FIN exam 4

A company has the following information. What is the quick ratio? Inventory $85,000 Cash and marketable securities 67,500 Total current assets 245,000 Accounts payable 78,500 Total current liabilities 102,000 Prepaid expenses 15,400

1.42 Rationale: (245,000 - 85,000 - 15,400)/102,000 = 1.42

A company has the following information. What is the quick ratio? Total current liabilities $106,000 Cash and marketable securities 85,500 Total current assets 324,000 Accounts payable 67,500 Inventory 132,000 Prepaid expenses 21,400

1.61 Rationale: (324,000 - 132,000 - 21,400)/106,000 = 1.61

A company has total asset turnover of 2.1, return on sales of 5.23%, a financial leverage ratio of 1.4, and fixed asset turnover of 2.7. What is return on equity?

15.38% Rationale: 5.23% x 2.1 x 1.4 = 15.38%

A company has total asset turnover of 2.4, return on sales of 4.23%, a financial leverage ratio of 1.6, and fixed asset turnover of 3.7. What is return on equity?

16.24% Rationale: 4.23% x 2.4 x 1.6 = 16.24%

What is the payback period for the following proposed capital budgeting project: Year Cash Flows 0 -1,000,000 1 200,000 2 400,000 3 300,000 4 500,000

3.2 years Rationale: For payback period, we assume that cash is received throughout the year. This project has not fully paid pack after three years, and needs part of the fourth year, so three years plus $100,000/$500,000 of year four = 3.2 years.

Two proposed projects require a common input, so no more than one may be chosen. Those projects are:

Mutually exclusive

Two proposed projects serve the same purpose, so no more than one may be chosen. Those projects are:

Mutually exclusive

DO NOT calculate IRR for projects that are:

Nonconventional

For mutually exclusive projects:

You accept one or none

For independent projects:

You may accept two or more

Your firm is considering an investment opportunity. Your firm has paid $50,000 for engineering, site surveys, and environmental impact studies. There were no environmental issues so the EPA approved the project. The hard construction costs will be $950,000 to build the project, and the present value of benefits will be $1,050,000. What is the NPV of the project?

$100,000 Rationale: The $50,000 engineering, etc. is a sunk cost, so it can be ignored. NPV = Present value of benefits - incremental costs = $1,050,000 - $950,000 = $100,000

What is the NPV of this project if the required rate of return is 14%? Year Cash Flows 0 -1,000,000 1 200,000 2 400,000 3 300,000 4 700,000

$100,173.26 Rationale: CF0 = -1,000,000, CO1 = 200,000, F01 = 1, C02 = 400,000, F02 = 1, C03 = 300,000, F03 = 1, C04 = 700,000, F04 = 1, I = 14 NPV CPT = $100,173.26

A new piece of specialty equipment costs $1,500,000 and will be depreciated to an expected salvage value of $300,000 on a straight-line basis over its 3-year life. Assuming a tax rate of 30%, what is its after-tax salvage value if the equipment is actually sold after 2 years for $800,000?

$770,000 Rationale: Annual depreciation expense = ($1,500,000 - $300,000)/3 = $400,000 BV2 = $1,500,000 - (2 * $400,000) = $700,000 Gain = selling price - BV2 = $800,000 - $700,000 = $100,000 Tax on gain = gain * tax rate = $100,000 * .30 = $30,000 After-tax Salvage Value = Selling Price - tax on gain = $800,000 - $30,000 = $770,000

A new machine costing $2,250,000 is considered three-year property and is being depreciated using the four MACRS rates provided below. The machine will produce $2,025,000 in annual revenues and $1,012,500 in annual cash expenses. Assume a 30% tax rate. What is the operating cash flow in year 1? MACRS Rate - Year 1: 33.33% MACRS Rate - Year 2: 44.45% MACRS Rate - Year 3: 14.81% MACRS Rate - Year 4: 7.41%

$933,728 Rationale: Depreciation Expense in year 4 = $2,250,000 * .3333 = $749,925 Operating Cash Flow (OCF) = [(Rev. - Exp.) * (1 - Tax Rate)] + (Depreciation Exp. * Tax Rate) = [($2,025,000 - 1,012,500) * (1 - 30%)] + (749,925 * 30%) = $933,728.

A project requires additional accounts receivable of $1,400,000 and additional inventory of $700,000. It results in additional accounts payable of $1,360,000. Net working capital will return to its normal level following the 3-year project. What is the effect on the NPV of the project solely due to this investment in net working capital, assuming a 10% required rate of return?

(184,027) Rationale: ΔNWC = ΔCA - ΔCL = $1,400,000 + 700,000 - 1,360,000 = $740,000 Present value of the recovery of NWC at the end of the project: N = 3 (years) I/Y = 10 (%) FV = - ΔNWC = - $740,000 (we made this negative just so PV would be positive - a benefit) CPT PV (of inflow) = $555,973 Net effect on NPV = outflow today + PV of inflow = - $740,000 + 555,973 = $(184,027)

A company has the following information. What is the debt-to-assets ratio? Total assets $736,000 Total liabilities 314,000 Interest expense 9,400 Net income 43,500 Tax expense 12,000

0.4266 Rationale: 314,000/736,000 = 0.4266

A company has the following information. What is the cash ratio? Accounts payable $167,500 Total current liabilities 214,000 Prepaid expenses 18,400 Cash and marketable securities 93,500 Total current assets 637,000 Inventory 332,000

0.44 Rationale: 93,500/214,000 = 0.44

A company has the following information. What is the cash ratio? Inventory $85,000 Cash and marketable securities 67,500 Total current assets 245,000 Accounts payable 78,500 Total current liabilities 102,000 Prepaid expenses 15,400

0.66 Rationale: 67,500/102,000 = 0.66

A company has the following information. What is the cash ratio? Total current liabilities $106,000 Cash and marketable securities 85,500 Total current assets 324,000 Accounts payable 67,500 Inventory 132,000 Prepaid expenses 21,400

0.81 Rationale: 85,500/106,000 = 0.81

What is the profitability index for this proposed project if the required rate of return is 13%? Year Cash Flows 0 -1,000,000 1 300,000 2 400,000 3 300,000 4 700,000

1.22 Rationale: CF0 = ZERO, CO1 = 300,000, F01 = 1, C02 = 400,000, F02 = 1, C03 = 300,000, F03 = 1, C04 = 700,000, F04 = 1, I = 13 NPV CPT gives us the present value of the inflows of $1,215,983.56, PI = $1,215,983.56 / $1,000,000 = 1.22

A company has the following information. What is the quick ratio? Accounts payable $167,500 Total current liabilities 214,000 Prepaid expenses 18,400 Cash and marketable securities 93,500 Total current assets 637,000 Inventory 332,000

1.34 Rationale: (637,000 - 332,000 - 18,400)/214,000 = 1.34

What is the internal rate of return for this project? Year Cash Flows 0 -1,000,000 1 300,000 2 400,000 3 300,000 4 600,000

19.56% Rationale: CF0 = -1,000,000, CO1 = 300,000, F01 = 1, C02 = 400,000, F02 = 1, C03 = 300,000, F03 = 1, C04 = 600,000, F04 = 1, IRR CPT = 19.56%

A company has the following information. What is the financial leverage ratio? Total assets $932,000 Total liabilities 514,000 Interest expense 19,400 Net income 93,500 Tax expense 15,000

2.2297 Rationale: 932,000/(932,000 - 514,000) = 2.2297

A company has the following information. What is the current ratio? Inventory $85,000 Cash and marketable securities 67,500 Total current assets 245,000 Accounts payable 78,500 Total current liabilities 102,000 Prepaid expenses 15,400

2.40 Rationale: 245,000/102,000 = 2.40

A company has the following information. What is the current ratio? Accounts payable $167,500 Total current liabilities 214,000 Prepaid expenses 18,400 Cash and marketable securities 93,500 Total current assets 637,000 Inventory 332,000

2.98 Rationale: 637,000/214,000 = 2.98

A company has the following information. What is the current ratio? Total current liabilities $106,000 Cash and marketable securities 85,500 Total current assets 324,000 Accounts payable 67,500 Inventory 132,000 Prepaid expenses 21,400

3.06 Rationale: 324,000/106,000 = 3.06

A company has the following information. What is days' payable outstanding? Average total assets $2,320,600 Average fixed assets 975,000 Total revenue 3,436,000 Cost of goods sold 2,365,000 Average inventory 531,745 Average accounts receivable 314,785 Average accounts payable 217,000

33.5 days Rationale: 365/(2,365,000/217,000) = 33.5 days

A company has the following information. What is gross profit margin? Total sales $1,560,000 Cost of goods sold 950,000 Operating profit 237,500 Average total assets 1,110,000 Average total equity 685,000 Net income 95,500

39.10 Rationale: (1,560,000 - 950,000)/1,560,000 = 39.10%

A company has the following information. What is return on sales? Total sales $645,000 Cost of goods sold 510,000 Operating profit 65,000 Average total assets 575,000 Average total equity 326,000 Net income 28,500

4.42% Rationale: 28,500/645,000 = 4.42%

Your company plans to spend $1,750,000 cash to build a plant that will produce benefits with a total present value of $3,000,000. Your company already owns the land on which it will build the plant. That land was purchased with cash several years ago for $300,000, which is the current book value of the land. The land could be sold for $1,275,000 after-tax today. What is the net present value of the proposed plant?

$(25,000) Rationale: Present value of the proposed plant = PV of benefits from the new plant - cash spent to build the new plant - opportunity cost = $3,000,000 - 1,750,000 - 1,275,000 = $(25,000) Note: The $300,000 original purchase price of the land is a sunk cost, so it is ignored.

A company has the following information. What is (common) dividends per share? Total revenue $1,050,000 Total expenses 950,000 Common dividends 20,000 Preferred dividends 15,000 Number of common shares 100,000 shares Common stock price $20 per share

$0.20 Rationale: 20,000/100,000 = 0.20

A new piece of specialty equipment costs $2,500,000 and will be depreciated to an expected salvage value of $400,000 on a straight-line basis over its 3-year life. Assuming a tax rate of 35%, what is its after-tax salvage value if the equipment is actually sold after 2 years for $1,250,000?

$1,197,500 Rationale: Annual depreciation expense = ($2,500,000 - $400,000)/3 = $700,000 BV2 = $2,500,000 - (2 * $700,000) = $1,100,000 Gain = selling price - BV2 = $1,250,000 - $1,100,000 = $150,000 Tax on gain = gain * tax rate = $150,000 * .35 = $52,500 After-tax Salvage Value = Selling Price - tax on gain = $1,250,000 - $52,500 = $1,197,500

Consider independent projects A and B. If NPVA = $5M and IRRA = 12% while NPVB = $7M and IRRB = 10%, then you would:

Choose both A and B

Consider independent projects A and B. If NPVA = $5M and NPVB = $7M, then you would:

Choose both A and B

Consider projects A and B. If NPVA = - $1M and NPVB = - $2M, then you would:

Choose neither A nor B, whether they are independent or mutually exclusive, because both projects have negative NPVs

A new piece of specialty equipment costs $1,500,000 and will be depreciated to an expected salvage value of $300,000 on a straight-line basis over its 3-year life. Assuming a tax rate of 30%, what is its after-tax salvage value if the equipment is actually sold after 2 years for $600,000?

Rationale: Annual depreciation expense = ($1,500,000 - $300,000)/3 = $400,000 BV2 = $1,500,000 - (2 * $400,000) = $700,000 Gain = selling price - BV2 = $600,000 - $700,000 = -$100,000 Tax on gain = gain * tax rate = -$100,000 * .30 = -$30,000 After-tax Salvage Value = Selling Price - tax on gain = $600,000 - -$30,000 = $630,000 The loss on sale produced a tax credit. We assume that the loss generates a tax savings that the firm can use to offset other taxes, so the taxes are a negative amount.

A new piece of specialty equipment costs $2,000,000 and will be depreciated to an expected salvage value of $250,000 on a straight-line basis over its 5-year life. Assuming a tax rate of 40%, what is its after-tax salvage value if the equipment is actually sold after 3 years for $650,000?

Rationale: $770,000 Annual depreciation expense = ($2,000,000 - $250,000)/5 = $350,000 BV3 = $2,000,000 - (3 * $350,000) = $950,000 Gain = selling price - BV3 = $650,000 - $950,000 = -$300,000 Tax on gain = gain * tax rate = -$300,000 * .40 = -$120,000 After-tax Salvage Value = Selling Price - tax on gain = $650,000 - -$120,000 = $770,000 The loss on sale produced a tax credit. We assume that the loss generates a tax savings that the firm can use to offset other taxes, so the taxes are a negative amount.

Problems with payback include - it ignores cash flows beyond the payback period

true

Problems with payback include - it ignores time value of money

true

Problems with payback include - it requires a predetermined arbitrary cutoff

true

A firm currently sells $1,500,000 annually of an expensive product line. That firm is considering a similar, less expensive, discount line, and projects sales of $300,000. The discount line is expected to reduce sales of the expensive product line to $1,320,000. What is the incremental revenue associated with the discount product line?

$120,000 Rationale: Discount line revenue of $300,000 less lost revenue due to erosion ($1,500,000 - 1,320,000) = $120,000 incremental revenue.

Your firm is considering an investment opportunity. Your firm has paid $85,000 for engineering, site surveys, and environmental impact studies. There were no environmental issues so the EPA approved the project. The hard construction costs will be $920,000 to build the project, and the present value of benefits will be $1,050,000. What is the NPV of the project?

$130,000

A company has the following information. What is net working capital? Inventory $85,000 Cash and marketable securities 67,500 Total current assets 245,000 Accounts payable 78,500 Total current liabilities 102,000 Prepaid expenses 15,400

$143,000 Rationale: 245,000 - 102,000 = 143,000

What is the NPV of this project if the required rate of return is 12%? Year Cash Flows 0 -1,000,000 1 200,000 2 400,000 3 300,000 4 700,000

$155,845.71 Rationale: CF0 = -1,000,000, CO1 = 200,000, F01 = 1, C02 = 400,000, F02 = 1, C03 = 300,000, F03 = 1, C04 = 700,000, F04 = 1, I = 12 NPV CPT = $155,845.71

A firm currently sells $2,000,000 annually of an expensive product line. That firm is considering a similar, less expensive, discount line, and projects sales of $400,000. The discount line is expected to reduce sales of the expensive product line to $1,800,000. What is the incremental revenue associated with the discount product line?

$200,000 Rationale: Discount line revenue of $400,000 less lost revenue due to erosion ($2,000,000 - 1,800,000) = $200,000 incremental revenue.

A company has the following information. What is net working capital? Total current liabilities $106,000 Cash and marketable securities 85,500 Total current assets 324,000 Accounts payable 67,500 Inventory 132,000 Prepaid expenses 21,400

$218,000 Rationale: 324,000 - 106,000 = 218,000

Project Z will result in unit sales of 1,750, at a price of $550 each. The variable cost (VC) of each unit is $275. The cost accountant will allocate overhead on the existing plant to Project Z at a rate of $21 per unit. A special piece of equipment must be leased for $59,000 per year for purposes related solely to Project Z. Project Z will reduce sales of the same company's Project X by 400 units (selling price of $850 with VC of $450 and overhead allocation of $32 per unit). What is the total incremental cash flow for Project Z?

$262,250 Rationale: Net increase in revenue = (1,750 * $550) - (400 lost units * $850) = $622,500 Less: Net increase in VC = (1,750 * $275) - (400 lost units * $450) = (301,250) Equipment lease (59,000) Incremental cash flow $262,250

A company has the following information. What is net working capital? Accounts payable $167,500 Total current liabilities 214,000 Prepaid expenses 18,400 Cash and marketable securities 93,500 Total current assets 637,000 Inventory 332,000

$423,000 Rationale: 637,000 - 214,000 = 423,000

XYZ, Inc. is considering a new project requiring a $180,000 initial investment in equipment having a useful life of 3 years with zero expected salvage value. The investment will produce $130,000 in annual revenues and $90,000 in annual costs. Assume a tax rate of 30% and straight-line depreciation. What is the operating cash flow per year?

$46,000 Rationale: Using the (Depreciation) Tax Shield Approach: Depreciation Expense per year = $180,000 / 3 = $60,000 Operating Cash Flow (OCF) = [(Revenue - Expense) * (1 - Tax Rate)] + (Depreciation Expense * Tax Rate) = [($130,000 - 90,000) * (1 - 30%)] + ($60,000 * 30%) = $46,000

A project requires an initial investment of $2,100,000, and produces an annual inflow of $500,000 at the end of years 1 - 7, and an inflow of $700,000 at the end of year 8. What is the NPV of this project using a discount rate of 12%?

$464,596.53 Rationale: CF0 = -2,100,000, CO1 = 500,000, F01 = 7, C02 (year 8) = 700,000, F02 = 1, I = 12, NPV CPT = $464,596.53

Opportunity costs are normally:

All of the above

"Nonconventional" typically refers to projects that:

Have a later outflow in addition to the investment up front

Cash flows that are present if a company undertakes a project, and are absent if the company does not undertake the project are:

Incremental

The discount rate that produces an NPV = 0 is the:

internal rate of return

An increase in net working capital is typically treated as:

all of the above

Sunk costs are:

all of the above