Question

1. An amount of P270,000 is invested in a certain project that will produce a uniform annual revenue of P185,400 for 5 years and a salvage value equivalent to 27,000 at the end of its life. Overhead expenses and operation maintenance will be P83,700 annually. Taxes and insurance will be 3% of the first cost per year. The company expects capital to earn not less than 25% before income taxes.

a.)What is the rate of return on the investment

b.)What is the net cash flows using an annual worth method

c.)What is the net cash flows using the present worth method

d.)What is the net cash flows using future worth Method

Answer 1

Solution
a) Finding out the rate of return on the investment.

Annual Revenue P185,400

Annual Cost :

Depreciation = Initial Cost ( P270,000 ) - Salvage Value ( P27,000) / F/A 25 % , 5 = P29,609

Operating and maintaince   P83,700

Tax and Insurance = Initial Cost or Investment P270,000 * (0.03) P8,100

• therefore Total annual cost ( Depreciation + Operating and matainace + Taxes)     P121,409

Annual Profit P63,991

There rate of return on investment is = P63991/P270,000 * 100 = 23.7%

Since the rate of return is less than 25 % Investing in this project is not justified or won't yield the expected return of 25% or more.

b) Now let's find the net cash flow using the annual worth method

Annual Revenue P185,400

Annual Costs :

Depreciation = Initial Cost of P270,000 - Salvage Value of 27,000/ F/A 25%, 5 P29,609

Operating and Maintainace cost P83,700

Taxes and Insurance P270,000 *( 0.03) { Rate of tax and insurance } P8,100

Interest on capital P270,000 * ( 0.25) { Rate of interest to be paid on capital } P 67,500

Total Annual Cost ( Depreciation + Maintainance + taxes and Interest ) P188,909

NET INCOME OR LOSS - 3,509

Again as annual cash outflow is more than cash inflows , the investment is not justified as the it will make the protect incurr excess cost of P3,509 over it's revenue.

c) Now let's find out the present value of net cash flow using Present worth method

Present Worth of cash inflows for 5 years = P 185,400 ( P/A 25%, 5 ) + 27,000 (P/F, 25%, 5)

= P185,000 (2.6893) + 27,000 (0.3277) = P 506370

Again, annual cost ( excluding Depreciation) = P83,700 + P270,000 ( 0.03) = P91800

Therefore PW of cash outflows = P 270,000 + P 91800 ( P/A 25% , 5 ) =P516880

• Since the PW of net cash is less than zero i.e. -P10,510 the investment is not justified

d) Now let's calculate the net cash flow using the future worth method

The Future Worth of cash inflows after 5 years = P27,000 + 185,400 (F/A 25 % , 5) = P27000 + 185400 (8.207)

= 1,548,578

The future value of of cash outflows = P91800 (F/A 25%, 5 ) + P270,00 ( F/F 25% , 5)

= P91800 ( 8.207 ) + P270,000 ( 3.0517 )

= P753,403 + P823,959 = 1577,362

• Since the future worth of cash outflows is more than cash inflows , the project or the investment is not justified and should be rejeted as 1577,362 is more than the inflow of 1548,578.