MIDTERM EXAMINATION

FINANCIAL MANAGEMENT 2

Instruction: choose the letter of the best answer. Answer it with love.

Multiple Choice. Theory

1. To approximate annual cash inflow, depreciation is
a. Added back to net income because it is an inflow of cash
b. Subtracted from net income because it is an outflow of cash
c. Subtracted from net income because it is an expense
d. Added back to net income because it is not an outflow of cash
2. In capital expenditures decisions, the following are relevant in estimating operating costs, except
a. Future costs b. Cash costs c. Differential costs d. Historical costs
3. An optimal capital budget is determined by the point where the marginal cost of capital is
a. Minimized
b. Equal to the average cost of capital
c. Equal to the rate of return on total assets
d. Equal to the marginal rate of return on investment
4. 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
5. The bail out payback period is
a. The payback period is used by firms with government insured loans
b. The length of time for payback using cash flows plus the salvage value to recover the original
investment
c. a and b
d. None of the above
6. Which of the following methods measures the cash flow and outflows of a project as if they occurred
at a single point in time?
a. Cash flow based payback period c. Payback method
b. Capital budgeting d. Discounted cash flow
7. In an investment in plant, the return that should keep the market price of the firm stock unchanged is
a. Payback c. Net present value
b. Discounted rate of return d. Cost of capital
8. The excess present value method is anchored on the theory that the future returns, expressed in terms
of present value, must at least be
a. Equal to the amount of investment c. More than the amount of investment
b. Less than the amount of investment d. Cannot be determined
9. A company had made the decision to finance next year’s capital projects through debt rather than
additional equity. The benchmark cost of capital for these projects should be
a. The before tax cost of new debt financing c. The cost of equity financing
b. The after tax cost of new debt financing d. The weighted average cost of capital
10. All of the following refer to the discount rate used by a firm in capital budgeting, except
a. Hurdle rate c. Opportunity costs
b. Required rate of return d. Opportunity cost of capital
11. When using the net present value method for capital budgeting analysis, the required rate of return is
called all of eth following, except
a. Risk free rate b. Cost of capital c. Discount rate d. Cutoff rate
12. A project’s net present value, ignoring income tax considerations, is normally affected by the
a. Proceeds from the sale of the asset to be replaced.
b. Carrying amount of the asset to be replaced by the project
c. Amount of annual depreciation on the asset to be replaced
d. Amount of annual depreciation on fixed assets used directly on project.
13. The discount rate that equates the present value of the expected cash flows with the cost of the
investment is the
a. Net present value c. Accounting rate of return
b. Internal rate of return d. Payback period
14. When ranking two mutually exclusive investments with different initial amounts, management should
give first priority to the project
a. That generates cash flows for the longer period of time
b. Whose net after tax flows equal the initial investment
c. That has the greater accounting rate of return
d. That has the greater profitability index
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FINANCIAL MANAGEMENT 2

15. Capital budgeting methods are often divided into two classifications: project screening and project
ranking. Which one of the following is considered a ranking method rather than a screening method?
a. Net present value c. Profitability index
b. Time adjusted rate of return d. Accounting rate of return
16. In equipment replacement decisions, which one of the following does not affect the decision making
process?
a. Current disposal price of the old equipment c. Original costs of the new equipment
b. Operating costs of the old equipment d. Operating costs of the new equipment
17. Which of the following statements concerning cash flow determination for capital budgeting purposes
is not correct?
a. Tax depreciation must be considered because it affects cash payment for taxes.
b. Book depreciation is relevant because it affects net income
c. Net working capital changes should be included in cash flow forecasts
d. Relevant opportunity costs should be included in cash flow forecasts.
18. The payback reciprocal can be used to approximate a project’s
a. Net present value
b. Payback period
c. Accounting rate of return if the cash flow pattern is relatively stable
d. Internal rate of return if the cash flow pattern is relative stable
19. Which of the following is necessary in order to calculate the payback period for a project?
a. Useful life c. Net present value
b. Minimum desired rate of return d. Annual cash flow
20. The method that devices a project’s annual after tax net income by the average investment cost to
measure the estimated performance of a capital investment is the
a. Internal rate of return method c. Net present value method
b. Accounting rate of return method d. Payback method
21. Which one of the following statements about the payback method of investments analysis is correct?
The payback method
a. Does not consider the time value of money
b. Considers cash flows after the payback has been reached
c. Uses discounted cash flow technique
d. Is rarely used in practice
22. The bailout payback method
a. Incorporates the time value of money
b. Measures the risk if a project is terminated
c. Eliminates disposal value form the payback calculation
d. Equals the recovery periods from normal operations
23. The discount (hurdle) rate of return must be determined in advance for the
a. Internal rate of return method c. Payback period method
b. Net present value method d. Time adjusted rate of return method
24. The net present value of a proposed project represents the
a. Cash flows less the present value of the cash flows
b. Cash flows less the original investment.
c. Present value of the cash flows plus the present value of the original investment less the original
investment.
d. Present value of the cash flows less original investment.
25. The net present of a proposed project is negative, therefore, the discount rate must be
a. Less than the project’s internal rate of return
b. Less than the risk free rate
c. Greater than the firm’s cost of equity
d. Greater than the project’s internal rate of return
26. East, Inc. is considering an investment that has a positive net present value based on its 16% hurdle
rate. The internal rate of return would be
a. More than 16% b. Less than 16% c. 16% d. Zero
27. Calculating the payback period for a capital project requires knowledge of which of the following?
a. Useful life of the project c. The project’s net present value
b. The firm’s minimum required rate of return d. The project’s annual cash flow
28. In contrast to payback and accounting rate of return methods, The NPV and IRR methods
a. Consider the time value of money c. use after tax cash inflows
b. Ignore depreciation d. All of the above
29. Which statement describes the relevance of depreciation in calculating cash flows?
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FINANCIAL MANAGEMENT 2

a. Depreciation is relevant only when there are income taxes

b. Depreciation is always relevant
c. Depreciation is never relevant
d. Depreciation is relevant only with discounted cash methods
30. All other things being equal, as the length of an annuity increases
a. Present value factors decreases
b. Present value factors remain constant
c. Present value factors increases
d. It is impossible to tell what happens to present value factors from the information given

Multiple Choice. Problems

1. Bee Corporation plans to replace a production machine that was acquired several years ago.
Acquisition cost is P450,000 with salvage value of P50,000. the machine being considered is worth
P800,000 an dthe supplier is willing to accept the old machine at a trade in value of P60,000. Should
the company decide not to acquire the new machine, it needs to repair the old one at a cost of
P200,000. Tax wise, the trade in transaction will not have any implication but the cost to repair is tax
deductible. The effective corporate tax rate is 35% of net income subject to tax. For purposes of
capital budgeting, the net investment in the new machine is
a. P540,000 b. P610,000 c.P660,000 d. P800,000
2. Mace is considering the sale of a machine with a book value of P80,000 and three years remaining
useful life. Straight line depreciation of P25,000 annually is available. The machine has a current
market value of P100,000. What is the cash flow from selling the machine, if the tax rate is 40%?
a. P25,000 b. P80,000 c. P92,000 d. P100,000
3. Harry Company is considering replacing a machine with a book value of P400,000, a remaining
useful life of 5 years, and an annual straight line depreciation of P80,000. The existing machine has a
current market value of P400,000. The replacement would cost P550,000, have a 5 year life, and save
P75,000 per year in cash operating costs. If the replacement machine would be depreciated using the
straight line method and the tax rate is 40%, what would be the net investment required to replace the
existing machine?
a. P90,000 b. P150,000 c. P330,000 d. P550,000
4. Lorie Industries is analyzing a capital investment proposal for new machinery to produce a new
product over the next ten years. At the end of the ten years, the machinery must be disposed of with a
zero net book value but with a scrap salvage value of P20,000. It will require some P30,000 to
remove the machinery. The applicable tax rate is 35%. The appropriate end of life cash flow based on
the foregoing information is
a. Inflow of P30,000 c. Outflow of P10,000
b. Outflow of P6,500 d. Outflow of P17,000
5. A project under consideration by the Blue Corporation would require a working capital investment of
P200,000. the working capital would be liquidated at the end of the project’s 10 year life. If Blue
Corporation has an after tax cost of capital of 10% and a marginal tax rate of 30%, what is the present
value of the working capital cash flow expected to be received in year 10?
a. P36,868 b. P77,100 c. P53,970 d. P23,130
6. FPJ, inc. is planning to purchase a new machine that will take six years to recover the cost. The new
machine is expected to produce cash flow from operations, net of income taxes, of P4,500 a year for
the first three years of the payback period and P3,500 a year of the last three years of the payback
period. Depreciation of P3,000 a year shall be charged to income of the six years of the payback
period. How much shall the machine cost?
a. P12,000 b. P18,000 c. P24,000 d. P36,000
7. Marko Company purchased a new machine on January 1 of this year for P90,000, with an estimated
useful life of 5 years and a salvage value of P10,000. the machine will be depreciated using the
straight line method. The machine is expected to produce cash flow from operations, net of income
taxes, of P36,000 a year in each of the next 5 years. The new machine’s salvage value is P20,000 in
years 1 and 2, and P15,000 in years 3 and 4. What will be the bailout period for the new machine?
a. 1.4 years b. 2.2 years c. 1.9 years d. 3.4 years
8. Nelly Company is considering an investment in a project that generates a profitability index of 1.3.
The present value of the cash inflows on the project is P44,000. What is the net present value of this
project?
a. P10,154 b. P13,200 c. P57,200 d. P33,846
9. Backpay Company is considering the purchase of a copier machine for P42,825. the copier machine
will be expected to economically productive for 4 years. The salvage value at the end of 4 years is
negligible. The machine is expected to provide 15% internal rate of return. The company is subject to
 MIDTERM EXAMINATION
FINANCIAL MANAGEMENT 2

40% income tax rate. The present value of an ordinary annuity of 1 for 4 periods is 2.85498. In order
to realize the internal rate of return of 15%, how much is the estimated before tax cash inflow to be
provided by the machine?
a. P17,860 b. P15,000 c. P25,000 d. P35,700
10. Automotive, inc. has implemented a new project that has an initial cost, and then generates inflows of
P10,000 a year for the next seven years. The project has a payback period of 4.0 years. What is the
project’s internal rate of return (IRR)?
a.14.79% b. 16.33% c. 18.54% d. 15.61%
11. Five mutually exclusive projects had the following information;
Project 1 Project 2 Project 3 Project 4
NPV P500 P(200) P200 P1,000
IRR 12% 8% 13% 10%
Which project is preferred?
a. Project 1 b. Project 2 c. Project 3 d. Project 4

Questions 12 and 13 are based on the following information.

Alpha Company plans to replace its company car with a new one. The new car costs P120,000 and its
estimated useful life is five years without scrap value. The old car has a book value of P15,000 and
can be sold at P12,000. The acquisition of the new car will yield annual cash savings of P20,000
before income tax. Income tax rate is 25%
12. The net investment of the new car is
a. P108,000 b. P108,750 c. P107,250 d. P107,000
13. The payback period of the investment is
a. 5.14 years b. 5.18 years c. 5.11 years d. 5.095 years

Questions 14 through 21 are based on the following information

The Burger Corporation is considering investing in a project. It requires an immediate cash outlay of
P100,000. It has a life of four years and will depreciated on a straight line basis. The firm’s tax rate is
25% and requires a return of 10%. Income depreciation is projected to be;
Year 1 Year 2 Year 3 Year 4
Income before depreciation P30,000 P30,000 P40,000 P40,000
Present value factor 0.909 0.826 0.751 0.683

14. The net cash flow for year 1 is

a. P25,850 b. P28,750 c. P31,250 d. P34,450
15. The net cash flow for year 4 is
a. P35,850 b. P35,950 c. P30,150 d. P36,250
16. The payback period for the project is
a. 3 years b. 3.17 years c. 3.5 years d. 4 years
17. The accounting rate of return of the project is
a.7% b. 9% c. 12% d. 15%
18. The present value of year two’s cash flow is
a. P23,747.50 b. P25, 856.25 c. P26,100.75 d. P29,750.75
19. The present value of the project’s net cash flow is
a. P95,650.15 b. P98,151.25 c. P101,863.75 d. P104,750.25
20. The profitability index of the project is
a. 0.96 b. 0.98 c. 1.02 d. 1.05

*****END OF EXAMINATION*****

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