Business Finance Exam 3
A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,6000,000. This in turn would cause inventory to increase by $125,000, accounts receivable to increase by $100,000, and accounts payable to increase by $90,000. What is the firm's expected change in net working capital?
$135,000
Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $45 million each year, and expects these to grow at 3% each year. The upfront project costs are $380 million and Fordʹs weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?
$360 million
The outstanding debt of Berstin Corp. has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%. A) 4.9% B) 6.5% C) 7.0% D) 7.37%
7.37%
$17,208
A bakery invests $40,000 in a light delivery truck. The was depreciated using the five-year MACRS schedule shown above. If the company sold it immediately after the end of year 2 for $21,000, what would be the after-tax cash flow from the ale of this asset, given a tax rate of 40%?
-$4507
A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%? A) -$3155 B) -$3606 C) -$4057 D) -$4507
$10,048
A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment?
$49,000.00
A firm incurs $70,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after tax interest rate expense for the firm?
$416,250
A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for 5 years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 35%?
$0
A firm's considering the purchase of a news machine for $325,000. The firm is unsure if it should use the 3 year MACRS schedule or straight line depreciation over 3 years. ShT is the difference in the book value after 3 years if the firm's uses MACRS instead of straight line depreciation?
$150,548
A garage is installing a new "bubble-wash" car wash. If will promote the car wash as a fun activity for the family, and is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 10%, what is the net present value of this project?
The mower is only expected to be needed for three years.
A lawn maintenance company compares two ride-on mowers--the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A) Fuel prices are expected to rise and raise the annual running costs of all mowers. B) The mower is only expected to be needed for three years. C) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate. D) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future.
Yes, because it agrees with the Net Present Value rule.
A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct? A) Yes, because it agrees with the Net Present Value rule. B) Yes, because it agrees with the payback rule. C) Yes, because it agrees with both the Net Present Value rule and the payback rule. D) Yes, because it disagrees with the Net Present Value rule.
option to expand
A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?
Job C,Job B,andJob E
A print shop has contracted to print a number of jobs within 24 hours. Any jobs not completely printed within this time will result in a penalty, as shown in the table above. However too many jobs have been accepted, and not all can be printed. Which jobs should be printed in the next 24 hours? A) Job D and Job A B) Job C and Job B C) Job C,Job B,andJob E D) Job D, Job A, and Job E
$337,500
A small manufacturer that makes clothespins and other household products buys new injection losing equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18000 per ton, what will be the increase in revenue next year from the new equipment?
IRR, NPV, Payback period
According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________.
Sensitivity Analysis
An analysis that breaks the net present Calle calculation into its component assumptions and shows how the net present value varies as one of the underlying assumptions changes is called
$489,597
An auto-parts company is deciding whether to sponsor a racing team for the cost of $1 million. The sponsorship would last 3 years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in value of the company if it chooses to go ahead with the sponsorship?
Scenario Analysis
An exploration of the effect of changing multiple project parameters on net present value is called
the cost of the research into the feasibility of renting the sixth floor
An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?
$2.91 million
An investor is considering a project that will generate $900,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000 . If the cost of capital is 4.4%, based on the MIRR, at what upfront costs does this project cease to be worthwhile? A) $2.62 million B) $2.91 million C) $3.21 million D) $3.50 million
$560 million
Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows ....... solve for NPV?
12.86%
Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price of IBM is $100 per share. What is IBM's cost of equity capital?
41.86% for debt, 58.14% for equity
Assume JUP has debt with a book value of $24 million, reading at 120% of par value. The firm has a book of equity of $28 million, and 2 million shares trading at $20 per share. What weights should JUP use on calculating WACC?
0.168 , 0.832
Assume Lavender Corporation has a market value of $4 billion of equity and market value of $19.8 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?
9.31%
Assume the market value of Ford's equity, preferred stock and debt are ........ solve for Ford's weighted average cost of capital of marginal tax rate is 40%?
Will decrease
Holding everything else constant, an increase in cash ________ a firm's net debt.
Project B
If WiseGuy Inc. uses payback period rule to choose projects, which of he project will rank highest?
option to delay
Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?
3%
Martin is offered an investment where for $4000 today, he will receive $6180 in one year. He borrows $4000 from the bank. What is the maximum interest rate the bank needs to offer on the loan for Martin to break even on this investment?
6%
Martin offered 4000 investment .....4240....4000
Rule I only
Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A) Rule I only B) Rule III only C) Rule II and III D) Rule I and II
Present Value (PV)
Most corporations measure the vaue ofna project in terns of which of the following?
IRR, NPV, Payback period
Most popular decision rules for capital budgeting used by CFOs
It is difficult to calculate
NOT a limitation of the payback rule
$1.66 million
Panjandrum industries problem solving for break even long for manufacturing expenses
Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan.
Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices?
$5.64 million
SAP Inc/ received $1.5 million grant under its small business innovation program..... solve for present value ?
9.70%
SIROM Scientific Solutions problem and solve for weighted average cost of capital if tax rate is 35%?
Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.
Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer?
$1,260,000
The Sisyphean company is considering a new project tang will have an annual deprecation expense of $3.6 million. If Sisypheans marginal corporate tax rate is 35%, and it's average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?
Is always less than
The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.
$46 thousand
The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is the firm's Net working capital ?
$260 million
The book value of a firm's equity is $100 million and its market value of equity is $200 million. The face value of its debt is $50 million and its market value of debt is $60 million. What is the market value of assets of the firm?
The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.
The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis? A) $780,000 B) $1,000,000 C) Cannot be determined because inadequate information is given. D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.
0.15
The profitability index for project B is closest to ________. A) 22.49 B) 14.99 C) 0.15 D) 0.09
Determine the effect of the decision to accept or reject a project on the firms cash flows
The ultimate goal of the capital budgeting process is to ________.
13%
Two mutually exclusive investment opportunities require an initial investment of $7 million. Investment A pays $2.0 million per year in perpetuity, while investment B pays $1.4 million in the first year, with cash flows increasing by 4% per year after that. At what cost of capital would an investor regard both opportunities as being equivalent?
subtracting depreciation expenses from taxable earnings
Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?
The amount by which a firm's earnings are expected to change as a result of an investment decision
Which of the following best describes incremental earnings?
Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.
Which of the following best describes the Net Present Value rule? A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV) C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.
These earnings are not actual cash flows.
Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?
Payback Period
Which of the following decision rules might be used as a supplement to net present value by a firm that favors liquidity?
Turn multiple negative cash flows to time 0 and leave the positive cash flows alone
Which of the following is NOT a valid method of modifying cash flows to produce MIRR?
Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.
Which of the following is NOT a valid method of modifying cash flows to produce a MIRR?
External equity is less expensive than retained earnings
Which of the following statements is false?
Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.
Which of the following statements regarding real options is NOT correct?
the cost of a marketing study completed last year
Which of the following would you NOT consider when making a capital budgeting decision?
Profitability Index
You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?
15.2%
Your estimate of the market risk premium is 7%. The risk free rate of return is 4% and General Motors has a beta of 1.6. What is the General Motors cost of equity capital?
