FIN437 Extra Questions for Exam 2

5. Which of the following does not characterize NPV? a. NPV does not explicitly incorporate risk into the analysis. b. NPV incorporates all relevant cash flow information. c. NPV uses all of the project's cash flows. d. NPV discounts all future cash flows. e. Using NPV will lead to decisions that maximize shareholder wealth.

a. NPV does not explicitly incorporate risk into the analysis

6. The discounted payback period rule: a. considers the time value of money. b. discounts the cutoff point. c. ignores uncertain cash flows in the long term. d. is preferred to the NPV rule. e. None of the above.

a. considers the time value of money.

8. You are considering the following two mutually exclusive projects that will not be repeated. The required rate of return is 11.25% for project A and 10.75% for project B. Which project should you accept and why? Year Project A Project B 0 -$48,000 -$126,900 1 $18,400 $ 69,700 2 $31,300 $ 80,900 3 $11,700 $ 0 a. project A; because its NPV is about $335 more than the NPV of project B b. project A; because it has the higher required rate of return c. project B; because it has the largest total cash inflow d. project B; because it returns all its cash flows within two years e. project B; because it is the largest sized project

a. project A; because its NPV is about $335 more than the NPV of project B

10. An investment has the following cash flows. Should the project be accepted by using IRR if it has been assigned a required return of 9.5%? Why or why not? Year Cash Flow 0 -$24,000 1 $ 8,000 2 $12,000 3 $ 9,000 a. yes; because the IRR exceeds the required return by about 0.39% b. yes; because the IRR is less than the required return by about 3.9% c. yes; because the IRR is positive d. no; because the IRR exceeds the required return by about 3.9% e. no; because the IRR is 9.89%

a. yes; because the IRR exceeds the required return by about 0.39%

31. The following information should be used for problems #29-31: The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its analysis on the expected case scenario. The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost estimate will be: a. $21,375 b. $22,500 c. $23,625 d. $24,125 e. $24,750

b. $22,500

17. Ben's Border Café is considering a project which will produce sales of $16,000 and increase cash expenses by $10,000. If the project is implemented, taxes will increase from $23,000 to $24,500 and depreciation will increase from $4,000 to $5,500. What is the amount of the operating cash flow? a. $4,000 b. $4,500 c. $6,000 d. $7,500 e. $8,500

b. $4,500

23. The following information should be used for problems #23-25: Margarite's Enterprises is considering a new project. The project will require $325,000 for new fixed assets, $160,000 for additional inventory and $35,000 for additional accounts receivable. Short-term debt is expected to increase by $100,000 and long-term debt is expected to increase by $300,000. The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 25% of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $554,000 and costs of $430,000. The tax rate is 35% and the required rate of return is 15%. What is the initial cost of this project? a. $325,000 b. $420,000 c. $425,000 d. $520,000 e. $620,000

b. $420,000

22.Ronnie's Custom Cars purchased some fixed assets two years ago for $39,000. The assets are classified as 5-year property for MACRS. Ronnie is considering selling these assets now so he can buy some newer fixed assets which utilize the latest in technology. Ronnie has been offered $19,000 for his old assets. What is the after-tax salvage value if the tax rate is 34%? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a. $16,358.88 b. $17,909.09 c. $18,720.00 d. $18,904.80

d. $18,904.80

14. Marshall's & Co. purchased a corner lot in Eglon City five years ago at a cost of $640,000. The lot was recently appraised at $810,000. At the time of the purchase, the company spent $50,000 to grade the lot and another $4,000 to build a small building on the lot to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.2 million. What amount should be used as the initial cash flow for this building project? a. $1,200,000 b. $1,840,000 c. $1,890,000 d. $2,010,000 e. $2,060,000

d. $2,010,000

29. The following information should be used for problems #29-31: The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its analysis on the expected case scenario. What is the sales revenue under the optimistic case scenario? a. $40,000 b. $43,120 c. $44,000 d. $44,880 e. $48,400

d. $44,880

18. A project is expected to create operating cash flows of $22,500 a year for three years. The initial cost of the fixed assets is $50,000. These assets will be worthless at the end of the project. An additional $3,000 of net working capital will be required for the project, while the net working capital will be completely recovered at the end of the project. What is the project's net present value if the required rate of return is 10%? a. $2,208.11 b. $2,954.17 c. $4,306.09 d. $5,208.11

d. $5,208.11

1. If a project has a net present value equal to zero, then: I. the present value of the cash inflows exceeds the initial cost of the project. II. the project produces a rate of return that just equals the rate required to accept the project. III. the project is expected to produce only the minimally required cash inflows. IV. any delay in receiving the projected cash inflows will cause the project to have a negative net present value. a. II and III only b. II and IV only c. I, II, and IV only d. II, III, and IV only

d. II, III, and IV only

Will Do, Inc. just purchased some equipment at a cost of $650,000. What is the proper methodology for computing the depreciation expense for year 3 if the equipment is classified as 5-year property for MACRS? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a. $650,000 x (1-.20) x (1-.32) x (1-.192) b. $650,000 x (1-.20) x (1-.32) c. $650,000 x (1+.20) x (1+.32) x (1+.192) d. $650,000 x (1-.192) e. $650,000 x .192

e. $650,000 x .192

12. You are analyzing the following two mutually exclusive projects and have developed the following information. What is the crossover rate? Project A Project B Year Cash Flow Cash Flow 0 -$84,500 -$76,900 1 $29,000 $25,000 2 $40,000 $35,000 3 $27,000 $26,000 a. 11.11% b. 13.01% c. 14.91% d. 16.75% e. 17.90%

e. 17.90%

3. The discounted payback rule may cause: a. some positive net present value projects to be rejected. b. the most liquid projects to be rejected in favor of less liquid projects. c. projects to be incorrectly accepted due to ignoring the time value of money. d. some projects with negative net present values to be accepted. e. Both A and D.

e. Both A and D.

11. Ginny Trueblood is considering an investment which will cost her $120,000. The investment produces no cash flows for the first year. In the second year the cash inflow is $35,000. This inflow will increase to $55,000 and then $75,000 for the following two years before ceasing permanently. Ginny requires a 10% rate of return and has a required discounted payback period of three years. Ginny should _____ this project because the discounted payback period is _____. a. accept; 2.03 years b. accept; 2.98 years c. accept; 3.98 years d. reject; 3.03 years e. reject; 3.98 years

e. reject; 3.98 years

32. A project has been assigned a discount rate of 12 percent. If the project starts immediately, it will have an initial cost of $480 and cash inflows of $350 a year for three years. If the start is delayed one year, the initial cost will rise to $520 and the cash flows will increase to $385 a year for three years. What is the value of the option to wait? a. $0.70 b. $1.08 c. $1.67 d. $2.20 e. $20

a. $0.70

15. Walks Softly, Inc. sells customized shoes. Currently, it sells 10,000 pairs of shoes annually at an average price of $68 a pair. It is considering adding a lower-priced line of shoes which sell for $49 a pair. Walks Softly estimates it can sell 5,000 pairs of the lower-priced shoes but will sell 1,000 less pairs of the higher-priced shoes by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced shoes? a. $177,000 b. $245,000 c. $313,000 d. $789,000 e. $857,000

a. $177,000

20. You just purchased some equipment that is classified as 5-year property for MACRS. The equipment cost $67,600. What will the book value of this equipment be at the end of three years should you decide to resell the equipment at that point in time? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a. $19,468.80 b. $20,280.20 c. $27,040.00 d. $48,131.20 e. $48,672.00

a. $19,468.80

34. The Can-Do Co. is analyzing a proposed project with anticipated sales of 12,000 units, give or take 4 percent. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The cost estimates have a range of plus or minus 6 percent. The depreciation expense is $29,600. The tax rate is 34 percent. The sale price is estimated at $14.99 a unit, give or take 1 percent. What is the OCF under the best-case scenario? a. $58,235.78 b $54,309.17 c. $56,208.01 d. $59,311.10 e. $54,499.29

a. $58,235.78

21. A project will increase sales by $140,000 and cash expenses by $95,000. The project will cost $100,000 and be depreciated using the straight-line method to a zero book value over the 4-year life of the project. The company has a marginal tax rate of 34%. What is the value of the depreciation tax shield? a. $8,500 b. $17,000 c. $22,500 d. $25,000

a. $8,500

24. The following information should be used for problems #23-25: Margarite's Enterprises is considering a new project. The project will require $325,000 for new fixed assets, $160,000 for additional inventory and $35,000 for additional accounts receivable. Short-term debt is expected to increase by $100,000 and long-term debt is expected to increase by $300,000. The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 25% of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $554,000 and costs of $430,000. The tax rate is 35% and the required rate of return is 15%. 24. What is the amount of the earnings before interest and taxes for the first year of this project? a. $38,500 b. $59,000 c. $67,000 d. $76,500 e. $159,000

b. $59,000

30. The following information should be used for problems #29-31: The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its analysis on the expected case scenario. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $17. Using this value, the earnings before interest and taxes will be: a. $4,000 b. $6,000 c. $8,500 d. $10,000 e. $18,500

b. $6,000

28. Sensitivity analysis helps you determine the: a. range of possible outcomes given possible ranges for every variable. b. degree to which the net present value reacts to changes in a single variable. c. net present value given the best and the worst possible situations. d. degree to which a project is reliant upon the fixed costs. e. level of variable costs in relation to the fixed costs of a project.

b. degree to which the net present value reacts to changes in a single variable.

33. Last month you introduced a new product to the market. Consumer demand has been overwhelming and it appears that strong demand will exist over the long-term. Given this situation, management should consider the option to: a. suspend b. expand c. abandon d. contract e. withdraw

b. expand

Tool Makers, Inc. uses tool and die machines to produce equipment for other firms. The initial cost of one customized tool and die machine is $850,000. This machine costs $10,000 a year to operate. Each machine has a life of 3 years before it is replaced. What is the equivalent annual cost of this machine if the required return is 9%? (Round your answer to whole dollars.) a. $325,797 b. $340,002 c. $345,797 d. $347,648 e. $351,619

c. $345,797

25. The following information should be used for problems #23-25: Margarite's Enterprises is considering a new project. The project will require $325,000 for new fixed assets, $160,000 for additional inventory and $35,000 for additional accounts receivable. Short-term debt is expected to increase by $100,000 and long-term debt is expected to increase by $300,000. The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 25% of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $554,000 and costs of $430,000. The tax rate is 35% and the required rate of return is 15%. What is the amount of the after-tax salvage value of the fixed assets at the end of this project? (Round your answer to whole dollars.) a. $28,438 b. $37,918 c. $52,813 d. $60,009 e. $81,250

c. $52,813

9. It will cost $2,600 to acquire a small ice cream cart. Cart sales are expected to be $1,400 a year for three years. After the three years, the cart is expected to be worthless as that is the expected remaining life of the cooling system. What is the payback period of the ice cream cart? a. .86 years b. 1.46 years c. 1.86 years d. 2.46 years

c. 1.86 years

4.Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data. Both projects have 5 year lives. Project A Project B NPV $15,090 $14,693 Payback per. 2.76 yrs 2.51 yrs Required return 8.3% 8.0% Matt has been asked for his best recommendation given this information. His recommendation should be to accept: a. project B because it has the shortest payback period. b. both projects as they both have positive net present values. c. project A and reject project B based on their net present values. d. project B and reject project A based on their average accounting returns. e. project B and reject project A based on both the payback period and the average accounting return.

c. project A and reject project B based on their net present values.

27. Bruno's, Inc. is analyzing two machines to determine which one it should purchase. The company requires a 14% rate of return and uses straight-line depreciation to a zero book value. Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3-year life. Machine B costs $180,000, has annual operating costs of $12,000, and has a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.) a. Machine A; because it will save the company about $8,600 a year b. Machine A; because it will save the company about $132,912 a year c. Machine B; because it will save the company about $200,000 a year d. Machine B; because it will save the company about $11,600 a year e. Machine B; because its equivalent annual cost is $199,759

d. Machine B; because it will save the company about $11,600 a year

2. All else equal, the payback period for a project will decrease whenever the: a. initial cost increases. b. required return for a project increases. c. assigned discount rate decreases. d. cash inflows are moved earlier in time. e. duration of a project is lengthened.

d. cash inflows are moved earlier in time.

13. The CFFAs for a company is computed as the: a. net operating cash flow generated by the project, less any sunk costs and erosion costs. b. sum of the incremental operating cash flow and after-tax salvage value of the project. c. net income generated by the project, plus the annual depreciation expense. d. sum of the incremental operating cash flow, net capital spending, and net working capital expenses incurred by the project. e. sum of the sunk costs, opportunity costs, and erosion costs of the project.

d. sum of the incremental operating cash flow, net capital spending, and net working capital expenses incurred by the project.

7. The problem of multiple IRRs can occur when: a. there is only one sign change in the cash flows. b. the first cash flow is always positive. c. the cash flows decline over the life of the project. d. there is more than one sign change in the cash flows. e. None of the above.

d. there is more than one sign change in the cash flows.

16. Ernie's Electrical is evaluating a project which will increase sales by $50,000 and costs by $30,000. The project will cost $150,000 and be depreciated straight-line to a zero book value over the 10 year life of the project. The applicable tax rate is 34%. What is the operating cash flow for this project? a. $3,300 b. $5,000 c. $8,300 d. $13,300 e. $18,300

e. $18,300