,772 P

Net advantage of making in 5 yrs.

P

1,517,913

2.

5,401,685

Some of the non-financial and qualitative factors to be considered before deciding whether to make or buy a part are: a. Availability of materials from supplier. b. Stability of prices of material. c. Quality of parts to be supplied. d. Dependability of past supplier. e. Impact of new technology.

[Problem 39] 1. Increase in direct materials [(P4.50 – P3.80) x 80,000] Decrease in direct labor and variable overhead (P1.60 x 80,000) Net operating cash savings before tax

P (56,000) 128,000 P 72,000 Years

1

2

3

4

5

Cash savings before tax

P72,000

P72,000

P72,000

P72,000

P72,000

Less: Depreciation expense using SYD

800,000

640,000

480,000

320,000

160,000

Income before income tax

(728,000)

(568,000)

(408,000)

Less: Tax (40%)

(291,200)

(227,200)

(163,200)

Net income (loss)

(436,800)

(340,800)

(244,800)

Add: Depreciation expense Annual cash inflows

2.

800,000 P363,200

640,000 P299,200

480,000 P235,200

(248,000) (99,200) (148,800) 320,000 P171,200

Regular operating cash inflows (P363,200 + P299,200 + P235,200 + P171,200 + P107,200) Salvage value (P100,000 x 60%)

Total cash inflows Less: Cost of investment Net cash inflows

P 1,176,000 60,000 1,236,000 2,500,000 P(1,264,000)

(88,000) (35,200) (52,800) 160,000 P107,200


Zero, there is no excess of after tax cash inflows over the cost of initial investment because the total cash inflow is even lower than the cost of investment.

Chapter 14 MAS agamata answer key.

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