Solution manual managerial accounting by cabrera 2010 chapter 20 answer

MANAGEMENT ACCOUNTING (VOLUME II) - Solutions Manual CHAPTER 20 CAPITAL BUDGETING DECISIONS I Questions A capital investment involves a current commitment of funds with the expectation of generating a satisfactory return on these funds over a relatively extended period of time in the future Cost of capital is the weighted minimum desired average rate that a company must pay for long-term capital while discounted rate of return is the maximum rate of interest that could be paid for the capital employed over the life of an investment without loss on the project The basic principles in capital budgeting are: Capital investment models are focused on the future cash inflows and outflows - rather than on net income Investment proposals should be evaluated according to their differential effects on the company’s cash flows as a whole Financing costs associated with the project are excluded in the analysis of incremental cash flows in order to avoid the “doublecounting” of the cost of money The concept of the time value of money recognizes that a peso of present return is worth more than a peso of future return Choose the investments that will maximize the total net present value of the projects subject to the capital availability constraint The major classifications as to purpose are: Replacement projects - those involving replacements of worn-out assets to avoid disruption of normal operations, or to improve efficiency Product or process improvement - projects that aim to produce additional revenue or to realize cost savings Expansion - projects that enhance long-term returns due to increased profitable volume Greater amounts of capital may be used in projects whose combined returns will exceed any alternate combination of total investment 20-1 Chapter 20 Capital Budgeting Decisions No This implies that any equity funds are cost free and this is a dangerous position because it ignores the opportunity cost or alternative earnings that could be had from the fund Yes, if there are alternative earnings foregone by stockholders II Matching Type A C F B I 10 H D G J E III Problems Problem (Equipment Replacement Sensitivity Analysis) Requirement Total Present Value A B New Situation: Recurring cash operating costs (P26,500 x 2.69) Cost of new equipment Disposal value of old equipment now Present value of net cash outflows Present Situation: Recurring cash operating costs (P45,000 x 2.69) Disposal value of old equipment four years hence (P2,600 x 0.516) Present value of net cash inflows Difference in favor of replacement P 71,285 44,000 (5,000) P110,285 P121,050 (1,342) P119,708 P 9,423 Requirement Payback period for the new equipment = = Requirement 20-2 P44,000 – P5,000 P18,500 2.1 years Capital Budgeting Decisions Chapter 20 Let X = annual cash savings Let O = net present value X (2.69) + P5,000 - P44,000 - P1,342 = O 2.69X = P40,342 X = P14,997 If the annual cash savings decrease from P18,850 to P14,997 or by P3,503, the point of indifference will be reached Another alternative way to get the same answer would be to divide the net present value of P9,423 by 2.690 Problem Annual cash expenses of the manual bookkeeping machine system, P9,800 x 12 Annual cash expenses of computerized data processing Annual cash savings before taxes Annual cash savings (a) Depreciation Inflow before tax Income tax (50%) (b) Cash inflow after tax (a - b) Year Year Year Year Salvage Year Tax loss Year P64,000 20,000 P44,000 22,000 P42,000 Year P64,000 16,000 P48,000 24,000 P40,000 Year P64,000 12,800 P51,200 25,600 P38,400 After Tax Cash Inflows P42,000 40,000 38,400 20,000 15,600* PV Factor x 0.909 x 0.826 x 0.750 x 0.750 x 0.750 PV P 38,178 33,040 28,800 15,000 11,700 P126,718 100,000 P 26,718 Investment (I) Net present value (NPV) _ * P117,600 53,600 P 64,000 The P15,600 tax benefit of the loss on the disposal of the computer at the end of year is computed as follows: Estimated salvage value Estimated book value: Historical cost P 20,000 P100,000 20-3 Chapter 20 Capital Budgeting Decisions Accumulated depreciation Estimated loss 48,800 Tax rate Tax effect of estimated loss 51,200 P(31,200) 50% P(15,600) Since the net present value is positive, the computer should be purchased replacing the manual bookkeeping system Problem Requirement (a) Purchase price of new equipment Disposal of existing equipment: Selling price Book value Loss on disposal Tax rate Tax benefit of loss on disposal Required investment (I) P(300,000) P 60,000 P60,000 0.4 (b) Increased cash flows resulting from change in contribution margin: Using new equipment [18,000 (P20 - P7)] * Using existing equipment [11,000 (P20 - P9)] Increased cash flows Less: Taxes (0.40 x P113,000) Increased cash flows after taxes Depreciation tax shield: Depreciation on new equipment (P300,000  5) P60,000 Depreciation on existing equipment (P60,000  5) 12,000 Increased depreciation charge P48,000 Tax rate 0.40 Depreciation tax shield Recurring annual cash flows _ * 24,000 P(276,000) P234,000 121,000 113,000 45,200 P 67,800 19,200 P 87,000 The new equipment is capable of producing 20,000 units, but ETC Products can sell only 18,000 units annually The sales manager made several errors in his calculations of required investment and annual cash flows The errors are as follows: 20-4 Capital Budgeting Decisions Chapter 20 Required investment: - The cost of the market research study (P44,000) is a sunk cost because it was incurred last year and will not change regardless of whether the investment is made or not - The loss on the disposal of the existing equipment does not result in an actual cash cost as shown by the sales manager The loss on disposal results in a reduction of taxes, which reduces the cost of the new equipment Annual cash flows: - The sales manager considered only the depreciation on the new equipment rather than just the additional depreciation which would result from the acquisition of the new equipment - The sales manager also failed to consider that the depreciation is a noncash expenditure which provides a tax shield - The sales manager’s use of the discount rate (i.e., cost of capital) was incorrect The discount rate should be used to reduce the value of future cash flows to their current equivalent at time period zero Requirement Present value of future cash flows (P87,000 x 3.36) Required investment (I) Net present value P292,320 276,000 P 16,320 Problem Requirement 1: P(507,000) Requirement 2: P(466,200) Requirement 3: P(23,400) IV Multiple Choice Questions D C B B A C D 11 12 13 14 15 16 17 D D D C C D D 21 22 23 24 25 26 27 20-5 C B C D C C D 31 32 33 34 35 36 37 D C C D D B B Chapter 20 Capital Budgeting Decisions B B 10 A 18 B 19 A 20 A 28 B 29 D 30 A 20-6 38 B 39 D 40 B ... Historical cost P 20, 000 P100,000 20- 3 Chapter 20 Capital Budgeting Decisions Accumulated depreciation Estimated loss 48,800 Tax rate Tax effect of estimated loss 51 ,200 P(31 ,200 ) 50% P(15,600)... C C D D 21 22 23 24 25 26 27 20- 5 C B C D C C D 31 32 33 34 35 36 37 D C C D D B B Chapter 20 Capital Budgeting Decisions B B 10 A 18 B 19 A 20 A 28 B 29 D 30 A 20- 6 38 B 39 D 40 B ... loss Year P64,000 20, 000 P44,000 22,000 P42,000 Year P64,000 16,000 P48,000 24,000 P40,000 Year P64,000 12,800 P51 ,200 25,600 P38,400 After Tax Cash Inflows P42,000 40,000 38,400 20, 000 15,600*