Finance Exam 3

38. A firm is considering the purchase of a new machine for $325,000. The firm is unsure if it should use the 3-Year MACRS schedule or straight-line depreciation over three years. What is the difference in the book value after three years if the firm uses MACRS instead of straight line depreciation?

$0

33. The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If the Sisyphean's marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?

$1,260,000

39. Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sales of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars) There are some concerns that estimates of manufacturing expenses may be low, due to the rising cost of raw materials. What is the break-even point for manufacturing expenses, if all other estimates are correct and the cost of capital is 9%?

$1.66 million

3. A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment?

$10,048

34. A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,600,000. This in turn would cause inventory to increase by $125,000, accounts receivable to increase by $100,000, and accounts payable to increase by $90,000. What is the firm's expected change in net working capital?

$135,000

32. A garage is installing a new "bubble-wash" car wash. It will promote the car wash a a fun activity for the family, and it is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 10%, what is the net present value (NPV) of this project?

$150,548

37. A bakery invests $40,000 in a light delivery truck. This was depreciated using the five-year MACRS schedule shown above. If the company sold it immediately after the end of year 2 for $21,000, what would be the after-tax cash flow from the sale of this asset, given a tax rate of 40%?

$17,208

15. An investor is considering a project that will generate $900,000 per year for five years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000. If the cost of capital is 4.4%, based on the MIRR, at what upfront cost does this project cease ti be worthwhile?

$2.91 million

45. The book value of a firm's equity is $100 million and its market value of equity is $200 million. The face value of its debt is $50 million and its market value of debt is $60 million. What is the market value of assets of the firm?

$260 million

28. A small manufacturer that makes clothespins and other household products buys new molding equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the new equipment?

$337,500

59. Assume Ford Motors Expects a new hybrid-engine project to produce incremental cash flows of $45 million each year, and expects these to grow at 3% each year. The upfront costs are $380 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

$360 million

35. A firm is considering a new project the will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firms marginal tax rate is 35%.

$416,250

31. The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is the firm's Net Working Capital?

$46 thousand

47. A firm incurs $70,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

$49,000.00

8. An auto-parts company is deciding whether to sponsor a racing team at a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?

$498,597

57. SAP Inc. received a $1.5 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water shipyards. The firm estimates that each shipyard spends $50,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards in the first year onward, what is the present value (PV) of the project (net of investment) if the cost of capital for SAP is %14 per year? Assume a cost of operations and other costs for SAP equal to 50% of revenue.

$5.64 million

58. Assume Ford Motors Expects a new hybrid-engine project to produce incremental cash flows of $50 million each year, and expects these to grow at 4% each year. The upfront costs are $420 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $20 million, what is the net present value (NPV) of the project?

$560 million

18. A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%?

-$4507

22. Consider the following two projects: The profitability index for project B is closest to __________.

0.15

46. Assume Lavender Corporation has a market value of $4 billion of equity and a market value of $19.8 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

0.168, 0.832

49. Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price pd IBM is $100 per share, What is IBM's cost of equity capital?

12.86%

17. Two mutually exclusive investment opportunities require an initial investment of $7 million. Investment A pays $2.0 per year in perpetuity, while investment B pays 1.4 million in the first year, with cash flows increasing by 4% per year after that. At what cost of capital would an investor regard both opportunities as being equivalent?

13%

50. Your estimate of the market risk premium is 7%. The risk-free rate of return is 4% and General Motors has a beta of 1.6. What is General Motors' cost of equity?

15.2%

4. Martin is offered an investment where for $6000 today, he will receive $6180 in one year. He decides to borrow $6000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on the investment?

3%

48. Assume JUP has a debt with a book value of $24 million, trading at 120% of par value. The firm has a book equity of $28 million, and 2 million shares trading at $20 per share. What weights should JUP use in calculating its WACC?

41.86% for debt, and 58.14% for equity

Martin is offered an investment where for $4000 today, he will receive $4240 in one year. He decides to borrow $4000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on the investment?

6%

55. Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 25% weight in equity, 10% in preferred stock, and 65% in debt. The cost of equity capital is %13, the cost of preferred stock is 9%, and the pretax cost of debt is 8%. What is the weights average cost of capital for Ford if its marginal tax rate is 40%?

7.27%

51. The outstanding debt of Berstin Corp. has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate us 30%?

7.37%

54. Assume the market value of Ford's equity, preferred stock and debt are $6 billion, $3 billion, and $13 billion respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $2.50 each year and trades at a price of $30 per share. Fords debt trades trades with a yield to maturity of 9.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?

9.31%

52. SIROM Scientific Solutions has a $12 million of outstanding equity and $4 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 1. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average costs of capital if the firms' tax rate is 30%.

9.70%

60. Which of the following statements is FALSE?

External equity is less expensive than retained earnings

10. According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are __________.

IRR,NPV,Payback Period

11. Which of the following is not a limitation of the payback rule?

It is difficult to calculate

20. A print shop has a contracted to print a number of jobs within 24 hours. Any jobs not completely printed within the same time will result in a penalty, as shown in the table above. However, too many jobs have been accepted, and not all can be printed. Which jobs should be printed in the next 24 hours?

Job C, Job B, and Job E

12. If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest?

Project B

44. Which of the following statements regarding real options is NOT correct?

Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.

14. Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 upfront, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) rule

Rule I only

23. Which of the following best describes the Net Present Value rule?

Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.

2. Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed ) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer?

Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

19. A lawn maintenance compare two ride-on mowers - the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides the purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision?

The mower if only expected to be needed for three years

9. The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis?

The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity

27. Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?

These earnings are not actual cash flows

16. Which of the following is NOT a valid method of modifying cash flows to produce a MIRR?

Turn multiple negative cash flows into a single cash flow by summing all negative cash flows over the project's lifetime.

13. A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year, and estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct?

Yes, because it agrees with the Net Present Value rule

6. Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays the for a year. What is the best alternative for Peter out of the following choices?

Yes, since he can borrow the $10,000 from a bank, invest $10,000 in the business opportunity, which, since it has an NPV > 0 will mean he will still come out ahead after repaying the loan.

25. The ultimate goal of the capital budgeting process is to __________.

determine the effect of the decision to accept or reject a project on the firm's cash flows

53. The after-tax cost of debt __________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

is always less than

42. Jim owns a farm that he wants to sell. He learns that a highway will be built by the farm in the future, giving access to the farmland from a nearby city and thus making the land more attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?

option to delay

43. A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with gaming versions of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving users the ability to back-light keys in different colors. If the device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturers gaining by the release of the new keyboard?

option to expand

24. Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity?

payback period

1. Most corporations measure the value of a project in terms of which of the following?

present value (PV)

21. You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?

profitability index

40. An exploration of the effect of changing multiple project parameters on net present value (NPV) is called __________.

scenario analysis

41. An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called __________.

sensitivity analysis

30. Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

subtracting depreciation expenses from taxable earnings

26. Which of the following best defines incremental earnings?

the amount by which a firm's earnings are expected to change as a result of an investment decision

29. Which of the following would you NOT consider when making a capital budgeting decision?

the cost of a marketing study completed last year

36. An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?

the cost of the research of renting the sixth floor

56. Holding everything else constant, an increase in cash __________ a firm's net debt.

will decrease