Exam 3

____________________ results from the use of fixed - cost assets or funds to magnify returns to a firm's owners.

Leverage

Maverick Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60% of sales, so the company's current operating income is $700,000. The company's interest expense is $533,873. What is the company's degree of financial leverage (DFL)? Answer to 2 decimal places.

Current Operating Income = $700,000 Earnings before Tax= Operating Income - Interest expenses Earnings before Tax = $700,000 - $533,873 = $166,127 Degree of Financial Leverage = Operating Income/Earnings before Tax Degree of Financial Leverage = $700,000/$166,127 Degree of Financial Leverage(DFL) = 4.21

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

Mutually Exclusive

The "gold standard" of investment criteria refers to:

NPV

Which of the following statements is correct?

The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales.

The dividend decision

if you can't find investments that make your minimum acceptable rate, return the cash to owners of your business

According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?

increase bank executive turnover

Generally, increases in leverage result in______________ return and _____________________ risk.

increased; increased

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​anyway?) The proposed project has the following​features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​$2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $20,000,000(excluding​ land, hint: the land is not subject to​depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​$3,500,000, accounts receivable by​ $1,500,000,and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​(including land) will be sold for $4,500,000(assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the operating cash flow​ @ t=2? Round to nearest whole dollar value.

3,212,500

Libscomb Technologies' annual sales are $6,615,140 and all sales are made on credit, it purchases $4,071,988 of materials each year (and this is its cost of goods sold). Libscomb also has $553,442 of inventory, $521,646 of accounts receivable, and beginning and ending of year $448,048 and $420,069 accounts payables (respectively). Assume a 365 day year. What is Libscomb's Cash Cycle (in days)?

Cash Cycle = Days inventory+Days receivable-Day payable Step 1: Find Days inventory= Inventory*365/cogs= 553,442*365/4,071,988=49.608773 Step 2: Find Days Receivable= receivables*365/sales=521,646*365/6,615,140=28.782579 Step 3: Find Day payable = (Avg. A/P)*365/cogs=((448,048+420,069)/2)*365/4,071,988)=38.907618 Step 4: Find Cash Cycle = Days inventory+Days receivable-Day payable= 49.608773+28.782579-38.907618=39.48

What are advantages of payback period?

Does not require complex calculations Measures Liquidity, Easy to communicate Does not require discount rate

Davis Supply maintains an average inventory of 2,000 dinosaur skulls for sale to filmmakers. The carrying cost per skull per year is estimated to be $150.00 and the fixed order cost is $71. What is the economic order quantity (EOQ)? (Round to the nearest whole number.)

EOQ=((2 x Annual demand x Ordering cost)/(Carrying cost))^.5 EOQ=((2x2000x71)/(150))^.5 EOQ=((284000)/(150))^.5 EOQ=(1893.33)^.5=43.51

What is the internal rate of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000 per year for 6 years?

FV - 0 PV - -10000 PMT- 2000 N - 6 CPT I - 5.47

It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent

False

Libscomb Technologies' annual sales are $5,038,637 and all sales are made on credit, it purchases $3,658,032 of materials each year (and this is its cost of goods sold). Libscomb also has $539,389 of inventory, $555,841 of accounts receivable, and $422,996 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Period (in days)?

Inventory Period(in days)?=365/ Inventory turnover Step 1: Find Inventory Turnover: Cogs/inventory: 3,658,032/539,389=6.781807 Step 2: Find Inventory Period: 365/inventory period: 365/6.781807=53.82

Hammond Supplies expects sales of 236,304 units per year with carrying costs of $3.21 per unit and ordering cost of $9.75 per order. Assuming the level of inventory is stable, what is the optimal average number of units in inventory? Round to the nearest whole number.

Optimal units = (2*Annual Demand*Ordering cost/Carrying cost)^.5 =(2*236304*9.75/3.26)^.5 = 1,198.12 Average number of units in inventory = EOQ/2 Average number of units in inventory = 1198.12/2 Average number of units in inventory = 599.06

What is the equivalent annual cost for a project that requires a $50,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?What is the equivalent annual cost for a project that requires a $50,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

Present value oof cash outflows = CF0+Annual Cash outflow*PVAF(10%,1-4 years) =50,000+10,000*3.16986544634 =81698.65 equivalent annual cost=Present value of cash outflows/PVAF(10%,1-4 years) =81698.65/3.1

The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

Libscomb Technologies' annual sales are $6,068,380 and all sales are made on credit, it purchases $4,006,330 of materials each year (and this is its cost of goods sold). Libscomb also has $546,527 of inventory, $1,475,000 of accounts receivable, and $1,400,000 of accounts payable. Assume a 365 day year. What is Libscomb's Receivables Period (in days)?

Receivables period= 365/ Receivables Turnover Step 1: Find Receivables Turnover: sales/accounts receivables 6,068,380/1,475,000=4.114156 Step 2: Find Receivables Period: 365/receivables 365/4.114156=88.72

What is the profitability index for Project A with a cost of capital of 8%? Year Project A Project B 0 ($42,000.00) ($45,000.00) 1 $14,000.00 $28,000.00 2 $14,000.00 $12,000.00 3 $14,000.00 $10,000.00 4 $14,000.00 $10,000.00 5 $14,000.00 $10,000.00

Value of cash inflows at the present =( (14000/1.08)+(14000/ (1.08)^2+(14000/(1.08)^3+(14000/(1.08)^4+(14000/(1.08)^5) = (12962.96+ 12002.74+11113.65+10290.41+9528.16) = 55898 (Approx) Net value of cash outflow at the beginning =42000 Profitability index=[present value of future inflows / initial outflows] =[55898/42000] =1.33

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

deemphasizing that variable as a critical factor.

Capital rationing may be beneficial to a firm if it:v

weeds out proposals with weaker or biased NPVs.

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​anyway?) The proposed project has the following​features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​$2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $20,000,000(excluding​ land, hint: the land is not subject to​depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​$3,500,000, accounts receivable by​ $1,500,000,and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​(including land) will be sold for $4,500,000(assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the total cash flow at​ t=10? Round to nearest whole dollar value.

t=10? Total Cash Flow at time 10? =ATSV+OCF+NWL(After tax salvage+operating cash flow + net working capital) =4,500,000+3,212,500+3,000,000 wwl=(inventories+Acts.Rec)-Accts.pay = (3,500,000+1,500,000)-2,000,000=3,000,000 = 10,712,500

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet demand for a new line of solar charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features; ​• The firm just spent​ $300,000 for marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $29,141,472 (excluding​ land, hint: land is not subject to​ depreciation). ​​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for ​$4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes) .0 What is the​ project's outflow at​ t=0? Answer to the nearest whole dollar value.

$29,141,472+$2,000,000 =$31,741,472

What is the amount of the operating cash flow for a firm with $340,638 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

(340,638*0.65)+100,000 = 321,414.7

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A decrease in the fixed costs

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format with 2 number after the decimal point

900/1.08) + (900/(1.08)^2) + (900/(1.08)^3) + (1400/(1.08)^4) + (1400/(1.08)^5) + (1400/(1.08)^6)= (833.33 + 771.60 + 714.45 + 1029.04 + 952.82 + 882.24)= 5183.48 5183.48 / 5000 = 1.036696 = 103.67%

What is the net effect on a firm's working capital if a new project requires: $41,375 increase in inventory, $35,370 increase in accounts receivable, $35,000.00 increase in machinery, and a $44,016 increase in accounts payable? Round to nearest dollar amount.

A/R: $35,370 Inventory: $41,375 A/P: $44,016 35,370+41,375-44,016=

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%.Year A B C0 $ (1,000) $(5,000) $(50,000)1 $ 300 $ 1,700 $ 02 $300 $ 1,700 $15,0003 $ 600 $1,700 $ 28,5004 $300 $1,700 $ 33,000What is the IRR of the best project? % terms to 2 decimal places w/o % sign

A: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =300/1.14+300/1.14^2+600/1.14^3+300/1.14^4 = 1076.61 NPV=Present value of inflows-Present value of outflows =1076.61-1000 = $76.61 B: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =1700/1.14+1700/1.14^2+1700/1.14^3+1700/1.14^4 =4953.31 NPV=Present value of inflows-Present value of outflows =4953.31-5000=-46.69 C: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =15000/1.14^2+28500/1.14^3+33000/1.14^4 =50317.35 NPV=Present value of inflows-Present value of outflows =50317.35-50000=$317.35 Hence C is the best project having highest NPV. Let irr be x%At irr,present value of inflows=present value of outflows. 50,000=15000/1.0x^2+28500/1.0x^3+33000/1.0x^4 Hence x=irr=14.23(Approx)

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​anyway?) The proposed project has the following​features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​$2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $20,000,000(excluding​ land, hint: the land is not subject to​depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​$3,500,000, accounts receivable by​ $1,500,000,and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​(including land) will be sold for $4,500,000(assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What are the after tax proceeds from the sale of the factory​ (i.e., ATSV)? Round to nearest whole dollar value.

After tax proceeds for factory At SV= Salvage value -tax*(salvage tax - Book value) Salvage value = 4,500,000 Bv Land = 2,000,000 Project = (4,500,000-2,000,000) = 2,500,000 Bv project = initial cost - (years*Depr)=20,000,000-(10*1,750,000) = 20,000,00 - 17,500,000 = 2,500,000 Bv Land + Project = 2,000,000 + 2,500,000 = 4,500,00 Tax gain = SV -Bv land & project = 4,500,000 - 4,500,000 = 0 taxes on gain = 0*.35=0 ATSV = 4,500,000 - 0 = 4,500,000

A corporation is contemplating an expansion project. The CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the corporation's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

Any opportunity costs associated with the project.

​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​$3,500,000, accounts receivable by​ $1,500,000,and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​(including land) will be sold for $4,500,000(assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the​ project's NPV? Round to nearest whole dollar value.

CFO = opportunity cost (lands current market. value) + initial cost + NWL = 2,987,253 + 20,000,000 + 3,000,000 = -25,987,253 Co1 = OCF (operating cost flow) = 3,212,500 Fo1 = 9 Co2 = (+=10) = 10,712,500 Fo2 = 1 I = 10 (Project Wacc%) CPT NPV = (-)3,356,256.502

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $186 at the end of the next three years and then $1,831 per year for the three years after that. If the discount rate is 2.18% then what is the NPV?

CFo= -5000 CO1= 186 FO1= 3 CO2= 1831 FO2= 3 I = 2.18 CPT NPV = $466.80

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $100 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's IRR? % terms to 2 decimal places and without the % sign.

CFo=-100,000,000 C01=-20,000,000 F01=1 C02=80,000,000 F02=1 C03=90,000,000 F03=1 I=11 CPT IRR = 15.95gr

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $123,666,186 now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's NPV?

CFo=-123,66,186 C01=-20,000,000 F01=1 C02=80,000,000 F02=1 C03=90,000,000 F03=1 I=11 CPT NPV = -10,947,185.0414

Mavericks Cosmetics buys $4,462,180 of product (net of discounts) on terms of 7/10, net 60, and it currently pays on the 10th day and takes discounts. Mavericks plans to expand, and this will require additional financing. If Mavericks decides to forego discounts, what would the effective percentage cost of its trade credit be, based on a 365-day year? Answer in % terms to 2 decimal places.

Calculate effective percentage cost of its trade as follows: Effective percentage cost of its trade = [(1+(discount rate/(1-discount rate))^(total days/discount days)-1 Effective percentage cost of its trade=[(1+(0.07/(1-0.07))]^(365/10)-1 Effective percentage cost of its trade=[(1+(0.07/(0.93))]^(365/10)-1 Effective percentage cost of its trade=[(1+0.075269]^(365/10)-1 Effective percentage cost of its trade=[1.075269]^36.5-1 Effective percentage cost of its trade=14.137599-1 Effective percentage cost of its trade=13.137599*100% Effective percentage cost of its trade=1313.7599%

Carlisle Transport had $4,640 cash at the beginning of the period. During the period, the firm collected $1,580 in receivables, paid $2,168 to supplier, had credit sales of $6,952, and incurred cash expenses of $500. What was the cash balance at the end of the period?

Cash balance at the beginning = 4640 Collection of receivables = 1580 Cash to supplier = 2168 Cash expenses = 500 Cash Balance at the end = Cash balance at the beginning+Colllection of receivables-Cash to supplier-Cash expenses =4640+1580-2168-500=3552

Compute the payback period for a project that requires an initial outlay of $124,220 that is expected to generate $40,000 per year for 9 years.

Cash outflow = $124,220 Cash inflow = $40,000 At the end of 3 years the cash inflow will be 40,000*3 = $120,000 Remaining amount =124,220-120,000 =$4,220 Years =4,220/40,000 =0.1055 Therefore payback period =3+0.1055 =3.1055

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital

False

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.

False

A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 40% of sales, while fixed cost will be $497,820. The first year's sales estimates are $1,250,000. Calculate the firm's degree of operating leverage (DOL). Answer to 2 decimal places.

Formula: Contribution margin / EBIT Contribution= Sales - Variable cost = 1250000-(1250000*.4) = 750000 EBIT= Sales-Variable cost-Fixed cost = 1250000-(1250000*.4)-497820 = 252180 Degree of operating leverage= 750000/252180 =2.97

Libscomb Technologies' annual sales are $5,219,840 and all sales are made on credit, it purchases $4,412,818 of materials each year (and this is its cost of goods sold). Libscomb also has $585,574 of inventory, $521,484 of accounts receivable, and $437,902 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Turnover?

Inventory turnover=cost of goods sold "material" /inventory 4,412,818/585,574=7.54

Mahrouq Technologies buys $10,261,535 of materials (net of discounts) on terms of 4/30, net 60, and it currently pays within 30 days and takes discounts. Mahrouq plans to expand, and this will require additional financing. If Mahrouq decides to forego discounts and thus to obtain additional credit from its suppliers, calculate the nominal cost of that credit. Answer in % terms to 2 decimal places (no % sign).

Nominal cost of trade credit = [Discount %/100%-Discount%)]x[365/(Final due date - Discount period)] Nominal cost of trade credit = [4/(100-4)x[365/(60-30)] Nominal cost of trade credit = 0.5069 or 50.69%

Libscomb Technologies' annual sales are $6,262,468 and all sales are made on credit, it purchases $3,366,755 of materials each year (and this is its cost of goods sold). Libscomb also has $502,700 of inventory, $543,118 of accounts receivable, and $418,276 of accounts payable. Assume a 365 day year. What is Libscomb's Operating Cycle (in days)?

Operating cycle=Inventory Period + Accounts receivables Period Step 1: Find Inventory Turnover= cogs/inventory=3,366,755/502,700=6.697344 Step 2: Find Inventory Period= 365/inventory turnover=365/6.697344=54.499214 Step 3: Find Receivables Turnover= sales/receivables 6,262,468/543,118 =11.530585 Step 4: Find Receivables Period= 365/receivables turnover 365/11.530585=31.654943 Step 4: Find Operating Cycle= Inventory period + Receivables period=54.499214+31.654943=86.15

Which of the following statements is correct for a project with a negative NPV?

The cost of capital exceeds the IRR

Libscomb Technologies' annual sales are $5,743,851 and all sales are made on credit, it purchases $3,033,224 of materials each year (and this is its cost of goods sold). Libscomb also has $557,028 of inventory, $567,444 of accounts receivable, and $469,017 of accounts payable. Assume a 365 day year. What is Libscomb's Receivables Turnover?

Receivables Turnover=Sales/Accounts Receivables 5,743,851/567,444=10.12

The disadvantages of the IRR period method is that it

Requires complex calculations Requires a lot of data (estimates of all CFs) Only works for normal cash flows

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $20,000,000 (excluding​ land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000,accounts receivable by​ $1,500,000, and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the operating cash flow​ @ t=1? Round to nearest whole dollar value.

Rev = 8,000,000 COGS: 8,000,000*.5 = 4,000,000 Dear:(initial cost - salvage value)/# of years :salvage value = value to be sold - book value purchased at = 20,000,000-(4,500,000-2,000,000)/10=1,750,000 EBT: Rev-COGS-Depr= 8,000,000-4,000,000-1,750,000 = 2,250,000 Tax: EBT*%=2,250,000*.35=787,500 Net income: 2,250,000 - 787,500 = 1,462,500 Depr. Exp: 1,750,000 OCF: Net income + Depr. = 1,462,500 + 1,750,000 = 3,212,500

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $72,088 2 $40,000 3 $20,000 4 $10,000 Thereafter 0 Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $40,000 in plant and equipment that will be depreciated using the straight-line method over 5 years. The firm recently spent $2,000 on a study to estimate the revenues of the new product. The tax rate is 20%. What is the operating cash flow in year 1? Answer to the nearest whole dollar amount.

Revenue: 72,088 Expenses: 0.5(72,088) = 36,044 Depreciation: 40,000/5 = 8,000 EBIT: 36,044 - 8,000 = 28,044 Tax: 0.2(28,044) = 5,608.8 Net Income: 28,044 - 5,608.8 = 22,435.2 OCF = 22,435.2 + 8,000 = 30,435.2

Maverick Technologies has sales of $3,000,000. The company's fixed operating costs total $526,088 and its variable costs equal 60% of sales. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)? Answer to 2 decimal places.

Sales = $3,000,000 Total Contribution = Sales*(1- % of Variable Costs) = $3,000,000*(1-0.60) = $1,200,000 Earnings before Tax = Total Contribution - Fixed Operating Costs - Interest Expenses Earnings before Tax = $1,200,000-$526,088-$500,000 = $173,912 Degree of Total Leverage = Total Contribution/Earnings before Tax Degree of Total Leverage = $1,200,000/$173,912 Degree of Total Leverage = 6.9

Gillstrap Promotions has projected the following values for the next three months: JanuaryFebruaryMarchSales$352,000$379,000$447,940Purchases on Trade Credit$218,000$240,000$260,000Cash Expenses$88,000$91,000$94,000Taxes, interest, and dividends$18,000$20,000$41,000Capital Expenditures$50,0000$25,000 All sales are credit sales with 40% collected in the month of sale, 50% collected the following month, and the remainder collected in the second month after the sale. Credit purchases are paid in 30 days and all other items require immediate payment. Compute the net cash inflow for March.

Sales collected = 40% of March sales + 50% of February sales + 10% of January Sales = 0.4 x 447,940 + 0.5 x 379,000 + 0.1 x 352,000 = 403,876 Cash out flows in March: Purchases on Trade credit for Feb = $240,000 + Cash Expenses = $94,000 + Taxes, interest and dividends = $41,000 + Capital expenditures = $25,000 Net Cash outflows = $400,000 Net Cash inflows = 403,876-400,000= 3,876

A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 56.31% of sales, while fixed cost will be $450,000. The first year's sales estimates are $1,433,346. Calculate the firm's operating breakeven level of sales. Answer to 2 decimal places.

Sales x (1-variable cost) 1433346*(1-.5631) = 626228.8674 Sales x (1-variable cost) - fixed cost 1433346 x (1-.5631) - 450000 = 176228.8674 626228.8674/176228.8674=3.55

List steps of the capital budgeting process

Step 1 - Proposal Generation Step 2 - Review and Analysis Step 3 - Decision Making Step 4 - Implementation Step 5 - Follow-up

Grill Master Johnnys is thinking about purchasing a new, energy-efficient grill. The grill will cost $53,000.00 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $11,750.00. The grill will have no effect on revenues but will save Johnny's $23,500.00 per year in energy expenses. The tax rate is 40%. The 3-year MACRS schedule; Year Depr % 1. 33.33 2. 44.45 3. 14.81 4. 7.41 What is the total cash flow in year 3?

Tax=14.81% Initial investment:-53,000 Depreciation: YEAR 1 53,000*33.33%=$17,664.90 YEAR 2 53,000*44.45%=$23,558.50 YEAR 3 53,000*14.81=$7,849.30 SV: $11,750 Saving: $23,500 (minus) Dep $7,849.30 (minus) EBIT $15,650.70 (minus) tax (15,650.7*.4)=$6,260.28 Equal: NI $9,390.42 (plus0 Dep $7,849.3 OCF $17,239.72 BV=initial cost-accumulated depreciationBV=53,000-($17,664.90+$23,558.50+$7,849.30) BV=$3,927.3 ATSV=SV-tax*(SV-BV) ATSV=11,750-0.40*(11,750-3,927.30) ATSV= $8,620.92 Total Cash Flow=OCF+ATSVtotal cash flow=17,239.72+8,620.92 =25,860.64

The degree of operating leverage has which of the following characteristics?

The DOL relates the change in sales to the change in net operating income.

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

True

Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as

a means to ensure regulatory compliance a balancing act that requires careful evaluation of the costs and benefits of each project

What types of analyses do the BNSF strategic studies team conduct?

discounted cash flow sensitivity

What types of projects does the BNSF strategic studies team evaluate?

discretionary

The finance decision

find the right kind of debt for your firm and the right mix of debt and equity to fund your operations

The investment decision

invest in assets that earn a return greater than the minimum acceptable hurdle rate

Identify which of these are the relevant cash flows when considering a capital budgeting project.

lost rent from retail facility remodeling expenses for new store increase in inventory expected salvage value of manufacturing equipment

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth.

In theory, a firm should maintain financial leverage consistent with a capital structure that

maximizes the owner's wealth