Finance Exam Study

When cash flows are conventional, NPV is ____

1. equal to 0 when the discount rate = IRR 2. positive for discount rates below the IRR 3. negative for discount rates above the IRR

Mac Company requires a 15% return on its investments. It's considering launching a new chair that will sell for $500 and cost $200 to make. Fixed costs will be $1 mil per year, and initial investment will be $4 mil. Company expects project to last for 10 years, after innovations will cause product to be obselete. Calculate the financial break even for the project. ten year annuity factor at 15% is 5.0188.

1. Calculate OCF = Initial Investment / annuity factor = 797,003.37 2. Find break even: Q = (FC + OCF) / (P-v) = 1,000,000 + 797,003.37/500-200 = 5990.01

Sonny Daze manages a "financial services" mutual fund. His portfolio is 2019 had beta of 1.25 and expected return of 11%. Sonny achieved 2019 actual return on his portfolio of 12.5%. Assume that the market portfolio returned 10% in 2019. What was Sonny's "alpha" in 2019?

1.5%

Compute Net accounting profit based on following information: Revenues = 4000 variable costs = 1600 fixed costs = 700 depreciation = 300 tax rate = 21%

1106

Saxon Company is considering a project that will generate net income of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?

20.48% average net income is (50000+75000+90000)/3=71670. The average accounting return is 71670/350000=20.48%

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years? Discount rate of 6.25%

9.70%

How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime.

An increase in size of cash flows makes period shorter, all else held constant.

If fixed costs are $3,500 and the operating cash flow is $4,500, then the degree of operating leverage is:

DOL = 1+ FC/OCF 1.78

Suppose Price per Unit is $6, variable cost is $2, fixed costs $400 and depreciation allowance each year is $500. Relationship between operating cash flow and sales volume (Q) are:

OCF = -400 + 4*Q

In which of the following scenarios would IRR always recommend the wrong decision?

Starting cash flow: 1000 Ending: -2000

T/F: The crossover rate is the rate at which the NPVs of two projects are equal.

True

The calculation of a portfolio beta is similar to the calculation of:

a portfolio's expected return

When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means the market:

already knew about most of the news items

Match scenarios

best case: high sales, high net profit margin worst case: low sales, low net profit margin.

If Kellogg's introduces a new brand of cereal, it will most likely lead to _____ of its current sales

erosion

Which costs are included in numberator of accounting profit break-even point equation?

fixed costs and depreciation

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are...

inaccurate.

IRR continues to be very popular in practice, partly because:

it gives a rate of return rather than a dollar value.

From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage:

low

By ignoring time value, the payback period rule may accept projects with a ________ NPV.

negative

The point at which the NPV profile crosses the vertical axis is the:

sum of the cash flows of the project

Blume's formula combines

the arithmetic average return and the geometric average return.

(T/F) Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.

true

T/F: Depreciation expense on a specific asset could be a fixed dollar amount of a variable dollar amount.

true. If the company uses straight line, the expense will be fixed. If accelerated method, expense will change each year.

Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:

0

Which of the following are true about depreciation expense?

1. it affects cash flows 2. affects the accounting profit break even point 3. it's a non cash expense.

Which of the following are advantages of AAR?

1. needed information is usually available 2. it's easy to compute

Which of the following is a legitimate reason for a project to have a positive NPV for Palmer Corp?

1. palmer has better distribution channel 2. can produce product more cheaply 3. has better product than competition

The IRR rule can lead to bad decisions when ___________ or _____________.

1. projects are mutually exclusive 2. cash flows are not conventional

Your basic NPV investment rule is:

1. reject a project if NPV is less than 0 2. If NPV is equal to 0, acceptance or rejection is a matter of indifference. 3. Accept a project if NPV is greater than zero.

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

1. scenario analysis 2. what if questions

Which of the following is true about variable costs?

1. total variable costs increase as the total number of units produced increases 2. the variable cost per unit may remain constant as the number of units produced increases.

What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and Year 2 if the discount rate is 12 %?

2.91

The geometric rate of return takes ______ into account

compounding

In capital budgeting, the net _______ determines the value of a project to the company.

present value

According to the basic IRR rule, we should:

reject a project if the IRR is less than the required return

What will the shapes of total revenue and total costs be on a graph that depicts number of units on the x axis and dollar amount (revenues and cost) on the y axis?

Both the total revenue and total cost curves will slope upward.

What does the security market line depict?

It is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta.

Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?

Project Beta

Example of sunk cast:

R&D accumulated expense in the past

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

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

Possibility that errors in projected cash flows will lead to incorrect decisions is called:

forecasting risk and estimation risk

Which of the following is a conclusion that can be drawn regarding market efficiency from capital market history?

future market prices are hard to predict based on publicly available information

When cash flows are conventional, NPV is ____. If the discount rate is above the IRR.

negative

Arrange the steps involved in discounted payback period in order starting with the first step.

1. Discount the cash flows using the discount rate. 2. Add the discounted cash flows. 3. Accept if the discounted payback period is less than some pre-specified number of years.

The 3 attributes of NPV are that it:

1. Discounts the cash flows properly 2. Uses all the cash flows of a project. 3. Uses cash flows.

The discounted payback period has which of these weaknesses?

1. Exclusion of some cash flows 2. Arbitrary Cut off date 3. Loss of simplicity as compared to payback method

What does variance measure?

1. It measures the dispersion of the sample of returns 2. It measures the riskiness of a security's returns.

If a project has multiple internal rates of return, which of the following methods should be used?

1. NPV 2. MIRR

According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the US?

1. Net Present Value 2. Internal Rate of Return

Which of the following are mutually exclusive investments?

1. a restaurant or a gas station on the same piece of land 2. two different choices for the assembly lines that will make the same product.

Which of the following projects is acceptable if the AAR is required to be at least 20%?

1. book store: average income = $140,000; Average book value: $600,000 2. Restaurant: average income: $450,000; average book value: $2,180,000

Computation of variance in correct order:

1. calculate the expected return 2. determine the squared deviation from the expected return 3. multiply each squared deviation by its probability 4. the result is the variance

Which of the following are weaknesses of the payback method?

1. cash flows received after payback period are ignored. 2. the cutoff date is arbitrary 3. time value of money principles are ignored.

The weighted average of the standard deviations of the assets in Portfolio C is 12.9%. Which of the following are possible values for the standard deivation of the portlio?

12.9% 10.9%

The sharpe ratio measures

reward to risk.