CASE 2 Lapu-lapu Inc. (LLI) is considering a five-year contract to replace a manufacturing equipment, with a book value of P250,000. The old equipment's cost was P1,000,000 while the new manufacturing equipment will cost P4,000,000. Shipping the equipment from the US to Cebu would cost P150,000 and an additional P100,000 for the insurance of the equipment during transit. The credit terms given by the supplier is 5/30, n/60. The old equipment can be sold to the market for P50,000. The new equipment would enable the entity to avoid immediate repairs of P45,000 on the old equipment. The project will require additional working capital: current assets of P150,000 and current liabilities of P50,000. The working capital will be returned to LLI at the end of 5 years. The equipment is to be depreciated over 5 years using the straight-line method, with no salvage value. Before-tax annual net cash receipts from daily operations (cash receipts minus cash payments) are shown as follows. Since depreciation expense is not a cash outflow, it is not included in these amounts. Year Net Cash Receipts 1 P 1,500,000 2 1,600,000 3 2,200,000 4 2,000,000 5 1,500,000 The management established a required rate of return of 10 percent for this proposal. The current corporate tax rate is 30%. Purchase price Working capital Annual cash receipts Annual depreciation Today (4,000,000) (200,000) Year 1 Year 2 Year 3 Year 4 Year 5 200,000 1,500,000 (800,000) The net present value computation of the inexperienced management accountant was: Total cash in (out) (4,200,000) PV factor (r=10%) 1.0000 Present value Net present value Decision: Reject the investment (4,200,000) 700,000 0.9091 636,370 1,600,000 (800,000) 800,000 0.8264 661,120 2,200,000 2,000,000 1,500,000 (800,000) (800,000) (800,000) 1,400,000 0.7513 1,051,820 1,200,000 0.6830 900,000 0.6209 819,600 558,810 (472,280) Requirements: 1. Recheck the capital budget computation on its accuracy and validity. List down all your observations. Explain briefly, if needed. (10 points) 2. Recompute the NPV of the project based on your observations. Make sure to include the effects of income taxes in your computation. After your revised computation, do you agree with the decision of the management accountant? Explain briefly. Show your solutions. (10 points) 3. If the tax rate today is 30%, 25% for year 1,24% for year 2, 23% for year 3, 22% for year 4, and 21% for year 5, what are the strategies that you will suggest to LLI to improve their capital budget and optimize their taxes? What would be the total value-added of your suggestions? Explain briefly or show your computations, if needed. (5 points)