Finance Final Exam

Compute the payback period for a project that requires an initial outlay of $297,771 that is expected to generate $40,000 per year for 9 years.

Payback Period = 297,771 / 40,000 = 7.44 years

The capital market is where firms obtain external short term financing. True or False

False

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $221 at the end of the next three years and then $1,789 per year for the three years after that. If the discount rate is 1.63% then what is the NPV?

Input into Calculator: CF0= -5,000 C01=221 F01= 3 C02= 1,789 F02= 3 => I = 1.63 CPT NPV= 592.58

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?

Input into calculator: CF0= -10,000 C01= 2,000 F01= 6 => CPT IRR= 5.47

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

Maximizes the owners wealth

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function. A. Indepedent B. Dependent C. Mutally Inclusive D. Mutually Exclusive

D. Mutually Exclusive

The "gold standard" of investment criteria refers to: A. IRR B. EVA C. Payback Period D. NPV E. Profitability Index

D. NPV

Capital rationing may be beneficial to a firm if it: A. reduces a firm's interest expense B. increases funds to be used for other purposes C. allows managers to select their favorite projects. D. weeds out proposals with weaker or biased NPVs.

D. Weeds out proposals with weaker or biased NPV's

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project? A. A decrease in the estimated annual sales B. An increase in the discount rate C. An increase in the initial investment D. A decrease in the fixed costs

D. a decrease in fixed costs

Investment banks make loans that individuals and businesses use to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to bank True or False

False

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 True or False?

False

Lending discrimination occurs when lenders base credit decisions on factors related to the applicant's creditworthiness. True or False

False

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

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. True or False?

False

The advantage to savers and investors of receiving compound interest rather than simple interest is that future values are larger because interest is earned on accumulated interest payments. Also, the difference in future values becomes smaller as time goes by. True or False

False

The shadow banking system has escaped regulation primarily because it does not accept traditional bank deposits. As a result, many of the shadow banking institutions have been able to employ higher market, credit and liquidity risks, and have higher capital requirements. True or False

False

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $107,863,025 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?

Input into Calculator: CF0= -107,836,025 C01= -20,000,000 F01= 1 C02= 80,000,000 F02= 1 C03= 90,000,000 F03= 1 => I = 11 CPT NPV = 4,855,975.95

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.

Input into calculator: CF0= -100,000,000 C01= -20,000,000 F01= 1 C02= 80,000,000 F02= 1 C03= 90,000,000 F03= 1 => I= 11 CPT NPV = CPT IRR = 15.95

What is the NPV of a project that costs $100,000.00 and returns $50,000.00 annually for three years if the opportunity cost of capital is 6.78%?

Input into calculator: CFo = -100,000 C01 = 50,000 F01 = 3 => NPV => I = 6.78 CPT NPV = 31,745.01

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

Leverage

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.

Net Working Capital = Current Assets - Current Liabilities (41,375 + 35,370) - 44,106 = 32,729

What is the amount of the operating cash flow for a firm with $303,534 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

OCF before taxes = 303,534 - Taxes = (303,534 * .35) = 106,236.90 = Net Income = 197,297.10 + Depreciation = 100,000 = OCF = 297,297.10

You should never compare cash flows occurring at different times without first discounting them to a common date. True or False

True

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

increased;decreased

What are the disadvantages of IRR?

- Requires complex calculations - Requires a lot of data (estimates of all CF's) - Only works for normal cash flows - Requires discount rate (for decision) - Does not always work for mutually exclusive projects

What are the disadvantages of NPV?

- Requires complex calculations - requires a lot of data (estimates of all CF's and r) - dollar value is not always intuitive

Identify which of these are the relevant cash flows when considering a capital budgeting project. - test marketing costs - fraction of CEO salary - lost rent from retail facility - remodeling expenses for new store - increase in inventory - expected salvage value of manufacturing equipment

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

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

True

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

True

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 sunk costs associated with the project. - Any interest expenses associated with the project. - Any opportunity costs associated with the project. - All past costs associated with the original project.

- Any opportunity costs associated with the project.

What are the disadvantages of the Payback Period method?

- Does not measure value - Does not fully adjust for TVM - Does not fully adjust for risk - No clear accept/reject decision - Ignores later CF's

What are the Advantages of NPV?

- Gives a clear accept/reject decision - uses all cash flows - adjusts for risk (with discount rate) - adjusts for TVM

What are the Advantages of the Payback Period method?

- Measure liquidity - Easy to communicate - Does not require all CF's - Does not require discount rate - Does not require complex calculations - Can be used to compare mutually exclusive projects

What are the advantages of IRR?

- More intuitive than NPV - Gives a clear accept/reject decision for independent projects - Uses all cash flows - Does not require a discount rate (for calculation) - Adjusts for TVM and therefore risk (in comparison to hurdle rate that adjusts for risk)

What is the future value of $100 invested at 10% compounded annually for 3 years?

100(1 + .10)^3 = 133.1

The primary purpose of capital budgeting is to: A. maximize the shareholders' wealth. B. maximize the budget. C. maximize the firm's profit. D. minimize the firm's costs.

A. maximize shareholders' wealth

_________results from the use of fixed - cost assets or funds to magnify returns to a firm's owners. A. Long - term debt B. Leverage C. Equity D. Capital structure

B. Leverage

What practice made it impossible for many members of minority groups to qualify for loans to buy and improve homes? A. Segregation B. Redlining C. Widespread use of credit reports D. Blacklining

B. Redlining

What is the hurdle rate? A. the cost of debt B. the cost of financing C. the cost of equity D. how quickly firms can get loan approvals

B. The cost of financing

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest: A. that the initial sales forecasts were inflated. B. deemphasizing that variable as a critical factor. C. requiring a more detailed sales forecast. D. reallocating fixed costs to this product.

B. deemphasizing that variable as a critical factor

Generally, increases in leverage result in______________ return and _____________________ risk. A. decreased; decreased B. increased; increased C. increased; decreased D. decreased; increased

B. increased;decreased

Suppose Fidelity Investments requires applicants for its financial advisor positions to have the Chartered Financial Analyst (CFA) designation, hires no Black financial advisors, and very few Blacks have the CFA designation. The disparity in Fidelity's hiring of White versus Black financial advisors is most likely attributable to A. No answer text provided. B. Taste-based discrimination C. Statisical Discrimination

C. Statistical Discrimination

The degree of operating leverage has which of the following characteristics? The closer the firm is operating to breakeven quantity, the smaller the DOL. A. A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. B. The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variables Q (Quantity), P (Price), and V (Volume). C. The DOL relates the change in sales to the change in net operating income. D. If the firm has no debt, the DOL will equal 1.

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

Which of the following statements is correct for a project with a negative NPV? A. The discount rate exceeds the cost of capital. B. Accepting the project has an indeterminate effect on shareholders. C. The cost of capital exceeds the IRR D. IRR exceeds the cost of capital.

C. The cost of capital exceeds the IRR

In theory, a firm should maintain financial leverage consistent with a capital structure that A. maximizes dividends B. meets the industry standards C. maximizes the owner's wealth D. meets the investor expectations

C. maximizes the owner's wealth

R = Revenues Year 1: R = 41,261 Year 2: R = 40,000 Year 3: R = 40,000 Year 4: R = 10,000 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 nearest whole dollar amount.

Revenue = 41,261 - Expenses = (41,261 * .50) = 20,630.50 - Depreciation = (40,000 / 5) = 8,000 = EBIT = 12,630.50 - Taxes = (12,630 * .20) = 2,526 = Net Income = 10,104.40 + Depreciation = 8,000 = Operating Cash Flow = 18,104.40

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.

Lending discrimination happens when lenders base credit decisions on factors other than the borrower's creditworthiness, including any of the protected classes defined under federal law. Today, what three federal laws offer protection against lending discrimination?

The Fair Housing Act, The Community Reinvestment Act, and the Equal Credit Opportunity Act

Financial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments. true or false

True

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

True