FINA 3313 Exam 3 uta adams
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
Your firm has a potential project that will cost $5,000 now to beginThe 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. the discount rate is 8% then what is the Answer in % format
Discount Rate = 8% Profitability Index formula : Profitability Index = Sum of PV of Cash Flow / Initial Investment PV of Cash Flow = Cash Flow / ( 1 + Discount Rate)^ Year Do that for year 1-6 so ex 900/1.08^1+... 1400/1.08^6= 5183.48 Profitability Index = 5183.48 / 5000 = 103.67%
What type of analyses do the BNSF strategic studies team conduct
Discount cash flow Sensitivity
What type of project does the BNSF strategic studies team evaluate
Discretionary
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
Net present value (NPV) is a sophisticated capital budgeting techniques 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
Financing Decision
Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations
Compute the payback period for a project that requires an initial outlay of $153,425 that is expected to generate $ 40,000 per year for 9 years
153424/40000 =3.84
What is the amount of the operating cash with $378,840 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate ?
378840* .65 = 246246+ 100,000 = 346246
What is the profitability index for Project A with a cost of capital of 8%? Year 2 Project A Project B ($42,000.00 ) ($45,000.00 ) 1 $14,000.00 $28,000.00 2 $14,000.00 $12,000.00 3 $14,000.00 $10,000.00 4 $14,000.00 $10,000.00 5 $14,000.00 $10,000.00
=( (14000/1.08)+(14000/ (1.08)^2+(14000/(1.08)^3+(14000/(1.08)^4+(14000/(1.08)^5) = (12962.96+ 12002.74+11113.65+10290.41+9528.16) = 55898 (Approx) Net value of cash outflow at the beginning =42000 Profitability index=[present value of future inflows / initial outflows] =[55898/42000] =1.33
NPV of a project that costs 100,000 returns 50,000 annually for 3 years if the opportunity cost of capital is 7.37%
CF0= -100,000 C01= 50,000 F01= 3 I= 7.37 % NPV= 30,333.81
Which of the following changes, if a sufficient magnitude. could turn a negative NPV project into a positive NPV project
A decrease in fixed costs
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
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 $22,129,287 (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.
Aero Motorcycles is considering a project and the project's outflow at t=0 can be found below Project outflow = Marketing Study + Project initial cost Project outflow = $300000 + $22129287 = $22429287 Project outflow at t=0 includes the cost borne by the company for undertaking that project at that time. The sunk cost (i.e. already incurred cost can not be included in projects initial outflow) hence the land which was acquired 5 years ago will not be included in project initial outflow.
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
What is the IRR for a project with an unyielding outlay of 10,000 that is expected to generate cash flows of 2,000 per year for 6 years?
CF0= -10,000 C01= 2,000 F01= 6 CPT IRR = 5.47%
dividend decision
If you can't find investments that make your minimum acceptable rate, return the cash to the owners of your business
According to the article, "Sunk cost fallacy: Throwing good money after bad" how can banks limit losses from bad loans?
Increase bank executive turnover
What the net effect on a firm's working capital if a new project requires: $40,054 increase in inventory $45,905 increase in accounts receivable$35,000.00 increase in machinery, and a $44,267 increase in accounts payable? Round to nearest dollar amount
Increase in AR 45905 + Inc. in Inv. 40054 - inc. in AP. -44267 =. 41692
What is the IRR
Internal rate of return; what discount rate is required to make the net present value of all cash uses/sources equal to 0.
investment decision
Invest in assets that earn a return greater than the minimum acceptable hurdle rate
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
Primary purpose of capital budgeting is to
Maximize the shareholders' wealth
Advantages of Payback Period
Measures liquidity, easy to communicate Does not require complex calculations Does not require discount rate
Gold standard of investment criteria refers to
NPV
You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. Year A. B. C 0 $( 1,000 ) \$(5,000)\$(50,000) 1 $ 300$ 1,700 $ 0 2 $300 $ 1,700 $15,000 3 $ 600 $1,700 $ 28,500 4 $300 $1,700 $ 33,000 What is the IRR of the best project ? % terms to 2 decimal places w /o% sign
Repeat same steps for every row until you get close to 14% CF0 = -1000 -5000. -50,000 CO1=300. 1700. 0 F01=1. 4. 1 C02=300. 15000 F02= 1. 1 C03=600. 28500 F03=1. 1 C04=300. 33000 F04 = 1. 1 IRR= 17.49. 13.54. 14.23 Row C has the best project IRR
Disadvantages of the IRR method is that it
Requires a lot of data Only works for normal CFs Requires complex calculations
Capital Budgeting Process steps
Step 1 proposal generation Step 2 review and analysis Step 3 decision making Step 4 implementation Step 5 follow up
The multiple IRR problem occurs when the sign of a project's CFs change more than once
TRUE
The internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0
True
mutually exclusive
Two events that cannot occur at the same time
oppurtunity cost
the most desirable alternative given up as the result of a decision
Profitability Index
the present value of an investment's future cash flows divided by its initial cost
Capital rationing may be beneficial to a firm if it
Weeds out proposals with weaker or biased NPVs
Risk-adjusted discount rate
a method of risk adjustment when the risk associated with the investment is greater than the risk involved in a typical endeavor. Using this method, the discount rate is adjusted upward to compensate for this added risk
Net Working Capital
current assets - current liabilities
pro forma
for the sake of form, a method of calculating financial results using certain projections or presumptions
Capital Rationing
the situation that exists if a firm has positive NPV projects but cannot find the necessary financing
Sensitivity Analysis
investigation of what happens to NPV when only one variable is changed
Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function
mutually exclusive projects
What is NPV?
net present value is the present values of future cash flows less the cost of the investment. If the NPV is above zero then it's a good investment.
Sunk costs are
previous cash outflows not relevant to the project decision.
Scenario Analysis
process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case
capital spending
refers to money spent by a business for an item that will be used over a long period
Payback Period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
incremental cash flows
the difference between a firm's future cash flows with a project and those without the project
Salvage value
the estimated value of a fixed asset at the end of its useful life
