Finance Ch. 9-11 Quizzes
Tedder Mining has analyzed a proposed expansion project and determined that the internal rate of return is lower than the firm desires. Which one of the following changes to the project would be most expected to increase the project's internal rate of return? Decreasing the required discount rate. Increasing the initial investment in fixed assets. Condensing the firm's cash inflows into fewer years without lowering the total amount of those inflows. Eliminating the salvage value. Decreasing the amount of the final cash inflow.
Condensing the firm's cash inflows into few years without lowering the total amount of those inflows.
The equivalent annual cost considers all of the following except the: Required rate of return. Operating costs. Need for replacement. Economic life. Costs of research conducted to identify equipment choices.
Costs of research conducted to identify equipment choices
The CFO of Edward's Food Distributors is continually receiving capital funding requests from its division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is: Operating at the accounting break-even point. Operating at the financial break-even point. Facing hard rationing. Operating with zero leverage. Operating at maximum capacity.
Facing hard rationing
In actual practice, managers most frequently use which two types of investment criteria? NPV and payback. AAR and IRR. IRR and NPV. IRR and payback. NPV and PI.
IRR and NPV
A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called?
Net Present Value
Webster's has sales of $649,000 and a profit margin of 7.2 percent. The annual depreciation expense is $102,600. What is the amount of the operating cash flow if the company has no long-term debt? $55,872 $39,341 $74,240 $149,328 $104,760
OCF = ($649,000 *.072) + $102,600 = $149,328
By definition, which one of the following must equal zero at the cash break-even point? Net present value. Internal rate of return. Contribution margin. Net income. Operating cash flow.
Operating cash flow
Assume a project has cash flows of -$51,300, $18,200, $37,300, and $14,300 for years 0 to 3, respectively. What is the profitability index given a required return of 12.5 percent?
PVInflows= $18,200 / 1.125 + $37,300 / 1.1252 + $14,300 / 1.1253 = $55,692.73 PI = $55,692.73 / $51,300 = 1.09
Which one of the following characteristics is most associated with financing type projects? Long payback period. Multiple internal rates of return. Cash inflows that equal cash outflows when ignoring the time value of money. Prepaid services. Conventional cash flows.
Prepaid services
Tucker's Trucking is considering a project with a discounted payback period just equal to the project's life. The projections include a sales price of $27, variable costs per unit of $16, and fixed costs of $81,000. The operating cash flow is $16,300. What is the break-even quantity? 7,363 units 1,211 units 1,482 units 2,301 units 8,845 units
QFinancial breakeven = ($81,000 + 16,300)/($27 - 16) = 8,845 units
Webster & Moore paid $148,000, in cash, for equipment three years ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $96,000 from a firm that would like to purchase it. The firm is debating whether to sell the equipment or to expand its operations so that the equipment can be used. The equipment, including the updates, has a book value of $44,500. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?
Relevant value = 96,000
Frank's is a furniture store that is considering adding appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances? Moving furniture to provide floor space for the appliances. Paying the rent for the store. Selling furniture to appliance customers. Having the current store manager oversee appliance sales. Using the store's billing system for appliance sales.
Selling furniture to appliance customers
An analysis that combines scenario analysis with sensitivity analysis is called _____ analysis. Forecasting Combined Complex Simulation Break-even
Simulation
Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million. For the firm as a whole, management has limited spending to $10 million for new projects next year even though the firm could afford additional investments. This is an example of: Scenario analysis. Sensitivity analysis. An operating leverage application. Soft rationing. Hard rationing.
Soft rationing
The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? Underlying value principle. Stand-alone principle. Equivalent cost principle. Salvage principle. Fundamental principle.
Stand alone principle
Which one of the following will best reduce the risk of a project by lowering the degree of operating leverage? Hiring additional employees rather than using temporary outside contractors. Subcontracting portions of the project rather than purchasing new equipment to do all the work in-house. Buying equipment rather than leasing it short-term. Lowering the projected selling price per unit. Changing the proposed labor-intensive production method to a more capital intensive method.
Subcontracting portions of the project rather than purchasing new equipment to do all the work in-house.
A project has cash flows of -$152,000, $60,800, $62,300 and $75,000 for years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value? .93; accept 1.07; accept 1.02; accept .93; reject 1.07 reject
1.02; accept PVInflows = $60,800 / 1.13 + $62,300 / 1.132 + $75,000 / 1.133 = $154,574.11 PI = $154,574.11 / $152,000 = 1.02 Since the PI is greater than 1, the project should be accepted. References
A project with financing type cash flows is typified by a project that has which one of the following characteristics? Conventional cash flows. Cash flows that extend beyond the acceptable payback period. A year or more in the middle of a project where the cash flows are equal to zero. A cash inflow at time zero. Cash inflows which are equal in amount.
A cash inflow at time zero
A project has an initial cost of $27,000 and a three-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,600, $2,200, and $1,700 a year for the next three years, respectively. What is the average accounting return?
AAR = [($1,600 + 2,200 + 1,700) / 3] / [($27,000 + 0) / 2] = .1358, or 13.58 percent
You are comparing two mutually exclusive projects. The crossover point is 12.3 percent. You have determined that you should accept project A if the required return is 13.1 percent. This implies you should: Always accept Project A. Be indifferent to the projects at any discount rate above 13.1 percent. Always accept Project A if the required return exceeds the crossover rate. Accept Project B only when the required return is equal to the crossover rate. Accept Project B if the required return is less than 13.1 percent.
Accept Project B only when the required return is equal to the crossover rate.
A project has a discount rate of 14 percent, an initial cost of $99,200, an inflow of $56,400 in year 1 and an inflow of $75,900 in year 2. Your boss requires that every project return a minimum of $1.06 for every $1 invested. Based on this information, what is your recommendation on this project? Accept the project because the PI is .90. Accept the project because the PI is 1.09. Accept the project because the PI is 1.11. Reject the project because the PI is .90. Reject the project because the PI is 1.09.
Accept the project because the PI is 1.09. NPVInflows = $56,400 / 1.14 + $75,900 / 1.142 = $107,876.27 PI = $107,876.27 / $99,200 = 1.09 Since the project PI exceeds the requirement, the project should be accepted.
Fixed costs: Change as a small quantity of output produced changes. Are constant over the short-run regardless of the quantity of output produced. Are defined as the change in total costs when one more unit of output is produced. Are subtracted from sales to compute the contribution margin. Can be ignored in scenario analysis since they are constant over the life of a project.
Are constant over the short-run regardless of the quantity of output produced.
Changes in the net working capital requirements: Can affect the cash flows of a project every year of the project's life. Only affect the initial cash flows of a project. Only affect the initial and final cash flows of a project. Are generally excluded from project analysis due to their irrelevance to the total project. Are excluded from the analysis as long as they are recovered when the project ends.
Can affect the cash flows of a project every year of the project's life
Net working capital: Can be ignored in project analysis because any expenditure is normally recouped at the end of the project. Requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. Is rarely affected when a new product is introduced. Can create either an initial cash inflow or outflow. Is the only expenditure where at least a partial recovery can be made at the end of a project.
Can create either an initial cash inflow or outflow
Which one of these is most associated with an IRR of -100 percent? Degree of operating leverage. Accounting break-even point. Contribution margin. Simulation analysis. Cash break-even point.
Cash break-even point
The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? Sunk. Total. Variable. Incremental. Fixed.
Incremental
Steele Insulators is analyzing a new type of insulation for interior walls. The initial fixed asset requirement is $1.3 million, which would be depreciated straight-line to zero over the 12-year life of the project. Projected fixed costs are $314,800 and the anticipated operating cash flow is $206,300. What is the degree of operating leverage for this project? 1.66 1.92 2.53 2.27 3.49
DOL = 1 + ($314,800 /$206,300) = 2.53
The net book value of equipment will: Remain constant over the life of the equipment. Vary in response to changes in the market value. Decrease at a constant rate when MACRS depreciation is used. Increase over the taxable life of an asset. Decrease slower under straight-line depreciation than under MACRS.
Decrease slower under straight-line depreciation than under MACRS.
Which one of the following is the relationship between the percentage change in operating cash flow and the percentage change in quantity sold? Degree of sensitivity. Degree of operating leverage. Accounting break-even. Cash break-even. Contribution margin.
Degree of operating leverage
Sensitivity analysis determines the: Range of possible outcomes given that most variables are reliable only within a stated range. Degree to which the net present value reacts to changes in a single variable. Net present value range that can be realized from a proposed project. Degree to which a project relies on its fixed costs. Ideal ratio of variable costs to fixed costs for profit maximization.
Degree to which the net present value reacts to changes in a single variable
Corner Market is considering adding a new product line that is expected to increase annual sales by $418,000 and cash expenses by $337,000. The initial investment will require $237,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the five-year life of the project. The company has a marginal tax rate of 34 percent. What is the annual value of the depreciation tax shield? $16,116 $13,160 $80,580 $32,560 $69,576
Depreciation tax shield = ($237,000 / 5) × .34 = $16,116
Keyser Mining is considering a project that will require the purchase of $875,000 of equipment. The equipment will be depreciated straight-line to a zero book value over the seven-year life of the project after which it will be worthless. The required return is 13 percent and the tax rate is 34 percent. What is the value of the depreciation tax shield in year 4 of the project? $42,500 $52,200 $68,600 $71,400 $76,500
Depreciation tax shield = ($875,000 / 7) *.34 = $42,500
Overland Trucking just purchased some fixed assets that are classified as three-year property for MACRS. The MACRS rates are .3333, .4445, .1481, and .0741 for years 1 to 4, respectively. What is the amount of the depreciation expense in Year 3 if the initial cost is $387,950? $28,747.10 $122,399.29 $57,455.40 $119,929.11 $42,177.56
Depreciation3 = $387,950 ×.1481 = $57,455.40
Scenario analysis is defined as the: Determination of the initial cash outlay required to implement a project. Determination of changes in NPV estimates when what-if questions are posed. Isolation of the effect that a single variable has on the NPV of a project. Separation of a project's sunk costs from its opportunity costs. Analysis of the effects that a project's terminal cash flows has on the project's NPV.
Determination of changes in NPV estimates when what-if questions are posed.
The internal rate of return is defined as the:
Discount rate which causes the net present value of a project to equal zero.
Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows? Constant dividend growth model. Discounted cash flow valuation. Average accounting return. Expected earnings model. Internal rate of return.
Discounted cash flow valuation.
Which one of the following is an advantage of the average accounting return method of analysis? Easy availability of information needed for the computation. Inclusion of time value of money considerations. The use of a cutoff rate as a benchmark. The use of pre-tax income in the computation. Use of real, versus nominal, average income.
Easy availability of information needed for the computation.
Assume a project has a discounted payback that equals the project's life. The project's sales quantity must be at which one of these break-even points? Accounting Leveraged Marginal Cash Financial
Financial
Which one of the following represents the level of output where a project produces a rate of return just equal to its requirement? Capital break-even. Cash break-even. Accounting break-even. Financial break-even. Internal break-even.
Financial break-even
Which of the following values will be equal to zero when a firm is operating at the accounting break-even level of output? IRR and OCF. Net income and contribution margin. IRR and net income. OCF and NPV. Net income and NPV.
IRR and net income
Pro forma statements for a proposed project should generally do all of the following except: Be compiled on a stand-alone basis. Include all project-related fixed asset acquisitions and disposals. Include all the incremental cash flows related to the project. Include taxes. Include interest expense.
Include interest expense
The operating cash flow for a project should exclude which one of the following? Taxes. Variable costs. Fixed costs. Interest expense. Depreciation tax shield.
Interest expense
The internal rate of return: May produce multiple rates of return when cash flows are conventional. Is best used when comparing mutually exclusive projects. Is rarely used in the business world today. Is principally used to evaluate small dollar projects. Is easy to understand.
Is Easy to understand
Which of the following are advantages of the payback method of project analysis? Considers time value of money, liquidity bias. Liquidity bias, arbitrary cutoff point. Liquidity bias, ease of use. Ignores time value of money, ease of use. Ease of use, arbitrary cutoff point.
Liquidity bias, ease of use.
TL Lumber is evaluating a project with cash flows of -$12,800, $7,400, $11,600, and -$3,200 for years 0 to 3, respectively. Given an interest rate of 8 percent, what is the MIRR using the discounted approach? 13.25 percent 14.08 percent 15.40 percent 14.36 percent 19.23 percent
MIRR = 0 = (-$12,800 - $3,200 / 1.083) + $7,400 / (1 + MIRR) + $11,600 / (1 + MIRR)2 MIRR = 14.36 percent
Mountain Gear can manufacture mountain climbing shoes for $22.36 per pair in variable raw material costs and $11.46 per pair in variable labor costs. The shoes sell for $97 per pair. Last year, production was 170,000 pairs and fixed costs were $1.18 million. The maximum production level for the firm given its current assets is 200,000 pairs. What is the minimum acceptable total revenue the company should accept for a one-time order for an extra 15,000 pairs? $611,418 $987,600 $507,300 $947,700 $1,164,100
Marginal total revenue = 15,000 *($22.36 + 11.46) = $507,300
A project will produce an operating cash flow of $31,200 a year for 7 years. The initial fixed asset investment in the project will be $204,900. The net aftertax salvage value is estimated at $62,000 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 11 percent? -$22,627.54 -$28,016.66 $4,120.52 $9,070.26 $21,040.83
NPV = -$204,900 + $31,200({1 - [1 / (1.11)7]} / .11) + $62,000 / 1.117 NPV = -$28,016.66
The Dry Dock is considering a project with an initial cost of $118,400. The project's cash inflows for years 1 through 3 are $37,200, $54,600, and $46,900, respectively. What is the IRR of this project?
NPV = 0 = -$118,400 + $37,200 / (1 + IRR) + $54,600 / (1 + IRR)2 + $46,900 / (1 + IRR)3 IRR = 8.04 percent
A project has cash flows of -$152,000, $60,800, $62,300, and $75,000 for years 0 to 3, respectively. The required rate of return is 13 percent. Based on the internal rate of return of _____ percent for this project, you should _____ the project. 14.67; accept 13.96; accept 14.67; reject 17.91; reject 18.46; reject
NPV = 0 = -$152,000 + $60,800 / (1 + IRR) + $62,300 / (1 + IRR)2 + $75,000 / (1 + IRR)3 IRR = 13.96 percent Since the IRR exceeds the required return, you should accept the project.
An investment that provides annual cash flows of $9,600 for 12 years costs $75,000 today. At what rate would you be indifferent between accepting the investment and rejecting it?
NPV = 0 = -$75,000 + $9,600({1 - [1 / (1 + IRR)12]} / IRR) IRR = 7.31 percent
Hunter's Hut is considering a project that will require additional inventory of $176,000 and will increase accounts payable by $148,000. Accounts receivable is currently $305,000 and is expected to increase by 11 percent if this project is accepted. What is the project's initial cash flow for net working capital? -$61,550 -$5,550 -$112,250 -$366,550 -$357,550
NWC requirement = -$176,000 + $148,000 - ($305,000 ×.11) = - $61,550
Home Furnishings is expanding its product offerings to reach a wider range of customers. The expansion project includes increasing floor inventory by $656,000 and increasing its debt to suppliers by 85 percent of that amount. The company will also spend $1,110,000 for a building contractor to expand the size of its showroom. As part of the expansion plan, the company will be offering credit to its customers and thus expects accounts receivable to rise by $275,000. For the project analysis, what amount should be used as the initial cash flow for net working capital? -$239,900 -$176,600 -$156,000 -$373,400 -$391,000
NWC0 = -$656,000 + (.85 × $656,000) - $275,000 = -$373,400
Wilson's Market is reviewing a project with sales of 6,200 units plus or minus 2 percent at a sales price of $29 plus or minus 1 percent per unit. The expected variable cost per unit is $11 plus or minus 3 percent and the expected fixed costs are $87,000plus or minus 1 percent. The depreciation expense is $68,000 and the tax rate is 35 percent. What is the net income under the worst-case scenario? -$8,578.42 -$32,674.93 $15,846.67 $28,704.11 $4,696.18
Net incomeWorst Case = {{[($29 × .99) - ($11 × 1.03)] × (6,200 × .98)} - ($87,000 × 1.01) - $68,000} {1 - .35} = -$32,674.93
You estimate that a project will cost $27,700 and will provide cash inflows of $11,800 in year 1 and $24,600 in year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14 percent? Why or why not? Yes; The PI is .97. Yes; The PI is .84. Yes; The PI is 1.06. No; The PI is 1.06. No; The PI is .97.
No; The PI is .97 PVInflows = $11,800 / 1.14 + $24,600 / 1.143 = $26,955.18 PI = $26,955.18 / $27,700 = .97 The PI is less than 1 so the project should be rejected.
A project has projected sales of $26,000, cash expenses of $18,500, depreciation of $1,730, taxes of $1,400, and an initial cash requirement of $2,200 for working capital. What is the amount of the operating cash flow using the top-down approach? $4,370 $3,900 $8,300 $6,100 $8,900
OCF = $26,000 - 18,500 - 1,400 = $6,100
Which of the following are inversely related to variable costs per unit? Sales quantity and sales price. Net profit per unit and sales quantity. Operating cash flow and sales quantity. Operating cash flow per unit and contribution margin per unit. Contribution margin per unit and marginal costs.
Operating cash flow per unit and contribution margin per unit
The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following? Initial cost of each project. Timing of the cash inflows. Total cash inflows of each project. Required rate of return. Length of each project's life.
Required rate of return
A decrease in which one of the following will increase the accounting break-even quantity? Assume straight-line depreciation is used and ignore taxes. Sales price per unit. Management salaries. Variable labor costs per unit. Initial fixed asset purchases. Fixed costs.
Sales price per unit
Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using? Simulation testing. Sensitivity analysis. Break-even analysis. Rationing analysis. Scenario analysis.
Scenario anaylsis
Lenora's creates exquisite gowns for special occasions on a prepaid basis only. The required return is 12.5 percent. The estimate for one gown order has cash flows of $165,000 in year 0 and -$188,000 in year 1. Which of these statements correctly applies to this order? The gown should not be sold for $165,000. As long as the selling price is $164,819 or higher, the gown should be sold. The gown must be sold for a minimum price of $167,111 to earn the required return. The IRR decision rule cannot be applied to this project. Insufficient information is provided to make a decision based on IRR.
The gown must be sold for a minimum price of $167,111 to earn the required return. NPV = 0 = $165,000 - $188,000 / (1 + IRR) IRR = 13.94 percent Minimum price = $188,000 / 1.125 = $167,111 This is a financing project so you should reject the project because the IRR is greater than the required return.
Precise Machinery is analyzing a proposed project. The company expects to sell 2,340 units, give or take 5 percent. The expected variable cost per unit is $260 and the expected fixed costs are $589,000. Cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation expense is $129,000. The sales price is estimated at $750 per unit, give or take 2 percent. What is the amount of the total costs per unit under the worst case scenario? $548.58 $551.62 $604.16 $638.23 $545.96
Total costs per unitWorst case = [(2,340 × .95) ($260 × 1.04) + ($589,000 × 1.04)]/(2,340× .95) = $545.96
The equivalent annual cost method is useful in determining: Which one of two machines to purchase if the machines are mutually exclusive, have differing lives, and are a one-time purchase. The operating cash flow for mutually exclusive projects ignoring any fixed asset acquisitions or dispositions. The minimum price that should be bid to earn a specified rate of return. Which one of two investments to accept when the investments have different required rates of return, different costs, and will not be replaced once they wear out. Which one of two machines should be purchased when the machines are mutually exclusive, have different lives, and will be replaced at the end of their lives.
Which one of two machines should be purchased when the machines are mutually exclusive, have different lives, and will be replaced at the end of their lives.
HH Companies has identified two mutually exclusive projects. Project A has cash flows of -$40,000, $21,200, $16,800, and $14,000 for Years 0 to 3, respectively. Project B has a cost of $40,000 and annual cash inflows of $25,500 for 2 years. At what rate would you be indifferent between these two projects? 16.34 percent −12.72 percent 9.41 percent 5.70 percent 8.28 percent
Year 0 difference = -$40,000 - (-40,000) = $0 Year 1 difference = $21,200 - 25,500 = -$4,300 Year 2 difference = $16,800 - 25,500 = -$8,700 Year 3 difference = $14,000 - 0 = $14,000 NPV = 0 = $0 - $4,300 / (I + IRR) - $8,700 / (1 + IRR)2 + $14,000 / (1 + IRR)3 IRR = 5.70 percent
The Metal Shop produces 2.1 million metal fasteners a year for industrial use. At this level of production, its total fixed costs are $320,000 and its total costs are $522,000. The firm can increase its production by 5 percent, without increasing either its total fixed costs or its variable costs per unit. A customer has made a one-time offer for an additional 50,000 units at a price per unit of $.10. Should the firm sell the additional units at the offered price? Why or why not? Yes.The offered price is less than the marginal cost. Yes.The offered price is equal to the marginal cost. Yes.The offered price is greater than the marginal cost. No.The offered price is less than the marginal cost. No.The offered price is greater than the marginal cost.
Yes.The offered price is greater than the marginal cost v = ($522,000 - 320,000)/ 2,100,000 = $.096 The marginal cost per unit for the one-time offer will be $.096 since the variable cost per unit will be unchanged. The order should be accepted because the offered price exceeds the marginal cost.
