FIN 319

In the formula for the future value of an annuity, the expression in brackets is equal to the:

Future value interest factor for an annuity

Which of the following are true? Ideally, we should use book values in the WACC. Ideally, we should use market values in the WACC. Book values are often similar to market values for debt. Book values are often similar to market values for equity.

Ideally, we should use market values in the WACC. Book values are often similar to market values for debt.

Which of these are required to calculate the current value of a bond?

Par value Applicable market rate Coupon Time remaining to maturity

Which of the following is an example of an opportunity cost?

Rental income likely to be lost by using a vacant building for an upcoming project

What are the two sets of accounting books?

Shareholders' books Tax books

What information is needed to compute a bond's yield to maturity?

The bond's current price Time to maturity Coupon rate

Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?

The rate of inflation

What is the equation for determining the real interest rate?

[(1+nominal interest rate)/(1+inflation rate)]-1

A zero-coupon bond is a bond that ____.

makes no interest payments

The bottom-up approach to calculating OCF starts with:

net income

The marketing department has projected that the firm's market share will be 8% of industry sales. Industry sales should total 75,000 units. If the price per unit is $200, the firm's expected sales revenue will be _____.

$1,200,000 Reason: (75,000*8%)*$200=$1,200,000

According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

$2,220 Reason: Note that depreciation has already been subtracted in calculating EBIT, so it must be added back. OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation $600 × (1−.30)1-.30 + $1,800 = $2,220

A small project has cash flows of -$10 and $45, and a large project has cash flows of -$30 and $70. What is the incremental NPV at a discount rate of 10%?

$2.73 Reason: The answer is the NPV of the difference in cash flows between the two projects. In this case, the time 0 cash flow difference is (-$30-(-$10)=-$20) and the second cash flow difference is $70-$45 = 25. NPV = -$20+ (25/1.10) = $2.73. You can also take the difference in the NPVs of the two projects.

At the end of a project, the company sold a machine for $50,000 with a book value of $10,000. Assuming a tax rate of 21%, what is the after tax salvage value?

$41,600 Reason: After tax salvage value = salvage value-[(salvage value-book value)*tax rate]

What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?

$5.94 Reason: NPV = -$95 + ($107/1.06) = $5.94

Which of the following is a perpetuity?

A constant stream of cash flows forever

_______ cash flows are the difference between the cash flows of the firm with the project and the cash flows of the firm without the project.

Incremental

Which of the following is the equation for estimating operating cash flows using the tax shield approach?

OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate

Which of the following statements is true in the context of comparing accounting profit and present value break-even point?

Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

What is the approximate formula for estimating the real interest rate?

Real interest rate = Nominal interest rate - Inflation rate

Which of the following are true about U.S. Treasury instruments?

They have never defaulted. They are not expected to default at this time.

What is the purpose of accounting profit break-even analysis?

To determine the level of sales at which profits are equal to zero.

If a firm has multiple projects, each project should be discounted using ___.

a discount rate commensurate with the project's risk

According to the basic investment rule for NPV, a firm should ____.

accept a project if the NPV is greater than zero. reject a project if NPV is less than zero. be indifferent towards accepting a project if NPV is equal to zero

The APR is meaningful for comparisons only when the number of ______ per year is given.

compounding periods

When interest rates in the market rise, we can expect the price of bonds to ____.

decrease

Internal rate of return (IRR) must be compared to the ______ rate in order to determine the acceptability of a project.

discount

NPV ______ cash flows properly.

discounts

One method for estimating the cost of equity is based on the ______ model.

dividend discount

The net present value technique does not discount earnings because earnings ___.

do not represent real money

The beta of a new project may be greater than the beta of existing pure play firms since it is likely to be more responsive to ___.

economywide movements

If a point plotted above the security market line (SML) represents a project being considered by an all-equity firm, the project's IRR must be greater than the cost of ______.

equity capital

When comparing projects with unequal lives, one should use which of the following methods:

equivalent annual costs

Assume you own a bond currently valued at $989. If the market rate of interest drops, the bond's current market value will _____.

increase

If the tax rate increases, the value of the depreciation tax shield will ____.

increase

When evaluating a project with an initial cash inflow followed by cash outflows, the NPV will _____ as the discount rate rises.

increase

When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ____.

increases

Buying new cost-cutting equipment affects operating cash flows by:

increasing taxes increasing pretax income increasing the depreciation deduction

Investment in net working capital arises when ___.

inventory is purchased credit sales are made cash is kept for unexpected expenditures

The IRR ______ to distinguish between investing or financing.

is unable

If the growth rate exceeds the discount rate, then dividends _____.

keep getting bigger

The computation of equivalent annual costs is useful when comparing projects with unequal _____.

lives

When comparing projects with different lives, one should choose the project with the ______ equivalent annual cost.

lower

When cash flows are conventional, NPV is ______ if the discount rate is above the IRR.

negative

The equation for determining the real interest rate has the nominal interest rate in the _____ and the inflation rate in the ______.

numerator; denominator

A firm's cost of debt can be ___.

obtained by talking to investment bankers estimated more easily than its cost of equity obtained by checking yields on publicly traded bonds

When a new project constitutes its own industry, comparing the values of its ______ to comparable firms should help determine an appropriate beta.

operating leverage financial leverage cyclicality of revenues

Preferred stock ___.

pays dividends in perpetuity pays a constant dividend

Other companies that specialize only in projects similar to the project your firm is considering are called ___.

pure plays

As a general rule, when estimating equivalent annual costs, ________ cash flows should be used.

real

Which of the following refers to a cash flows purchasing power?

real cash flow

Erosion will ______ the sales of existing products.

reduce

The CAPM can be used to estimate the ___.

required return on equity

Break-even analysis determines how low

sales

Interest paid twice a year is known as ______ compounding.

semiannual

Depreciation × Tax rate represent the depreciation tax

shield

A decision _______ involves mapping the sequential outcomes of various decisions and corresponding probabilities.

tree

The IRR is ______ to account for the scale of the project.

unable

The first cash flow at the end of week 1 is $100, the second cash flow at the end of month 2 is $100, and the third cash flow at the end of year 3 is $100. This cash flow pattern is a(n) ______ type of cash flow.

uneven

Variable costs typically ______ based on the level of production and are ______ per unit of output.

vary; constant

An accounting break-even point of 1,000 means that ____.

when the firm sells 1,000 units, profits will be equal to zero

What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

$540 Reason: Tax shield = $1,800 × .3 = $540

To find the future value annuity factor using the time value of money table, read down the rows to find T = 2, then across the columns for an interest rate of 10 percent. The intersection of that row and column will show the factor ____.

2.100

Which of the following is true? A company can deduct interest paid on debt up to 30% of EBIT when computing taxable income. A company cannot deduct interest paid on debt when computing taxable income. A company can deduct dividends paid to shareholders when computing taxable income.

A company can deduct interest paid on debt up to 30% of EBIT when computing taxable income.

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.

What are the implications of the time value of money concept?

A dollar today is worth more than a dollar tomorrow A dollar tomorrow is worth less than a dollar today

Which of the following represents an infinite and constant stream of cash flows?

A perpetuity

In general, what is the decision rule for evaluating two mutually exclusive projects using NPV?

Accept the project that has the higher positive NPV.

Which compounding interval will result in the lowest future value assuming everything else is held constant?

Annual

True or false: Projects should always be discounted at the firm's overall cost of capital.

False Reason: Projects' discount rates should reflect their particular level of risk.

Which of the following is the formula for the present value of a growing perpetuity?

C/(r - g)

Which of the following are examples of variable costs for a car manufacturer?

Labor costs Freight costs Cost of steel

True or false: NPV will be the same regardless of whether nominal or real cash flows are used.

True

If you invest in a corporate bond, how many times can you expect, in general, to receive interest?

Twice a year

For a project with a positive initial cash flow followed by negative cash flows, we should ___.

accept if the IRR is less than R

Incremental cash flows of a project are changes in a firm's cash flows that occur as a direct consequence of ____.

accepting a project

The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm is due to the property called value ______

additivity

Discounting is the process of converting ______ dollars into a ______ value.

future; present

The value of a firm is the function of its ______ rate and its _______ rate.

growth; discount

There is a(n) ______ relationship between market interest rates and bond values.

negative

It is appropriate to use the approximate formula for estimating the real interest rate when:

the interest rate and inflation rate are low

When a firm evaluates a proposal to make an existing facility more cost effective, the cost savings must be large enough to justify:

the necessary capital expenditure

When using nominal cash flows, the NPV will be _____ when using real cash flows.

the same as

Which of the following cause issues when comparing two mutually exclusive projects using IRR?

timing of cash flows scale of cash flows

One of the most basic principles of finance is that rational individuals prefer to receive a dollar ____ than a dollar ______.

today; tomorrow

Net investment is equal to the ______ minus ____.

total investment; depreciation

Compute net accounting profit based on the following information: Revenues = $4,000; Variable costs = $1,600; Fixed costs = $700; Depreciation = $300; Tax rate = 20 percent.

$1,120 Reason: Profit = ($4,000 - 1,600 - 700 - 300)(1 - .2) = $1,120

What is the present value of the annual interest payments on a 20-year, $1,000 par value bond with a 5 percent coupon paid annually, if the yield on similar bonds is 10 percent?

$425.68 Reason: PV = (.05 × $1,000) × (1 - 1/1.1020)/.10 = $425.68

What is the contribution margin if the sales price per unit is $15,000, variable cost per unit is $10,000 and fixed costs are $2,000? Ignore taxes.

$5,000 Reason: CM = Sales price - Variable cost = $15,000 - 10,000 = $5000

If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, what is the real rate of return?

2.94%

What is the real interest rate if the nominal annual interest rate is 10 percent and the annual inflation rate is 4 percent?

5.77%

Compute the NPV break-even point based on the following information: EAC = $20,000; Fixed cost = $35,000; Tax rate = 20 percent; Depreciation = $500; Contribution margin = $1,000.

60 units Reason: {$20,000 + [$35,000 × (1 - .2)] - ($500 × .2)}/[$1,000 × (1 - .2)] = 60 units

How long will it take to double your money at 10% per year?

7.2 years

Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?

As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase.

The __________ can be used to estimate the required return on equity.

CAPM

The idea behind ______ is that interest is earned on interest.

Compounding

Which of the following defines the contribution margin? Ignore taxes.

Contribution Margin = Sales - Variable costs

How is a conventional bond different from a zero coupon bond?

Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeroes can not. A conventional bond pays periodic coupon interest whiles zeroes make no interest payments.

Which of the following variables are required to calculate the value of a bond?

Coupon rate Remaining life of bond Market yield

What is a discount bond?

Discount bonds are bonds that sell for less than the face value.

True or false: A firm evaluating two mutually exclusive projects can accept both projects.

False

True or false: A sunk cost is an example of a relevant incremental cash flow.

False

In the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.

Which of the following is true about the WACC?

It is also referred to as the discount rate that is used to discount cash flows in capital budgeting problems. It represents the marginal cost of capital.

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

NPV considers all the cash flows. NPV considers time value of money.

What is the difference between nominal cash flow and real cash flow?

Nominal cash flow is the actual dollars to be received. Real cash flow refers to the cash flow's purchasing power.

What is the CAPM formula?

RS = RF + β× (RM- RF)

Which of the following pieces of information are required in order to compute NPV?

The discount rate Projected future cash flows The time horizon of the project

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

The operating cash flows from net sales over the life of the project

True or false: The rate of return required by shareholders is the same as the firm's cost of equity capital.

True

True or false: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.

True

Opportunity costs are ____.

benefits lost due to taking on a particular project

Allocated costs arise when a specific expenditure ____.

benefits more than one project or division

Capital ______ is the decision-making process for accepting and rejecting projects.

budgeting

Corporate finance emphasizes _____ while financial accounting emphasizes ______.

cash flows; earnings

A key reason that makes NPV a superior capital budgeting technique is that it uses _____ instead of ______.

cash flows; profits

A corporate bond's yield to maturity ____.

changes over time can be greater than, equal to, or less than the bond's coupon rate

If a bond is selling at a discount from its par value, the YTM must be _____ the coupon rate.

greater than

When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ____ 6 percent.

lower than Reason: The YTM is less than the coupon rate for a premium bond.

If reinvestment of interest or dividends does not occur, then the future value of an investment will be _____ and the realized yield will be ____ than if reinvestment had occurred.

lower; lower

The discount rate assigned to a project reflects the ____.

opportunity cost to the investor risk of the project

Under capital budgeting, required working capital is classified as a cash ______.

outflow