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Capital Budgeting- also called Capital Expenditure Planning, deals with the allocation
of capital among alternative investment opportunities. There are typically two types of
investment decisions:
Opportunity Cost – it is the foregone benefits that could be derived from other possible
alternative by choosing another alternative.
1. Payback Period – is the length of time requires recovering the initial investment from
the incremental cash benefits after tax. The conventional payback period does not
consider the time value of money while the discounted payback period gives due
allowance for the time value of money.
2. Accounting Rate of Return – is defined as the average annual net income from the
project divided by the average (or initial) investment in the project. The net income is
net of depreciation and income taxes.
Accounting Rate of Return = Average Annual Net Income of Project (Net of Tax)
Average (or initial) Investment in the Project
5. Profitability Index – it is computed by dividing the present value of cash flows by the
initial investment. Profitability index is used in comparing the net present values of
different projects to make the comparison more meaningful.
PROBLEM 1
The Graven Company is planning to spend P60,000 for a machine which will be
depreciated on a straight – line basis over ten – year period. The machine will generate
additional cash revenues of P12,000 a year. Graven will incur additional costs except for
depreciation. The income tax rate is 35 %
REQUIRED :
REQUIRED:
Determine the maximum interest rate (time – adjusted rate of return) that could be
paid for the capital employed over the life of this asset without toss, on this project.
PROBLEM 3
NPV Company is considering to purchase a new machine which cost P50, 000. It will be
a labor saving investment which will reduce payroll by P13, 500 per year. Its useful life
is 8 years and it wilt have zero salvage value. A minimum desired rate of return of 18%
is used for capital investment decisions. Information on present value factors is as
follows:
PROBLEM 4
Virginia Company invested in a four – year project. The company’s expected rate
of return is 10%. Additional information on the project is as follows:
Assuming a positive Net Present Value of P10,000, determine the amount of the original
investment.