Problem 1 (Equipment Replacement Sensitivity Analysis)

Requirement 1
Total Present Value
A. New Situation:
Recurring cash operating costs (P26,500 x 2.69) P 71,285
Cost of new equipment 44,000
Disposal value of old equipment now (5,000)
Present value of net cash outflows P110,285

B. Present Situation:
Recurring cash operating costs (P45,000 x 2.69) P121,050
Disposal value of old equipment four years
hence (1,342)
(P2,600 x 0.516)
Present value of net cash inflows P119,708
Difference in favor of replacement P 9,423

Requirement 2
P44,000 – P5,000
Payback period for the new equipment =
P18,500
= 2.1 years
Requirement 3

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 2

Annual cash expenses of the manual bookkeeping

machine system, P9,800 x 12 P117,600
Annual cash expenses of computerized data processing 53,600
Annual cash savings before taxes P 64,000

Year 1 Year 2 Year 3

Annual cash savings (a) P64,000 P64,000 P64,000
Depreciation 20,000 16,000 12,800
 Inflow before tax P44,000 P48,000 P51,200
Income tax (50%) (b) 22,000 24,000 25,600
Cash inflow after tax (a - b) P42,000 P40,000 P38,400

After Tax
Cash Inflows PV Factor PV
Year 1 P42,000 x 0.909 P 38,178
Year 2 40,000 x 0.826 33,040
Year 3 38,400 x 0.750 28,800
Year 3 Salvage 20,000 x 0.750 15,000
Year 3 Tax loss 15,600* x 0.750 11,700
P126,718
Investment (I) 100,000
Net present value (NPV) P 26,718
_________________
* The P15,600 tax benefit of the loss on the disposal of the computer at the end of year 3 is computed as
follows:
Estimated salvage value P 20,000
Estimated book value:
Historical cost P100,000
Accumulated depreciation 48,800 51,200
Estimated loss P(31,200)

Tax rate 50%

Tax effect of estimated loss P(15,600)

Problem 3

Requirement 1

(a) Purchase price of new equipment P(300,000)

Disposal of existing equipment:
Selling price P 0
Book value 60,000
Loss on disposal P60,000
Tax rate 0.4
Tax benefit of loss on disposal 24,000
Required investment (I) P(276,000)

(b) Increased cash flows resulting from

change in contribution margin:
Using new equipment [18,000 (P20 - P7)] * P234,000
Using existing equipment [11,000 (P20 - P9)] 121,000
Increased cash flows 113,000
Less: Taxes (0.40 x P113,000) 45,200
Increased cash flows after taxes P 67,800
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 19,200
Recurring annual cash flows P 87,000

Requirement 2

Present value of future cash flows (P87,000 x 3.36) P292,320

Required investment (I) 276,000
Net present value P 16,320

Problem 4

Requirement 1: P(507,000)

Requirement 2: P(466,200)

Requirement 3: P(23,400)

Problem 5

1. The net annual cost savings is computed as follows:

Reduction in labor costs........................................................................ P240,000

Reduction in material costs...................................................................    96,000
Total cost reductions............................................................................. 336,000
Less increased maintenance costs (P4,250 × 12)...................................    51,000
Net annual cost savings......................................................................... P285,000

2. Using this cost savings figure, and other data provided in the text, the net present value analysis
is:
Amount of Cash 18% Present Value of
Year(s) Flows Factor Cash Flows
Cost of the machine..................................... Now P(900,000) 1.000 P (900,000)
Installation and software.............................. Now P(650,000) 1.000 (650,000)
Salvage of the old machine.......................... Now P70,000 1.000 70,000
Annual cost savings...................................... 1-10 P285,000 4.494 1,280,790
Overhaul required........................................ 6 P(90,000) 0.370 (33,300)
Salvage of the new machine........................ 10 P210,000 0.191      40,110
Net present value......................................... P (192,400)

No, the etching machine should not be purchased. It has a negative net present value at an 18%
discount rate.

3. The intangible benefits would have to be worth at least P42,813 per year as shown below:
Required increase in net present value P192,400
= = P42,813
Factor for 10 years 4.494
 Problem 6
(2) (1) × (2)
Tax After-Tax 12% Present Value
Items and Computations Year(s) (1) Amount Effect Cash Flows Factor of Cash Flows
Investment in new trucks.................................. Now P(450,000) P(450,000) 1.000 P(450,000)
Salvage from sale of the old trucks................... Now P30,000 1 – 0.30 P21,000 1.000 21,000
Net annual cash receipts................................... 1-8 P108,000 1 – 0.30 P75,600 4.968 375,581
Depreciation deductions*................................. 1-8 P56,250 0.30 P16,875 4.968 83,835
Overhaul of motors........................................... 5 P(45,000) 1 – 0.30 P(31,500) 0.567 (17,861)
Salvage from the new trucks............................. 8 P20,000 1 – 0.30 P14,000 0.404      5,656
Net present value.............................................. P  18,211

Since the project has a positive net present value, the contract should be accepted.

Problem 7

1. Factor of the internal Required investment

rate of return = Annual cash inflow
P142,950
= P37,500 = 3.812

A factor of 3.812 equals an 18% rate of return.

Verification of the 18% rate of return:

Amount of 18% Present Value of

Item Year(s) Cash Flows Factor Cash Flows
Investment in equipment....................... Now P(142,950) 1.000 P(142,950)
Annual cash inflows................................ 1-7 P37,500 3.812    142,950
Net present value................................... P            0

2.
Factor of the internal Required investment P142,950
rate of return = Annual cash inflow = 4.288
Annual cash inflow

Therefore, the annual cash inflow would have to be:

P142,950 ÷ 4.288 = P33,337.

3. a. 5-year life for the equipment:

The factor for the internal rate of return would still be 3.812. Reading along the 5-period line of
the PV table, a factor of 3.812 is closest to 3.791, the factor for 10%. Thus, to the nearest whole
percent, the internal rate of return is 10%.

b. 9-year life for the equipment:

The factor of the internal rate of return would again be 3.812. From the PV table, reading along
the 9-period line, a factor of 3.812 is closest to 3.786, the factor for 22%. Thus, to the nearest
whole percent, the internal rate of return is 22%.
 The 10% return in part (a) is less than the 14% minimum return that Dr. Blue wants to earn on
the project. Of equal or even greater importance, the following diagram should be pointed out to
Dr. Blue:

4. a. The expected annual cash inflow would be:

P37,500 x 120% = P45,000

P142,950
P45,000 = 3.177

b. The expected annual cash inflow would be:

P37,500 x 80% = P30,000

P142,950
P30,000 = 4.765

5.
Amount of 12% Present Value of
Item Year(s) Cash Flows Factor Cash Flows
Investment in the equipment........................... Now P(142,950) 1.000 P(142,950)
Annual cash inflow............................................ 1-5 P30,000 3.605 108,150
Sale of the equipment....................................... 5 P61,375 0.567     34,800
Net present value.............................................. P          0