Business Finance

What is the profitability index for Project A with a cost of capital of 8%? YearProject AProject B0($42,000.00)($45,000.00)1$14,000.00$28,000.002$14,000.00$12,000.003$14,000.00$10,000.004$14,000.00$10,000.005$14,000.00$10,000.00

1.33

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A decrease in the fixed costs

The financing decision

Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations

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

True

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format

103.67

Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as

- a means to ensure regulatory compliance - a balancing act that requires careful evaluation of the costs and benefits of each project

What types of analyses do the BNSF strategic studies team conduct?

- discounted cash flow - sensitivity

Identify which of these are the relevant cash flows when considering a capital budgeting project.

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

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $280 at the end of the next three years and then $1,840 per year for the three years after that. If the discount rate is 8.53% then what is the NPV?

-611.09

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 6.74%?

31,841.62

What is the amount of the operating cash flow for a firm with $399,744 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

359,833.6

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 opportunity costs associated with the project.

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

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

False

Mutually Exclusive

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

NPV

The "gold standard" of investment criteria refers to:

maximize the shareholders' wealth.

The primary purpose of capital budgeting is to:

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

True

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

deemphasizing that variable as a critical factor.

What types of projects does the BNSF strategic studies team evaluate?

discretionary

According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?

increase bank executive turnover

The investment decision

invest in assets that earn a return greater than the minimum acceptable hurdle rate

Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs.

What are advantages of payback period?

-Measures Liquidity, Easy to communicate -Does not require discount rate -Does not require complex calculations

The disadvantages of the IRR period method is that it

-Only works for normal cash flows -Requires complex calculations -Requires a lot of data (estimates of all CFs)

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $55,246 2 40,000 3 20,000 4 10,000 Thereafter 0 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.

23,698

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet demand for a new line of solar charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features; ​• The firm just spent​ $300,000 for marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $29,141,472 (excluding​ land, hint: land is not subject to​ depreciation). ​​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for ​$4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes) .0 What is the​ project's outflow at​ t=0? Answer to the nearest whole dollar value.

31,741,472

The dividend decision

If you can't find investments that make your minimum acceptable hurdle rate, return the cash to owners of your business

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?

5.47

Compute the payback period for a project that requires an initial outlay of $248,607 that is expected to generate $40,000 per year for 9 years.

6.22

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.

False