Exam 3 study set

A firm is considering purchasing an asset that will cost $5 million. Other depreciable costs include$800,000 in installation costs. If the asset is classified in the 5-year class, what is the annual depreciation for years 1, 3, and 6 for this asset, using the fixed depreciation percentages given by MACRS? (The percentages are 20.00%, 19.20%, and 5.76%, respectively.

$1,160,000, $1,113,600, and $334,080 for years 1, 3, and 6, respectively

Eastern Inc. purchases a machine for $15,000. This machine qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Eastern has a tax rate of 20%. If the machine is sold at the end of four years for $4,000, what is the after-tax cash flow from disposal?

$3,718.40

A firm is considering purchasing an asset that will cost $1 million. Other depreciable costs include $100,000 in installation costs. If the asset is classified in the 3-year class, what is the annual depreciation for each year for this asset using the fixed depreciation percentages given by MACRS? (The percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively.)

$366,630, $488,950, $162,910, and $81,510 for years 1, 2, 3, and 4, respectively

Southern Co. purchases an asset for $50,000. This asset qualifies as a five-year recovery asset under MACRS, with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Southern has a tax rate of 20%. If the asset is sold at the end of four years for $5,000, what is the after-tax cash flow from disposal?

$5,728

Lauer's have decided to expand their retail shop by building on a vacant lot they own. The company will build a new building at an estimated cost of $5 million. The firm will spend another $500 thousand on the parking and access roads. The land was purchased ten years ago at a cost of $1 million. Today, that land is worth 2.5 million. What is the total cost of this expansion project?

$8.0 million

A firm is estimating the total increment cash flow in the terminal year for a 3-year project. The managers estimate that the required net fixed assets for the project will have a book value of $100,000 at the end of the 3 years. The estimated salvage value of the fixed assets is $150,000. The project also requires $200,000 of net working capital, all of which will be recouped at the end of the 3 years. Management estimates that the operating cash flow will be $500,000 per year for years 1, 2, and 3. The capital gain tax rate is 20 percent. What is this project's total incremental cash flow in the terminal year (year 3)?

$840,000

Given annual returns of -10%, 14%, 9% and -1% What is the arithmetic average of the returns?

-0.1+0.14+0.09-0.01)/4=0.03 =3.0%

In general, we have the following steps in the estimation of after-tax cash flow at disposal:

1) If selling price is greater than book value: Selling Price - Tax on Gain 2) If SELLING PRICE is less than BOOK VALUE: Selling Price + Tax Credit on Loss. 3) If selling price equals book value: Selling Price. NOTE: If book value is less than selling price: SELLING PRICE - TAX ON GAIN.

A project requires an initial investment of $40,000 and has cash inflows of $10,000 each year for 10years. What is the profitability index if the required return is 12%?

1.4126

Fat Tire Bicycle Company currently sells 40,000 bicycles per year. The current bike is a standard balloon tire bike, selling for $80 with a production and shipping cost of $25. The company is thinking of introducing an off-road bike with a projected selling price of $410 and a production and shipping cost of $360. The projected annual sales for the off-road bike are 12,000. The company will lose sales in fat-tire bikes of 10,000 units per year if it introduces the new bike, however. What is the erosion cost from the new bike?

10000(80-25) =550,000

Assume the following information about the market and JumpMasters' stock. JumpMasters' beta = 1.50, the risk-free rate is 3.50%, the market risk premium is 10.0%. Using the SML, what is the expected return for JumpMasters' stock?

18.5%

The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds (1957 replicas). The purchase price of the necessary foundry equipment is $2,000,000. The equipment also requires delivery and installation costs of $100,000. Net working capital increases by $300,000 at the beginning of the project (Year 0) . What is the incremental cash flow of the project at the beginning of the project (Year 0)?

2,000,000+100,000+300,000= 2,400,000

Given annual returns of -10%, 14%, 9% and -1%, what is the geometric average?

2.578% [(1-0.1)(1+0.14)(1+0.09)(1-0.01)]^(1/4)-1 = .02578

The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds (1957 replicas). The purchase price of the necessary foundry equipment is $3,000,000. The equipment also requires delivery and installation costs of $100,000. Net working capital increases by $400,000 at the beginning of the project (Year 0) . What is the incremental cash flow of the project at the beginning of the project (Year 0)?

3,000,000+100,000+400,000= 3,500,000

Consider the following four-year project. The initial after-tax outlay or after-tax cost is $1,000,000.The future after-tax cash inflows for years 1, 2, 3 and 4 are: $400,000, $300,000, $200,000 and $200,000,respectively. What is the payback period without discounting cash flows?

3.5 years

Fat Tire Bicycle Company currently sells 40,000 bicycles per year. The current bike is a standard balloon tire bike, selling for $90 with a production and shipping cost of $35. The company is thinking of introducing an off-road bike with a projected selling price of $410 and a production and shipping cost of $360. The projected annual sales for the off-road bike are 12,000. The company will lose sales in fat-tire bikes of 4,000 units per year if it introduces the new bike, however. What is the erosion cost from the new bike?

4,000(90-35)= 220,000

The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds (1957 replicas). The purchase price of the necessary foundry equipment is $4,000,000. The equipment also requires delivery and installation costs of $100,000. Net working capital increases by $800,000 at the beginning of the project (Year 0) . What is the incremental cash flow of the project at the beginning of the project (Year 0)?

4,000,000+100,000+800,000= 4,900,000

You have $1,200,000 to invest in a stock portfolio. Your choices are stock X with an expected return of 15% and stock Y with an expected return of 9%. Your goal is to create a portfolio with an expected return of 13%. How much money do you invest in stock Y

400,000

A firm has revenue of $50,000, the cost of goods sold is $23,000, other expenses (from selling and administration) are $14,000, interest expenses are $4,000 and depreciation is $5,000. What is the EBIT?

50,000-23,000-14,000-5,000 =8,000

The stock of Hybrid Motors, Inc. has a beta of 0.84. The market risk premium is 5.2 percent and the risk-free rate is 2.6 percent. What is the expected return on this stock?

6.968%

Baldwin Co. purchases an asset for $50,000. This asset qualifies as a five-year recovery asset underMACRS, with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 =19.20%; year 4 = 11.52%. Baldwin has a tax rate of 35%. If the asset is sold at the end of four years for$5,000, what is the after-tax cash flow from disposal?

6274.00

Fat Tire Bicycle Company currently sells 40,000 bicycles per year. The current bike is a standard balloon tire bike, selling for $100 with a production and shipping cost of $35. The company is thinking of introducing an off-road bike with a projected selling price of $410 and a production and shipping cost of $360. The projected annual sales for the off-road bike are 12,000. The company will lose sales in fat-tire bikes of 8,000 units per year if it introduces the new bike, however. What is the erosion cost from the new bike?

8,000(100-35) = 520,000

Rene owns the following portfolio of securities. What is the beta for the portfolio?

= 1.82 ∗ 50% + 0.53 ∗ 30% + 0.67 ∗ 20% = 1.20.

Assume the following information about the market and Lithium Motors Stock. Lithium's beta = 1.80, the risk-free rate is 2.50%, the market risk premium is 8.0%. Using the SML, what is the expected return for the firm's stock?

= 2.50% + 1.80 ∗ (10.50% - 2.50%) = 16.90%. Answer = 16.90%

Which of the following is statements is TRUE?

A beta > 1 implies the asset has more systematic risk than the overall market.

Which of the following statements is true about variance?

A) Variance describes how spread out a set of numbers or values are around their mean or average. B) Variance is essentially the variability from the average. C) The larger the variance, the greater the dispersion. D) All of the above statements are true. ANS: D, all of thee above

You wish to diversify your single-security portfolio in a way that will maximize your reduction in risk. Which of the following securities should you add to your portfolio?

Alpha Company stock that has a correlation coefficient of -0.25 with your current security

Which of the statements below is TRUE?

An increase in working capital can be brought about by an increase in inventory.

You purchased 1000 shares of stock for $25 per share. After holding the stock for 6 years and not receiving any dividends, you sell the stock for $42 per share. What is the effective annual return on this investment?

Answer= 9.03% HPR=[ending price + distrobutions - beg. price]/ beg.price = .68 EAR=(1+HPR)^m-1 =1.68^(1/6)-1 = 9.03%

Find the standard deviation for a security that has three one-year returns of -5%, 15%, and 20%.

Average return = Σrt/n = (-5% + 15% + 20%)/3 = 10% = [[(-5% - 10%)2 + (15% - 10%)2 + (20% - 10%)2]/(3 - 1)]^(1/2) = 13.23% ANS= 13.23%

which of the statements below is false?

Book value is the original cost of the asset plus the accumulated depreciation

Richard owns the following portfolio of securities. What is the beta for the portfolio?

D) 1.38

Which of the following statements is false?

Despite all of the advantages of using the NPV model, it is inconsistent with the concept of the time-value-of-money.

A firm has revenue of $50,000, the cost of goods sold is $32,000, other expenses (from selling and administration) are $14,000, interest expenses are $4,000 and depreciation is $5,000. What is the EBIT?

EBIT = Revenue - Cost of Goods Sold - Other Expenses - Depreciation= $50,000 -$32,000 -$14,000 -$5,000 = $-1,000 Note: interest is not considered when computing the EBIT

Which of the below statements is FALSE?

Erosion results in incremental cash inflows.

From 1925-2006, the portfolio of large U.S. stocks has had a greater variance than the portfolio of small U.S. stocks.

False

To be considered acceptable, a project must have a NPV greater than 1.0 (T/F)

False

A firm is estimating the total increment cash flow in the terminal year for a 3-year project. The managers estimate that the required net fixed assets for the project will have a book value of $74,100 at the end of the 3 years. The estimated salvage value of the fixed assets is $100,000. The project also requires $200,000 of net working capital, all of which will be recouped at the end of the 3 years. Management estimates that the operating cash flow will be $250,000 per year for years 1, 2, and 3. The capital gain tax rate is 30 percent. What is this project's total incremental cash flow in the terminal year (year 3)?

Gain (loss) = Salvage value - Book value = 100,000 - 74,100 = 25,900 Taxes = 0.30×25,900 = 7,770 After-tax salvage value = 100,000 - 7,770 = 92,230 Total incremental cash flow in year 3 = 250,000 + 92,230 +200,000 = 542,230

Geronimo, Inc. is considering a project that has an initial after-tax outlay or after-tax cost of $220,000. The respective future cash inflows from its four-year project for years 1 through 4 are: $50,000, $60,000, $70,000 and $80,000. Geronimo uses the net present value method and has a discount rate of 11%. Will Geronimo accept the project?

Geronimo rejects the project because the NPV is about -$22,375.73.

Which is NOT a step in the estimation of after-tax cash flow at disposal?

If book value is less than selling price: Selling Price + Tax Credit on Loss.

Which of the statements below is TRUE concerning risk-averse investors?

Investors want to maximize return and minimize risk.

Which of the statements below is TRUE of the payback period method?

It ignores the cash flow after the initial outflow has been removed.

The advantage of ________ over ________ depreciation is that you can write off more of your capital costs in the earlier years.

MACRS; straight-line depreciation

The crossover rate is the discount rate where both projects have the same ________.

NVP

The ________ model is usually considered the best of the capital budgeting decision-making models.

Net Present Value (NPV)

Cranium, Inc. is considering a four-year project that has an initial outlay or cost of $100,000. The respective future cash inflows from its project for years 1, 2, 3 and 4 are: $50,000, $40,000, $30,000 and $20,000. Will it accept the project if it's payback period is 26 months?

No, because it pays back in 28 months!!! 50,000 (Yr 1)40,000 (Yr 2)and balance of 10,000 from btwn Yr 2 and Yr 3payback period = 2 + (10,000/30,000) = 2.33 yearsThe payback period is in 28 months

The EBIT is $16,000, depreciation is $4,000, interest payments are $6,000, and taxes are $2,000. What is the operating cash flow (OCF)?

OCF = EBIT + Depreciation - Taxes = $16,000 + $4,000 - $2,000 = $18,000

Nodak, Inc. is currently considering an eight-year project that has an initial outlay or cost of $160,000. The cash inflows from its project for years 1 through 5 are the same at $55,000. Nodak has a discount rate of 11%. Because there is a shortage of funds to finance all good projects, Nodak wants to compute the profitability index (PI) for each project. That way Nodak can get an idea as to which project might be a better choice. What is the PI for Nodak's current project?

PI = (43,274.34 + 160,000)/160,000 = 1.27046 -> 1.27 About 1.27

________ is a modification of NPV to produce the ratio of the present value of the benefits (future cash inflow) to the present value of the costs (initial investment).

Profitability Index (PI)

__________ is a modification of NPV to produce the ratio of the present value of the benefits (future cash inflow) to the present value of the costs (initial investment)

Profitability Index (PI)

Which method is designed to give the dollar amount of return for every $1.00 invested in the project in terms of current dollars?

Profitability Index Method

________ may be defined as a measure of uncertainty in a set of potential outcomes for an event in which there is a chance for some loss.

Risk

Rocket Red, Inc. is considering a five-year project that has initial after-tax outlay or after-tax cost of $170,000. The future after-tax cash inflows from its project for years 1 through 5 are $45,000 for each year. Rocket Red uses the net present value method and has a discount rate of 11.25%. Will Rocket Red accept the project?

Rocket Red rejects the project because the NPV is about -$4,725.

Sandstone, Inc. is considering a four-year project that has an initial after-tax outlay or after-tax cost of $80,000. The future cash inflows from its project are $40,000, $40,000, $30,000 and $30,000 for years 1, 2, 3 and 4, respectively. Sandstone uses the net present value method and has a discount rate of 12%. Will Sandstone accept the project?

Sandstone accepts the project because it has a positive NPV of over $28,000.

Stock A has a beta of 0.98 and standard deviation of returns of 35%. Stock B has a beta of 1.15 and a standard deviation of returns of 23%. Which stock has more total risk?

Stock A

Stocks A, B, C, and D have standard deviations, respectively, of 20%, 5%, 10%, and 15%. Which one is the riskiest?

Stock A

Which of the statements below describes the IRR decision criterion?

The decision criterion is to accept a project if the IRR exceeds the hurdle rate or required return rate.

Given annual returns of -10%, 14%, 9% and -1% What is the standard deviation of the returns?

Variance = [(-0.1-0.03)^2 + (0.14-0.03)^2 + (0.09-0.03)^2 + (-0.01-0.03)^2]/3 = 0.0114 Standard deviation = 0.0114^1/2 = 0.10677 =10.677%

The initial outlay or cost is $1,500,000 for a four-year project. The respective future cash inflows for years 1, 2, 3 and 4 are: $400,000, $500,000, $600,000 and $200,000. What is the payback period without discounting cash flows?

We can see that after three years, we will have paid back $1,500,000. Thus, the payback period is about 3.0 years!!!

Project A has an NPV of $20,000 and a PI of 1.2. Project B has an NPV of $10,000 and a PI of 1.3. The two projects are independent of one another and both projects have equal lives. We have enough capital to fund project A, project B, or both projects. Which of the following statements is true?

We should accept both Project A and Project B.

Project A has an NPV of $20,000 and a PI of 1.2. Project B has an NPV of $10,000 and a PI of 1.3. Both projects have equal lives. What should the best decision if we are NOT concerned with capital rationing (that is, we are NOT concerned with being short of funds)?

We should accept both projects.

Webster, Inc. is considering an eight-year project that has an initial after-tax outlay or after-tax cost of $180,000. The future after-tax cash inflows from its project for years 1 through 8 are the same at $35,000. Webster uses the net present value method and has a discount rate of 12%. Will Webster accept the project?

Webster rejects the project bc the NPV is about -$6,133

Given annual returns of -9%, 14%, 5% and 8%, what is the geometric average?

[(1-0.09)(1+0.14)(1+0.05)(1+0.08)]^(1/4)-1 = 0.0415 =4.15%

Which of the following is NOT a definition of beta?

a measure of risk that can be avoided

B&H, Inc. is currently considering an five-year project that has an initial outlay or cost of $220,000. The future cash inflows from its project for years 1 through 5 are the same at $50,000. B&H has a discount rate of 8%. Because of capital rationing (shortage of funds for financing), B&H wants to compute the profitability index (PI) for each project. What is the PI for B&H's current project?

about .91

The initial outlay or cost is $1,000,000 for a four-year project. The respective future cash inflows for years 1, 2, 3 and 4 are: $500,000, $300,000, $300,000 and $300,000. What is the payback period without discounting cash flows?

about 2.67 years

To project the appropriate anticipated cash flow for a project, we must put all cash flow knowledge together. This includes ________ of the incremental cash flow.

both the amount and the timing

________ is at the heart of corporate finance, because it is concerned with making the best choices about project selection.

capital budgeting

If an asset's disposal value is less than its ________, a loss on disposal occurs.

current book value

Which of the following in NOT a potential problem suffered by the IRR method of capital budgeting?

disagreement with the NPV as to whether a project with ordinary cash flows is profitable or not

If an asset's ________ is greater than its current book value, a gain on disposal occurs.

disposal value

The practice of not putting all of your eggs in one basket is an illustration of ________.

diversification

The advantage of MACRS over straight-line depreciation is that you can write off more of your capital costs in the ________ years.

earlier

Whenever a new product competes against a company's already existing products and reduces the sales of those products, ________ occur.

erosion costs

To be considered acceptable, a project must have an NPV greater than 1.0

false

the goal of diversification is to eliminate

firm-specific risk

A gain on disposal is recognized when the selling price of the asset is ________ the book value.

greater than

A project provides cash inflows of $2,822 each year for four years. What is the payback period if the cost is $12,500?

none of the above

Once the operations for a new project are up and running, we need to estimate the cash flow from ________.

operations

________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow of a new project.

opportunity costs

The __________ method is simple and fast but economically unsoundterm-20 as it ignores all cash flow after the cutoff date and ignores the time-value of money.

payback period

The __________ model answers one basic question: How soon will I recover my initial investment?

payback period

Consider the following three-year project. The initial after-tax outlay or after-tax cost is $1,500,000. The future after-tax cash inflows for years 1, 2, 3 and 4 are: $800,000, $800,000, $300,000 and $100,000, respectively. What is the payback period without discounting cash flows?

payback period = 1 + (700,000/800,000) = 1.875 years

________ are an accounting measure of performance during a specific period of time, while ________ is the actual inflow or outflow of money.

profits; cash flow

________ of a project are those that have already been incurred and cannot be reversed.

sunk costs

A financial manager examines concepts such as sunk costs, opportunity costs, and erosion costs to help understand how to estimate the incremental cash flow of a project, which is ________.

the additional money the firm receives from taking on a new project

the IRR is defined as

the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost (the investment or cash outflows) equals the present value of the future benefits.

The net present value of an investment is ________.

the present value of all benefits (cash inflows) minus the present value of all costs (cash outflows) of the project

The IRR is the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost equals ________.

the present value of the future benefits or cash inflows

The NPV profile of a project is ________.

the project's NPVs at different discount rates.

The NPV profile of a project is __________.

the project's NPVs at different discount rates.

If the company had a large depreciation expense during the period, the income statement could show a loss for the period, even though the cash account may have grown during the same period

true

The type of risk that can be diversified away is called ________.

unsystematic risk

At the end of a project's life, we will recover any initial changes in ________ from the beginning of the project.

working capital