FINAL EXAM (2,5,6,9,10,11,14)

2 independent projects

accept project a. reject project b

A company's current cost of capital is based on:

both the returns currently required by its debtholders and stockholders.

You are investing $100 today in a savings account. Which one of the following terms refers to the total value of this investment one year from now?

future value

The percentage of the next dollar you earn that must be paid in taxes is referred to as the ________ tax rate.

marginal

The contribution margin per unit is equal to the:

sales price per unit minus the variable cost per unit.

Which of the following variables will be forecast at their highest expected level under a best-case scenario?

salvage value and units sold

Noncash items refer to:

expenses that do not directly affect cash flows

Cash flow from assets is also known as the firm's:

free cash flow

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

Selling fewer hot dogs because hamburgers were added to the menu

Textile Mills borrows money at a rate of 8.7 percent. This interest rate is referred to as the:

cost of debt

Which one of the following is an example of a sunk cost?

$1,200 paid to repair a machine last year

A project has cash flows of −$161,900, $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.

10.41; reject

Chapman Machine Shop

A

Precise Machinery, 7500 units

A

Project A cashflows of -72,000

A

Which one of these will increase a company's aftertax cost of debt?

A decrease in the company's tax rate

Which one of the following statements related to the cash flow to creditors must be correct?

A positive cash flow to creditors represents a net cash outflow from the firm.

Which one of the following statements is correct?

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

You are comparing two annuities that offer regular payments of $2,500 for five years and pay .75 percent interest per month. You will purchase one of these today with a single lump sum payment. Annuity A will pay you monthly, starting today, while annuity B will pay monthly, starting one month from today. Which one of the following statements is correct concerning these two annuities?

Annuity B has a smaller present value than annuity A.

Tidewater Fishing has a current beta of 1.16...

B

two mutually exclusive projects (47,500) each

B

Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning at 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true?

Barb will earn more interest in Year 2 than Andy.

A project requires the purchase of $587,000 of equipment ...

C

Beef exporters

C

Dee's Fashions

C

Dexter Smith & Co.

C

Fashion Wear

C

Handy Man Inc.

C

Mullineaux Corporation

C

W&M paid $179,000, in cash

C

maintenance expenses

C

Rossiter Restaurants is analyzing a project that requires $180,000 of fixed assets. When the project ends, those assets are expected to have an aftertax salvage value of $45,000. How is the $45,000 salvage value handled when computing the net present value of the project?

Cash inflow in the final year of the project

Alt's

D

Chelsea Fashions

D

Colors and More

D

Grill Works

D

Home Furnishings

D

Phillippe invested $1,000 ten years ago and expected to have $1,800 today He has neither added nor withdrawn any money since his initial investment. All interest was reinvested and compounded annually. As it turns out, he only has $1,680 in his account today. Which one of the following must be true?

He earned a lower interest rate than he expected

Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

Hiring additional employees to handle the increased workload should the firm accept the wreath project

Which one of the following statements related to loan interest rates is correct?

Lenders are most apt to quote the effective annual rate.

Which one of the following statements related to liquidity is correct?

Liquid assets are valuable to a firm.

Which of the following are inversely related to variable costs per unit?

Operating cash flow per unit and contribution margin per unit

You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate. (No calculations needed.)

Option B has a higher present value at Time 0.

Project X has cash flows of $8,500, $8,000, $7,500, and $7,000 for Years 1 to 4, respectively. Project Y has cash flows of $7,000, $7,500, $8,000, and $8,500 for Years 1 to 4, respectively. Which one of the following statements is true concerning these two projects given a positive discount rate? (No calculations needed)

Project X has both a higher present and a higher future value than Project Y.

Black River Tours has a capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. The dividend payout ratio is 30 percent, the company's beta is 1.21, and the tax rate is 21 percent. Given this, which one of the following statements is correct?

The cost of equity is unaffected by a change in the company's tax rate.

Which one of the following statements related to corporate taxes is correct?

The marginal tax rate for a company can be either higher than or equal to the average tax rate.

The bid price always assumes which one of the following?

The net present value of the project is zero.

This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in 40 years. Which one of the following statements is correct?

The present value of this investment is equal to $1,000.

Which one of the following accounts is the most liquid?

accounts receivable

The depreciation tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense.

Which one of the following will increase a bid price?

an increase in the required rate of return

Which one of the following compounding periods will yield the lowest effective annual rate given a stated future value at Year 5 and an annual percentage rate of 10 percent?

annual

Your credit card charges you .85 percent interest per month. This rate when multiplied by 12 is called the ________ rate.

annual percentage

The capital structure weights used in computing a company's weighted average cost of capital:

are based on the market values of the outstanding securities.

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith Inc. What is the return that these individuals require on this investment called?

cost of equity

Sam just opened a savings account paying 3.5 percent interest, compounded annually. After four years, the savings account will be worth $5,000. Assume there are no additional deposits or withdrawals. Given this, Sam:

could have deposited less money today and still had $5,000 in four years if the account paid a higher rate of interest.

Which one of these will increase the present value of a set amount to be received sometime in the future?

decrease in interest rate

Which one of the following is a project cash inflow? Ignore any tax effects.

decrease in inventory

Ignoring bonus depreciation, the net book value of equipment will:

decrease slower under straight-line depreciation than under MACRS.

Sensitivity analysis determines the:

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

The cost of capital for a new project:

depends upon how the funds raised for that project are going to be spent.

Increasing which one of the following will increase the operating cash flow of a profitable, tax paying company assuming that the bottom-up approach is used to compute the operating cash flow?

depreciation expense

A company's overall cost of equity is:

directly related to the risk level of the firm.

The internal rate of return is defined as the:

discount rate which causes the net present value of a project to equal zero.

The process of determining the present value of future cash flows in order to know their value today is referred to as:

discounted cash flow valuation

Terry is calculating the present value of a bonus he will receive next year. The process he is using is called:

discounting

The actual interest rate on a loan that is compounded monthly but expressed as an annual rate is referred to as the ________ rate.

effective annual

The value of which one of the following is included in the market value of a firm but is excluded from the firm's book value?

employee's experience

Decreasing which one of the following will increase the acceptability of a project?

equivalent annual cost

The top-down approach to computing the operating cash flow:

ignores noncash expenses

Pro forma statements for a proposed project should generally do all of the following except:

include interest expense

Net present value:

is the best method of analyzing mutually exclusive projects.

Your goal is to have $1 million in your retirement savings on the day you retire. To fund this goal, you will make one lump sum deposit today. If you plan to retire ________ rather than ________ and earn a ________ rate of interest, then you can deposit a smaller lump sum today.

later; sooner; high

A project's cash flow is equal to the project's operating cash flow:

minus both the project's change in net working capital and capital spending.

Which one of the following variables is the exponent in the present value formula?

number of time periods

Which term relates to the cash flow that results from a company's ongoing, normal business activities?

operating cash flow

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?

opportunity cost

A Canadian consol is best categorized as a(n):

perpetuity

Kurt won a lottery and will receive $1,000 a year for the next 50 years. The current value of these winnings is called the:

present value

The weighted average cost of capital for a company is least dependent upon the:

standard deviation of the company's common stock.

GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?

sunk

What is the relationship between the present value and future value interest factors?

the factors are reciprocals of each other.

The bottom-up approach to computing the operating cash flow applies only when:

the interest expense is equal to zero.

The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the:

weighted average cost of capital.

Simulation analysis is based on assigning a ________ and analyzing the results.

wide range of values to multiple variables simultaneously

When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as:

worst-case scenario analysis

A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not?

yes, the irr exceeds required return

A company's weighted average cost of capital:

is the return investors require on the total assets of the firm.

The base case values used in scenario analysis are the values considered to be the most:

likely to occur

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?

stand-alone principle

If a project has a net present value equal to zero, then:

the project earns a return exactly equal to the discount rate.

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?

Selling furniture to appliance customers

Which one of the following statements is correct concerning a corporation with taxable income of $125,000?

An increase in depreciation will increase the operating cash flow.

Scenario analysis is best suited to accomplishing which one of the following when analyzing a project?

Identifying the potential range of reasonable outcomes

Chang Lee is going to receive $20,000 six years from now. Soo Lee is going to receive $20,000 nine years from now. Which one of the following statements is correct if both individuals apply a discount rate of 7 percent?

In today's dollars, Chang Lee's money is worth more than Soo Lee's.

Which one of these combinations must increase the contribution margin?

Increasing the sales price and decreasing the variable cost per unit

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0?

Initial investment in inventory to support the project

In actual practice, managers most frequently use which two types of investment criteria?

Internal rate of return and net present value

Which one of the following statements concerning scenario analysis is correct?

Scenario analysis helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions.

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

Tax due on the current salvage value of that asset

Which one of the following statements related to the internal rate of return (IRR) is correct?

The IRR is equal to the required return when the net present value is equal to zero.

Which one of the following statements related to WACC is correct for a company that uses debt in its capital structure?

The WACC would most likely decrease if the firm replaced its preferred stock with debt.

Why is payback often used as the sole method of analyzing a proposed small project?

The benefits of payback analysis usually outweigh the costs of the analysis

Mutually exclusive projects are best defined as competing projects that:

both require the total use of the same limited resource.

The operating cash flow of a cost-cutting project:

can be positive even though there are no sales.

The cash flow related to interest payments less any net new borrowing is called the:

cash flow to creditors

The interest earned on both the initial principal and the interest reinvested from prior periods is called:

compound interest

Christina invested $3,000 five years ago and earns 2 percent annual interest. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as:

compounding

The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:

crossover rate

Net working capital is defined as:

current assets minus current liabilities

The operating cash flow for a project should exclude which one of the following?

interest expense

Art invested $100 two years ago at 8 percent interest. The first year, he earned $8 interest on his $100 investment. He reinvested the $8. The second year, he earned $8.64 interest on his $108 investment. The extra $.64 he earned in interest the second year is referred to as:

interest on interest

The cost of equity for a company with a debt-equity ratio of .41:

is affected by either a change in the company's beta or its projected rate of growth.

A company's pretax cost of debt:

is based on the current yield to maturity of the company's outstanding bonds.

Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity:

is dependent upon a reliable estimate of the market risk premium.

The cost of preferred stock:

is equal to the dividend yield.

The aftertax cost of debt:

is highly dependent upon a company's tax rate.

The dividend growth model:

is only as reliable as the estimated rate of growth.

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be?

(C) Accept Project B and reject Project A based on the NPVs

Projects A and B are mutually exclusive. Project A has cash flows of −$10,000, $5,100, $3,400, and $4,500 for Years 0 to 3, respectively. Project B has cash flows of −$10,000, $4,500, $3,400, and $5,100 for Years 0 to 3, respectively. What is the crossover rate for these two projects?

0%

The relevant discount rate is 14 percent for a project with cash flows of −$9,200, $4,600, $3,300, and $3,800 for Years 0 to 3, respectively. What is the profitability index?

0.99

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, you should ________ the project.

13.96; accept

A firm evaluates all of its projects by applying the IRR rule. The current proposed project has cash flows of −$37,048, $16,850, $15,700, and $19,300 for Years 0 to 3, respectively. The required return is 18 percent. What is the project IRR? Should the project be accepted or rejected?

18.42 percent; accept

A project has projected sales of $76,400, cash expenses of $42,900, depreciation of $3,730, taxes of $7,200, 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?

26,300

Which one of the following will produce the lowest present value interest factor?

8 percent interest for 10 years

Corner Market

A

Highway Express

A

Which one of the following statements related to annuities and perpetuities is correct?

A perpetuity comprised of $100 monthly payments is worth more than an annuity of $100 monthly payments provided the discount rates are equal.

All else constant, which one of the following will increase a company's cost of equity if the company computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

A reduction in the risk-free rate

According to the Rule of 72, you can do which one of the following?

Approximately double your money in 11 years at 6.55 percent interest

A project will require $543,000 for fixed assets

B

Dependable Motors just purchased some MACRS five-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for Years 1 to 3, respectively. Assume the firm opted to forego any bonus depreciation. Which one of the following will correctly give you the book value of this equipment at the end of Year 2?

B

EDP

B

NPV if required return is 12.9%

B

Project A required return 9.2%

B

The Market Place

B

The Shoe Outlet

B

Theresa's Flower garden

B

assume investment cashflows -39,700

B

Jay's Bakery

D

Pre-Fab

D

Preston Industries

D

cash flows of -108,000

D

Better Beverages

E

Florida Groves

E

Gateway communications

E

Globsl wholesalers

E

Jenner's

E

Marie's Fashions

E

Panelli's

E

Precise Machinery, 2450 units

E

The Lunch Counter

E

Nan and Neal are twins. Nan invests $5,000 at 7 percent at age 25. Neal invests $5,000 at 7 percent at age 30. Both investments compound interest annually. Both twins retire at age 60 and neither adds nor withdraws funds prior to retirement. Which statement is correct?

Nan will have more money than Neal at any age

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero?

Net income + Depreciation

A project has an initial cost of $31,800 and a market value of $29,600. What is the difference between these two values called?

Net present value

Chris has three options for settling an insurance claim. Option A will provide $1,500 a month for 6 years. Option B will pay $1,025 a month for 10 years. Option C offers $85,000 as a lump sum payment today. The applicable discount rate is 6.8 percent, compounded monthly. Which option should Chris select, and why, if he is only concerned with the financial aspects of the offers?

Option B: It has the largest value today.

Project A has cash flows of $4,000, $3,000, $0, and $3,000 for Years 1 to 4, respectively. Project B has cash flows of $2,000, $3,000, $2,000, and $3,000 for Years 1 to 4, respectively. Which one of the following statements is correct assuming the discount rate is positive? (No calculations needed)

Project B is worth less today than Project A

A firm's managers realize they cannot monitor all aspects of their projects but do want to maintain a constant focus on the key aspect of each project in an attempt to maximize their firm's value. Given this specific desire, which type of analysis should they require for each project and why?

Sensitivity analysis; to identify the key variable that affects a project's profitability

A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project?

The cash flow in Year 2 is valued just as highly as the cash flow in Year 1.

A positive cash flow to stockholders indicates which one of the following with certainty?

The dividends paid exceeded the net new equity raised.

Which one of the following statements concerning interest rates is correct?

The effective annual rate equals the annual percentage rate when interest is compounded annually.

Which one of the following will be used in the computation of the best-case analysis of a proposed project?

The lowest variable cost per unit that can reasonably be expected

Which one of these statements related to growing annuities and perpetuities is correct?

The present value of a growing perpetuity will decrease if the discount rate is increased.

A project has a net present value of zero. Which one of the following best describes this project?

The project's cash inflows equal its cash outflows in current dollar terms.

Which one of the following statements correctly defines a time value of money relationship?

Time and present value are inversely related, all else held constant

Project A costs $47,800 with cash inflows of $34,200 in Year 1 and $28,700 in Year 2. Project B costs $63,200 with cash inflows of $21,900 in Year 1 and $59,200 in Year 2. These projects are independent and have an assigned discount rate of 15 percent. Based on the profitability index, what is your recommendation concerning these projects?

accept both projects

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:

accepted because the profitability index is greater than 1.

The interest rate that is most commonly quoted by a lender is referred to as the:

annual percentage rate

Fixed costs:

are constant over the short-run regardless of the quantity of output produced.

The capital asset pricing model approach to equity valuation:

assumes the reward-to-risk ratio is constant.

The book value of a firm is:

based on historical cost

Scenario analysis is defined as the:

determination of changes in NPV estimates when what-if questions are posed.

Steve just computed the present value of a $10,000 bonus he will receive next year. The interest rate he used in his computation is referred to as the:

discount rate

Cash flow to stockholders is defined as:

dividend payments less net new equity raised.

An ordinary annuity is best defined as:

equal payments paid at the end of regular intervals over a stated time period.

There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to:

have multiple rates of return.

The key means of defending against forecasting risk is to:

identify sources of value within a project.

Which one of the following is the financial statement that summarizes a firm's revenue and expenses over a period of time?

income statement

Forecasting risk is defined as the possibility that:

incorrect decisions will be made due to erroneous cash flow projections.

Your grandmother has promised to give you $10,000 when you graduate from college. If you speed up your graduation by one year and graduate two years from now rather than the expected three years, the present value of this gift will:

increase

If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to:

increase the average risk level of the company over time.

Which one of the following will decrease the net present value of a project?

increasing the project's initial cost at time zero

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

incremental

The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's:

incremental cash flows

Steve, the sales manager for TL Products, wants to sponsor a one-week "Customer Appreciation Sale" where the firm offers to sell additional units of a product at the lowest price possible without negatively affecting the firm's profits. Which one of the following represents the price that should be charged for the additional units during this sale?

marginal cost

The change in variable costs that occurs when production is increased by one unit is referred to as the:

marginal cost

The change in revenue that occurs when one more unit of output is sold is referred to as:

marginal revenue

Assigning discount rates to individual projects based on the risk level of each project:

may cause the company's overall weighted average cost of capital to either increase or decrease over time.

If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:

mutually exclusive.

By definition, which one of the following must equal zero at the accounting break-even point?

net income

Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods?

net present value

The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following?

net present value

The profitability index is most closely related to which one of the following?

net present value

As the degree of financial leverage increases, the:

probability a firm will encounter financial distress increases.

Which one of the following methods of analysis provides the best information on the cost-benefit aspects of a project?

profitability index

The weighted average cost of capital for a firm with debt is the:

rate of return a company must earn on its existing assets to maintain the current value of its stock.

The cost of preferred stock is computed the same as the:

rate of return on a perpetuity.

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 he using?

scenario analysis

Which one of the following will decrease the value of a firm's net working capital?

selling inventory at a loss

An analysis of the change in a project's NPV when a single variable is changed is called ________ analysis.

sensitivity

Pro forma financial statements can best be described as financial statements:

showing projected values for future time periods.

Renee invested $2,000 six years ago at 4.5 percent interest. She spends all of her interest earnings immediately so she only receives interest on her initial $2,000 investment. Which type of interest is she earning?

simple interest

Combining scenario analysis with sensitivity analysis can yield a crude form of ________ analysis.

simulation

The internal rate of return is:

tedious to compute without the use of either a financial calculator or a computer.

The bid price is the:

the minimum price that will provide your target rate of return.

Swenson's is considering two mutually exclusive projects, Projects A and B, and has determined that the crossover rate for these projects is 11.7 percent. Given this you know that:

the project that is acceptable at a discount rate of 11 percent should be rejected at a discount rate of 12 percent.

The discount rate assigned to an individual project should be based on:

the risks associated with the use of the funds required by the project.

The primary advantage of using the dividend growth model to estimate a company's cost of equity is:

the simplicity of the model.

A perpetuity is defined as:

unending equal payments paid at equal time intervals.

Which one of the following is the primary determinant of a firm's cost of capital?

use of the funds raised

Variable costs can be defined as the costs that:

vary directly with sales.

You are considering two mutually exclusive projects. Project A has cash flows of −$125,000, $51,400, $52,900, and $63,300 for Years 0 to 3, respectively. Project B has cash flows of −$85,000, $23,100, $28,200, and $69,800 for Years 0 to 3, respectively. Project A has a required return of 9 percent while Project B's required return is 11 percent. Should you accept or reject these mutually exclusive projects based on IRR analysis?

you should not use irr; use a different method of analysis