Finance Test 2

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

include interest expense

A company that utilizes the MACRS system of depreciation but does not use bonus depreciation:

will have a greater depreciation tax shield in Year 2 than in Year 1

A 5-year project is expected to generate annual sales of 8,000 units at a price of $67 per unit and a variable cost of $38 per unit. The equipment necessary for the project will cost $245,000 and will be depreciated on a straight-line basis over the life of the project. Fixed costs are $145,000 per year and the tax rate is 40 percent. How sensitive is the operating cash flow to a $1 change in the per unit sales price?

$4,800 Base OCF = [8,000($67 − 38) − 145,000](1 − .40) + .40($245,000/5) Base OCF = $71,800 New OCF = [8,000($68 − 38) − 145,000](1 − .40) + .40($245,000/5) Base OCF = $76,600 Change in OCF = ($71,800 − 76,600)/(67 − 68) Change in OCF = $4,800

A 4-year project has an annual operating cash flow of $52,500. At the beginning of the project, $4,350 in net working capital was required, which will be recovered at the end of the project. The firm also spent $22,600 on equipment to start the project. This equipment will have a book value of $4,740 at the end of the project, but can be sold for $5,730. The tax rate is 40 percent. What is the Year 4 cash flow?

$62,184 Cash flow = $52,500 + 4,350 + 5,730 + .40($4,740 − 5,730) Cash flow = $62,184

An asset has an average return of 9.79 percent and a standard deviation of 18.78 percent. What range of returns should you expect to see with a 68 percent probability?

-8.99% to 28.57%

If the economy booms, RTF, Inc., stock is expected to return 11 percent. If the economy goes into a recessionary period, then RTF is expected to only return 2 percent. The probability of a boom is 74 percent while the probability of a recession is 26 percent. What is the variance of the returns on RTF, Inc., stock?

.001558 E(R) = .74(.11) + .26(.02) E(R) = .0866

A stock will have a loss of 10.1 percent in a bad economy, a return of 9.9 percent in a normal economy, and a return of 23.8 percent in a hot economy. There is 23 percent probability of a bad economy, 46 percent probability of a normal economy, and 31 percent probability of a hot economy. What is the variance of the stock's returns?

.01518 E(R) = .23(−0.101) + .46(0.099) + .31(0.238) E(R) = .0961, or 9.61% σ^2 = .23(−0.101 − .0961)^2 + .46(0.099 − .0961)^2 + .31(0.238 − .0961)^2 σ^2 = .01518

The common stock of Air Express had annual returns of 11.7 percent, 8.8 percent, 16.7 percent, and −7.9 percent over the last four years, respectively. What is the standard deviation of these returns?

10.66% Average return = (.117 + .088 + .167 − .079)/4 Average return = .07325 or 7.325% σ = {[1/(4 − 1)] [(.117 − .07325)^2 + (.088 − .07325)^2 + (.167 − .07325)^2 + (−.079 − .07325)^2]}^.5 σ = .1066, or 10.66%

You purchased shares of stock one year ago at a price of $64.68 per share. During the year, you received dividend payments of $2.19 and sold the stock for $71.80 per share. If the inflation rate during the year was 2.91 percent, what was your real return?

11.16% Nominal total return = ($71.80 − 64.68 + 2.19) / $64.68 Nominal total return = .1439, or 14.39% Real return = [(1 + .1439) / (1 + .0291)] − 1 Real return = .1116, or 11.16%

You recently purchased a stock that is expected to earn 19 percent in a booming economy, 12 percent in a normal economy, and lose 8 percent in a recessionary economy. The probability of a boom economy is 16 percent while the probability of a normal economy is 78 percent. What is your expected rate of return on this stock?

11.92% E(r) = .16(.19) + .78(.12) + .06(−.08) E(r) = .1192, or 11.92%

The risk-free rate is 3.9 percent and the market expected return is 11.4 percent. What is the expected return of a stock that has a beta of 1.24?

13.20% E(R) = .039 + 1.24(.114 − .039) E(R) = .1320, or 13.20%

You just sold 427 shares of stock at a price of $19.07 a share. You purchased the stock for $18.83 a share and have received total dividends of $614. What is the total capital gain on this investment?

$102.48 Capital gain = ($19.07 − 18.83) (427) Capital gain = $102.48

A company has a project available with the following cash flows: Year 0 - $-35510 Year 1 - $12630 Year 2 - 14740 Year 3 - 19800 Year 4 - 11120 If the required return for the project is 8.1 percent, what is the project's NPV?

$12,605.06 NPV = −$35,510 + $12,630/(1 + .081) + $14,740/(1 + .081)2 + $19,800/(1 + .081)3 + $11,120/(1 + .081)4NPV = $12,605.06

Carland, Inc., has a project available with the following cash flows. If the required return for the project is 7.6 percent, what is the project's NPV? Year 0: $-225,000 Year 1: 62,700 Year 2: 87,100 Year 3: 116,300 Year 4: 69,700 Year 5: -11,700

$15,743.67 NPV = −$255,000 + $62,700/(1 + .076) + $87,100/(1 + .076)^2 + $116,300/(1 + .076)^3 + $69,700/(1 + .076)^4 − $11,700/(1 + .076)^5 NPV = $15,743.67

At a production level of 5,280 units, a project has total costs of $150,000. The variable cost per unit is $23.12. Assume the firm can increase production by 750 units without increasing its fixed costs. What will the total costs be if 6,000 units are produced?

$166,646 Total cost6,000 = $150,000 + (6,000 − 5,280) ($23.12) Total cost6,000 = $166,646

A project has base-case earnings before interest and taxes of $36,408, fixed costs of $42,700, a selling price of $24 a unit, and a sales quantity of 22,000 units. All estimates are accurate within ±2 percent. Depreciation is $16,700. What is the base-case variable cost per unit?

$19.65 EBITBase-case = $36,408 = [22,000 ($24 − ν)] − $42,700 − 16,700 ν = $19.65

Precise Machinery is analyzing a proposed project. The company expects to sell 7,500 units, ±10 percent. The expected variable cost per unit is $314 and the expected fixed costs are $647,000. Cost estimates are considered accurate within a ±4 percent range. The depreciation expense is $187,000. The sales price is estimated at $849 per unit, give or take 2 percent. The tax rate is 21 percent. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $850. What is the operating cash flow based on this analysis?

$2,703,940 OCF = {[($850 − 314) 7,500] − $647,000}{1 − .21} + ($187,000) (.21) OCF = $2,703,940

Bubbly Waters currently sells 510 Class A spas, 660 Class C spas, and 410 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 585 units per year. However, if the new spa is added, Class A sales are expected to decline to 330 units while the Class C sales are expected to increase to 685. The sales of the deluxe model will not be affected. Class A spas sell for an average of $16,100 each. Class C spas are priced at $8,100 and the deluxe models sell for $19,100 each. The new mid-range spa will sell for $10,100. What annual sales figure should you use in your analysis?

$3,213,000 Sales = 585($10,100) + (330 − 510)($16,100) + (685 − 660)($8,100) Sales = $3,213,000

A project will reduce costs by $40,600 but increase depreciation by $19,700. What is the operating cash flow if the tax rate is 40 percent?

$32,240 OCF = $40,600(1 − .40) + .40($19,700) OCF = $32,240

A project has annual depreciation of $25,500, costs of $101,900, and sales of $150,500. The applicable tax rate is 34 percent. What is the operating cash flow?

$40,746 OCF = ($150,500 − 101,900)(1 − .34) + .34($25,500) OCF = $40,746

The Creamery is analyzing a project with expected sales of 5,700 units, ±5 percent. The expected variable cost per unit is $168 and the expected fixed costs are $424,000. Cost estimates are considered accurate within a ±3 percent range. The depreciation expense is $156,000. The sales price is estimated at $339 per unit, ±5 percent. The tax rate is 21 percent. The company is conducting a sensitivity analysis with fixed costs of $425,000. What is the OCF given this analysis?

$467,023 OCF = {[($339 − 168) 5,700] − $425,000} {1 − .21} + $156,000 (.21) OCF = $467,023

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 $38,000 and annual cash inflows of $25,500 for 2 years. At what rate would you be indifferent between these two projects?

-4.38% Year 0 difference = −$40,000 − (-$38,000) = −$2,000 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/(1 + IRR) − $8,700/(1 + IRR)^2 + $14,000/(1 + IRR)^3 IRR = −.0438, or −4.38%

What range of returns should you expect to see with a 99 percent probability on an asset that has an average return of 10.25 percent and a standard deviation of 24.34 percent?

-62.77% to 83.27% Range = 10.25% +/− (24.34*3)% Range = −62.77% to 83.27%

You purchased a stock at a price of $59.20. The stock paid a dividend of $2.19 per share and the stock price at the end of the year was $66.58. What was the total return for the year?

16.17% Total return = ($66.58 − 59.20 + 2.19)/$59.20 Total return = .1617, or 16.17%

Blinding Light Co. has a project available with the following cash flows: Year 0 - $-35,550 Year 1 - 7,880 Year 2 - 9,450 Year 3 - 13,350 Year 4 - 15,490 Year 5 - 10,160 What is the projects IRR?

16.23% 0 = −$35,550 + $7,880/(1 + IRR) + $9,450/(1 + IRR)^2 + $13,350/(1 + IRR)^3 + $15,490/(1 + IRR)^4 + $10,160/(1 + IRR)^5 IRR = .1623, or 16.23%

Your portfolio has a beta of 1.57. The portfolio consists of 16 percent U.S. Treasury bills, 35 percent Stock A, and 49 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B?

2.49

There is a project with the following cash flows : Year 0 - $-26,100 Year 1 - 7,700 Year 2 - 8,050 Year 3 - 7,450 Year 4 - 5,800 What is the payback period?

3.50 years Amount short after 3 years = $26,100 − 7,700 − 8,050 − 7,450 Amount short after 3 years = $2,900 Payback period = 3 + $2,900/$5,800 Payback period = 3.50 years

Galvatron Metals has a bond outstanding with a coupon rate of 6.4 percent and semiannual payments. The bond currently sells for $1,912 and matures in 16 years. The par value is $2,000 and the company's tax rate is 35 percent. What is the company's aftertax cost of debt?

4.46%

Bethesda Water has an issue of preferred stock outstanding with a coupon rate of 4.90 percent that sells for $93.10 per share. If the par value is $100, what is the cost of the company's preferred stock?

5.26% RP = $4.90/$93.10 RP = .0526, or 5.26%

A venture will provide a net cash inflow of $57,000 in Year 1. The annual cash flows are projected to grow at a rate of 7 percent per year forever. The project requires an initial investment of $739,000 and has a required return of 15.6 percent. The company is somewhat unsure about the growth rate assumption. At what constant rate of growth would the company just break even?

7.89% NPV = 0 = −$739,000 + $57,000/(.156 − g)g = .0789, or 7.89%

Charlotte's Crochet Shoppe has 12,500 shares of common stock outstanding at a price per share of $69 and a rate of return of 11.37 percent. The company also has 380 bonds outstanding, with a par value of $1,000 per bond. The pretax cost of debt is 6.01 percent and the bonds sell for 95.4 percent of par. What is the firm's WACC if the tax rate is 40 percent?

9.07%

Which one of the following statements is correct?

A project can create a positive operating cash flow without affecting sales.

Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions?

Efficient capital market

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

You estimate that a project will cost $33,700 and will provide cash inflows of $14,800 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 14.2 percent? Why or why not?

No; The PI is .87. PVInflows = $14,800/1.142 + $24,600/1.142^3 PVInflows = $29,476.93 PI = $29,476.93/$33,700 PI = .87

Suzie owns five different bonds and twelve different stocks. Which one of the following terms most applies to her investments?

Portfolio

A project has a discount rate of 15.5 percent, an initial cost of $109,200, 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?

Reject the project because the PI is .97 NPVInflows = $56,400/1.155 + $75,900/1.155^2 NPVInflows = $105,726.65 PI = 105,726.65/109,200 PI = .97

Which one of the following is a risk that applies to most securities?

Systematic

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient.

The information was expected

Which one of the following statements is a correct reflection of the U.S. financial markets for the period 1926-2016?

U.S. Treasury bills had an annual return in excess of 10 percent in three or more years.

The capital asset pricing model approach to equity valuation:

assumes the reward-to-risk ratio is constant

Mutually exclusive projects are best defined as competing projects that:

both require the total use of the same limited resource.

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

likely to occur.

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate

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

showing projected values for future time periods.