FIN 3403 UCF - Exam 3 Practice

The -- approach is used by corporations that attempt to consider differential project risk in their capital budgeting procedures.

risk-adjusted discount rate

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 2 years. At the end of the second year, the machine will be sold for $50,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%. What is the NPV of the project?

$-16,752

You have purchased a canning machine for $9,500.00. You expect the machine to save your company $3,600.00 each year for the next 10 years. What is the NPV of the machine? Use a discount rate of 11.90%.

$10,924

SanData Inc. recently paid its annual dividend ($3.00). Dividends have consistently grown at a rate of 3.00%. You estimate that the stock has a required rate of 17.00%. What is the intrinsic value of this stock?

$22.07

SanData Inc. recently paid its annual dividend ($3.00). Dividends have consistently grown at a rate of 3.20%. You estimate that the stock has a required rate of 16.00%. What is the intrinsic value of this stock?

$24.19

Colonnade Corporation purchased a machine for use in the firm's manufacturing process. The original cost of the machine was $1,800,000. The machine has a class life of 15 years, but after 13 years, the firm has decided to sell the machine for $320,000. If Colonnade has a marginal tax rate of 34%, what is the tax effect associated with the decision? Assume the machine was depreciated straight-line over the 15-year life to zero salvage value.

$27,200 payment

X-Ray Inc. recently paid its annual dividend ($3.00), and reported an ROE of 15%, of which 50% is paid as dividends. Based on your analysis, you estimate that the stock has a required rate of 15.50%. What is the intrinsic value of this stock?

$40.31

The preferred stock of Dallas Platinum Exchange (par-value of $65.00) pays a 7.25% dividend rate per year. You calculated a beta of 1.05 for the stock. The risk-free rate is 2.70% and the market risk premium (RM - RF) is 6.50%. Assuming that C

$49.48

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 2 years. At the end of the second year, the machine will be sold for $100,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%. What is the NPV of the project?

$9,555

Driver Products recently paid its annual dividend ($4.00), and reported an ROE of 15%, of which 50% is paid as dividends. The stock has a beta of 1.15. The current risk-free rate is 2.70% and the market return (RM) is 11.00%. Assuming that CAPM holds, what is the intrinsic value of this stock?

$90.62

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 5 years. At the end of the fifth year, the machine will be sold for $20,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%. What is the NPV of the project?

$98,934

Book Value =

(Depreciable Asset / Useful Life) * years remaining

A replacement computer will cost you $1,500.00, but save you $950.00 each year because of the faster processor. What is the payback period of the computer?

1.58

A capital project costing $6,000.00 will generate annual savings of $3,775.00 for the foreseeable future. What is the payback period of the project?

1.59

Sparrow Products Industries is currently selling for $80.00. It just paid its annual dividend of $2.00 after reporting an ROE of 15%, of which 50% is paid as dividends. What is the expected return of this stock?

10.19%

Bay Beach Industries wants to maintain their capital structure of 40% debt and 60% equity. The firm's tax rate is 34%. The firm can issue the following securities to finance the investments: Bonds: Mortgage bonds can be issued at a pre-tax cost of 9 percent. Debentures can be issued at a pre-tax cost of 10.5 percent. Common Equity: Some retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $46. Flotation costs will be $3 per share. The recent common stock dividend was $3.60. Dividends are expected to grow at 6% in the future. What is the cost of capital using debentures and external equity?

11.69%

A $63,000 machine with a 7-year class life was purchased 2 years ago. The machine will now be sold for $50,000 and replaced with a new machine costing $75,000, with a 5-year class life. The new machine will not increase sales, but will decrease operating costs by $16,000 per year. Simplified straight line depreciation is employed for both machines, and the marginal corporate tax rate is 34 percent. What is the incremental annual cash flow associated with the project?

12,600

Hampton Corporation has a beta of 1.3 and a marginal tax rate of 34%. The expected return on the market is 11% and the risk-free interest rate is 6%. Estimate the firm's cost of internal equity.

12.5%

Southern Corporation has a capital structure of 40% debt and 60% common equity. This capital structure is expected not to change. The firm's tax rate is 34%. The firm can issue the following securities to finance capital investments: Debt: Capital can be raised through bank loans at a pretax cost of 8.5%. Also, bonds can be issued at a pretax cost of 10%. Common Stock: Retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $59. Flotation costs will be $3 per share. The recent common stock dividend was $3.15. Dividends are expected to grow at 7% in the future. What is the cost of external equity?

13%

Hampton Corporation has a beta of 1.3 and a marginal tax rate of 34%. The expected return on the market is 11% and the risk-free interest rate is 4%. Estimate the firm's cost of internal equity.

13.1%

Hampton Corporation has a beta of 1.6 and a marginal tax rate of 34%. The expected return on the market is 11% and the risk-free interest rate is 6%. Estimate the firm's cost of internal equity.

14.0%

Bay Beach Industries wants to maintain their capital structure of 40% debt and 60% equity. The firm's tax rate is 34%. The firm can issue the following securities to finance the investments: Bonds: Mortgage bonds can be issued at a pre-tax cost of 9 percent. Debentures can be issued at a pre-tax cost of 10.5 percent. Common Equity: Some retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $46. Flotation costs will be $3 per share. The recent common stock dividend was $3.60. Dividends are expected to grow at 6% in the future. What is the cost of external equity?

14.87%

A new transmission in your truck will cost $7,500.00. Luckily, it should recude maintenance expense by $3,525.00 each year for the next 10 years. What is the profitability index of the transmission? Use a discount rate of 12.30%.

2.62

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 5 years. At the end of the fifth year, the machine will be sold for $20,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%. What is the IRR of the project?

28.2%

You have purchased a canning machine for $7,000.00. You expect the machine to save your company $3,775.00 each year for the next 10 years. What is the profitability index of the machine? Use a discount rate of 10.90%.

3.19

A replacement computer will cost you $3,500.00, but save you $750.00 each year because of the faster processor. What is the payback period of the computer?

4.67

By purchasing training software for $7,000.00, you can eliminate other training costs of $3,400.00 each year for the next 10 years. What is the IRR of the software?

47.58%

Guano Industries is currently selling for $79.00. It just paid its annual dividend of $2.00, which have consistently grown at a rate of 2.60%. What is the expected return of this stock?

5.20%

Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing?

5.65%

Heritage Corporation is trying to decide whether to invest in equipment to manufacture a new product. If the investment project is accepted, sales revenue will increase by $65,000 per year and materials costs will decrease by $16,000 per year. The equipment will cost $140,000 and is depreciable over 10 years using simplified straight line (zero salvage value). The firm has a marginal tax rate of 34%. Calculate the firm's annual cash flows resulting from the new project.

58,220

Suppose Hampton Corporation sells land for $8,000,000. Hampton paid $5,000,000 for the land several years ago. Assuming a marginal tax rate of 34%, calculate the after-tax cash flow resulting from the land sale.

6,980,000

St. Thomas Company is planning to issue $1,000 par value bonds. The bonds will have a coupon rate of 9.5 percent and will be sold at a market price of $980. Flotation costs will amount to 4 percent of market value. The bonds will mature in 15 years and coupon payments will be semi-annual. St. Thomas' marginal tax rate is 35%. What is the firm's cost of debt financing?

6.68%

Alistar Inc. recently issued $75.00 par-value preferred stock that pays a 7.00% dividend rate per year. If the stock is currently selling for $69.00, what is the expected return of this preferred stock?

7.61%

A firm has preferred stock that pays an 8 percent dividend on a $75 par value. If a new issue is offered, flotation costs will be 3 percent of the current market price of $80. The firm's marginal tax rate is 35 percent. What is the firm's cost of preferred stock financing?

7.7%

A new transmission in your truck will cost $5,000.00. Luckily, it should recude maintenance expense by $3,600.00 each year for the next 10 years. What is the IRR of the transmission?

71.68%

Alistar Inc. recently issued $90.00 par-value preferred stock that pays a 8.25% dividend rate per year. If the stock is currently selling for $85.00, what is the expected return of this preferred stock?

8.74%

Sparrow Products Industries is currently selling for $73.00. It just paid its annual dividend of $1.00 after reporting an ROE of 15%, of which 50% is paid as dividends. What is the expected return of this stock?

8.97%

Eastern Corporation has $21,000,000 in equipment that has a 15 year class life. The equipment is 8 years old. Eastern is selling the equipment for $10,000,000. Eastern uses simplified straight line depreciation (zero salvage value) and has a marginal tax rate of 34%. What is the terminal cash flow? Assume no working capital.

9,932,000

Southern Corporation has a capital structure of 40% debt and 60% common equity. This capital structure is expected not to change. The firm's tax rate is 34%. The firm can issue the following securities to finance capital investments: Debt: Capital can be raised through bank loans at a pretax cost of 8.5%. Also, bonds can be issued at a pretax cost of 10%. Common Stock: Retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $59. Flotation costs will be $3 per share. The recent common stock dividend was $3.15. Dividends are expected to grow at 7% in the future. What is the cost of capital if the firm uses bank loans and retained earnings?

9.9%

Annual Cash Flow calculation

Incremental Revenue - Incremental costs - depreciation on project = Incremental EBT - Tax on Incremental EBT = Incremental Earnings after taxes + Depreciation reversal = Annual Cash Flow

According to the survey in Module 8, which capital budgeting technique were highly levered firms more likely to use than firms with little debt?

NPV & IRR

Initial Outlay calculation

Purchase Price of the asset + shipping & installation costs = Depreciable Asset + Investment in NWC + after-tax proceeds from sale of old asset = Net Initial Outlay

Capital Gain/Loss =

SV - BV

Terminal Cash Flow Calculation

Salvage value +/- Tax effects of capital gain/loss + NWC = Terminal Cash Flow

Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal?

cost of issuing new bonds to finance the new project