AGEC 330 - Quiz 13
One way to analyze the effect of inflation is to project cash flows in ________________ and use a discount rate that includes a premium for inflation. Nominal values Current values Real values Both a. & b.
Nominal values
What is the rate of inflation? Percentage change in the general price level Nominal change in the general price level Real change in the general price level None of the above
Percentage change in the general price level
The _________________ is the investor's reward for bear risk. Inflation premium Risk premium Risk-free rate Both b. and c.
Risk premium
A simple method to account for risk in capital budgeting is to add a risk premium to the inflation rate.
false
Adding the risk premium increases the discount rate thus increasing an investment's present value holding everything else constant.
false
Both the payment series and the discount rate must be specified in both nominal and real values.
false
In smaller businesses choosing a risk premium does not depend on preferences.
false
Inflation only affects the general level of prices for goods.
false
Nominal cash flows can be discounted by either a nominal discount rate or a real discount rate.
false
Nominal cash flows can be discounted by either a nominal discount rate or a real discount rate. However, real cash flows must be discounted by a real discount rate only.
false
Nominal cash flows should be discounted with a real discount rate.
false
Real cash flows can be discounted by either a nominal discount rate or a real discount rate. However, nominal cash flows must be discounted by a nominal discount rate only.
false
Real cash flows should be discounted with a nominal discount rate.
false
Risk Aversion means the subjective tendency of investors to seek out unnecessary risk.
false
Risk Premium only depends on an individual's risk/return preference.
false
The only commonly accepted method to account for risk in capital budgeting is to adjust the discount rate.
false
The annual rate of inflation is 1.5%. What is the real value of the projected payment in three years? $104.57 $104.50 $101.50 $106.57
$104.57
The annual rate of inflation is 3.5%. What is the real value of projected payment in two years' time? $106.12 $103.50 $107.12 $108.50
$107.12
Bill's initial investment in his trailer home was $35,000. Bill decided to depreciate his home using the straight-line method over the next 8 years. However, the investment life is only 4 years. What is the present value of the tax savings from depreciation over the investment life? The marginal tax rate is 20% and the after-tax risk adjusted discount rate is 10%. $35,000 $4,375 $875 $2,773.63
$2,773.63 Solution: (35,000/8)*20% = 875 = mD; 875[USPV10%,4] = 2,773.63
Fernando purchased an X-ray machine for his veterinary clinic. The real terminal value after the investment life of 5 years is $20,000. Suppose the nominal terminal value capital gain for tax purposes is $5,000, the inflation rate is 2% and the marginal tax rate is 25%. Taking inflation into account, what is the after-tax terminal value? $20,000 $22,081.62 $20,831.62 $1,250
$20,831.62 Solution: $20,000*(1+2%)^5 - $5,000*25% = $20,831.62
Suppose that the inflation rate is 2.5% and the real terminal value of an investment is expected to be $20,000 in 2 years. Calculate the nominal terminal value of the investment at the end of year 2. $21,013 $21,000 $20,500 $20,487
$21,013 $ 20,000+ (20,000 X 2.5%) = $ 20,500 20,500+(20,500*2.5%)= $ 21,012.5 or $ 21,013
Suppose that the inflation rate is 5% and the real terminal value of an investment is expected to be $50,000 in 5 years. Calculate the nominal terminal value of the investment at the end of year 5. $52,500 $55,000 $60,623 $63,814
$63,814
Suppose that the inflation rate is 4% and the real terminal value of an investment is expected to be $70,000 in 4 years. Calculate the nominal terminal value of the investment at the end of year 4. $81,890 $72,800 $78,614 $75,600
$81,890
Suppose that the inflation rate is 2% and the real terminal value of an investment is expected to be $82,500 in 4 years. Calculate the nominal terminal value of the investment at the end of year 4. $85,800 $84,150 $89,301 $87,515
$89,301 Inflation rate = 2% Normal terminal rate at end of year 4 = 8 2500 * (1+2%)4 = 89300.65
Drew owns and operates an onion packing plant. To help reduce costs on labor and to increase efficiency, Drew is considering purchasing an automatic 50 lb. bagging machine and a machine that automatically stacks the 50 lb. bags onto pallets. The cost of the two machines combined and their installation is $300,000. Drew will make a 20% down payment and finance the rest of the machinery with an amortized loan over 15 years at a 5.5% interest rate. Drew predicts that by using these two machines, his plant will be able to increase output, therefore increasing operating receipts by $30,000 per year. Also, this machinery will save him approximately $10,000 in labor costs each year by the increase in efficiency. However, other operating expenses such as electricity and insurance will increase by approximately $5,000 per year. Drew assumed a straight-line depreciation over 15 years and the life of the investment is 7 years. The real terminal value is $180,000 after the 7 years, and Drew requires a pretax 10% rate of return to capital. The marginal tax rate over the next 10 years is 25%, the rate of inflation is 3% and the risk premium is 1%. What is the nominal pre-tax terminal value? a.$180,000 b.$221,377.30 c.$206,032.97 d.$205,439.68 What is the after-tax, risk adjusted discount rate? a.6.41% b.10% c.8.25% d.7.5% What are the tax savings from depreciation? a.$5,000 b.$7,142.86 c.$8,333.33 d.$1,666.67 What is the after-tax terminal value? a.$180,000 b.$205,439.68 c.$216,032.97 d.$221,377.30 What is the nominal after-tax net return in year 6? a.$30,430.94 b.$35,000 c.$31,343.87 d.$28,684.08 What is the net present value? a.($4,541.74) b.$4,541.74 c.($19,071.16) d.$19,071.16
(i) (ii) (iii) (iv) (v) (vi) (vii)
Nominal Initial Cost = $68,000 Nominal Before-tax Net Return = 11,000 Marginal Tax Rate = 20% Required rate of return = 12% Real Terminal Value = $60,000 Investment Life = 3 years Inflation Rate = 4% Risk Premium = 2% Suppose that IRS will allow the investor to depreciate the investment using straight-line over 12 years. (i) What is the after-tax, risk adjusted discount rate? a. 14.4% b. 11.65% c. 11.2% d. 13.2% (ii) What is the nominal after-tax net return at the end of year 2? a. $9,518 b. $9,898 c. $9,252 d. $9,598 (iii) What is the annual tax saving? a. $1,133 b. $1,533 c. $2,720 d. $680 (iv) What is the nominal after-tax terminal value? a. $60,120 b. $64,600 c. $64,193 d. $64,005 (v) What is the present value of the nominal after-tax terminal value? a. $41,446 b. $44,534 c. $46,685 d. $44,124 (vi) What is the NPV of this investment? a. $4,571 .32 b. $4,754.17 c. $4,388.17 d. $3,657.06
(i) c (ii) a (iii) a (iv) c (v) c (vi) a
A farmer expects irrigation system will increase real operating receipts by $20,000 per year but will also increase real operating expenses by $8,000. Suppose that the inflation rate is 4% and the marginal tax rate is 20%. (i) What is the nominal net return at the end of year 2? a. $12,000 b. $14,400 c. $12,972 d. $11,520 (ii) Calculate the nominal after-tax net return at the end of year 2. a. $10,383 b. $13,824 c. $14,400 d. $17,280
(i) c. $12,972 (ii) a. $10,383
John is a farmer in the midwest who currently uses fossil fuels to dry his corn crop. He currently has a high-speed, high-temperature drying system, and to reduce his fuel costs, he wishes to switch to a combination of high-temperature and low-temperature drying system that allows him to use natural solar energy for part of the drying process. John will run 15,000 bushels/day for 40 days through the new drying system and estimates the solar drying will save him $0.01/bushel, therefore increasing his net returns. The initial cost of the system is $80,000, has a real terminal value of $30,000 and has an investment life of 9 years. John has a required rate of return of 8%, a marginal tax rate of 25% and the system will be depreciated using a straight-line method over 15 years. Assume an inflation rate of 2% and a risk premium of 1%. (i) What is the after-tax, risk adjusted discount rate? a.10% b.7.7% c.8.25% d.6.75% (ii) What are the pre-tax real net returns? a.$9,000 b.$12,000 c.$6,000 d.$7,560 (iii) What is the yearly allowable depreciation using the straight-line method? a.$5,000 b.$5,333.33 c.$4,000 d.$4,285.71 (iv) What is the capital gain/loss? a.$5,333.33 b.$3,852.78 c.($7,333.33) d.$9,903.17 (v) What is the life of the investment? a.9 years b.8 years c.4 years d.10 years (vi) What is the accumulated depreciation after 9 years? a.$53,333.33 b.$41,333.33 c.$48,000 d.$50,000 (vii) What is the NPV? a.($11,848.36) b.$10,120.58 c.($11,152.93) d.($19,358.84)
(i) a (ii) c (iii) b.$5,333.33 (iv) b.$3,852.78 (v) a. 9 years (vi) c.$48,000 (vii)a.($11,848.36) b.$10,120.58 c.($11,152.93)
Nominal Initial Cost = $25,000; Nominal Before-tax Net Return = $5,000 Marginal Tax Rate = 15%; Required rate of return = 10% Real Terminal Value = $0; Investment Life = 8 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 10 years and the inflation rate is 4%. (i) What is the nominal terminal value? a. $0 b. $25,000 c. $20,000 d. $22,000 (ii) What is the annual depreciation expense? a. $3,250 b. $2,600 c. $3,125 d. $2,500 (iii) What is the nominal after-tax terminal value? a. $750 b. $722 c. $700 d. $725
(i) a. $0 (ii) d. $2,500 (iii) a. $750
Nominal Initial Cost = $30,000; Nominal Before-tax Net Return = $8,000 Marginal Tax Rate = 10%; Required rate of return = 10% Real Terminal Value = $0; Investment Life = 5 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 15 years and the inflation rate is 4%. (i) What is the nominal terminal value? a. $0 b. $30,000 c. $31,000 d. $27,000 (ii) What is the annual depreciation expense? a. $2,000 b. $2,080 c. $6,000 d. $6,240 (iii) What is the nominal after-tax terminal value? a. $2,000 b. $2,900 c. $2,100 d. $2,700
(i) a. $0 (ii) a. $2,000 (iii) a. $2,000
A farmer expects irrigation system will increase real operating receipts by $32,000 per year but will also increase real operating expenses by $21,000. Suppose that the inflation rate is 2.5% and the marginal tax rate is 20%. (i) What is the nominal net return at the end of year 4? a. $12,142 b. $13,200 c. $11,000 d. $10,725 (ii) Calculate the nominal after-tax net return at the end of year 4. a. $9,714 b. $13,200 c. $15,840 d. $12,870
(i) a. $12,142 (ii) a. $9,714
Given the following information : Nominal Initial Cost = $30,000; Nominal Before-tax Net Return = $8,000 Marginal Tax Rate = 10%; Required rate of return = 10% Real Terminal Value = $0; Investment Life = 5 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 15 years and the inflation rate is 4%. (i) What is the annual depreciation expense? a. $2,000 b. $2,080 c. $6,000 d. $6,240 (ii) What are the tax savings from depreciation? a. $250 b. $160 c. $200 d. $80
(i) a. $2,000 30,000/15 (ii) c. $200 2000 (.10)
Given the following information : Nominal Initial Cost = $90,500; Nominal Before-tax Net Return = $7,000 Marginal Tax Rate = 20%; Required rate of return = 11% Real Terminal Value = $110,500; Investment Life = 5 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 12 years and the inflation rate is 5%. (i) What is the annual depreciation expense? a. $7,542 b. $7,919 c. $8,100 d. $7,905 (ii) What are the tax savings from depreciation? a. $819.72 b. $1,508.33 c. $372.60 d. $1,400.00
(i) a. $7,542 (ii) b. $1,508.33
Nominal Initial Cost = $80,000; Nominal Before-tax Net Return = 14,000 Marginal Tax Rate = 20%; Required rate of return = 13% Real Terminal Value = $60,000; Investment Life = 3 years Inflation Rate = 4%; Risk Premium = 4% Suppose that IRS will allow the investor to depreciate the investment using straight-line over 10 years. (i) What is the after-tax, risk adjusted discount rate? a. 13.6% b. 12% c. 15% d. 13.728% (ii) What is the nominal after-tax net return at the end of year 2? a. $12,648 b. $12,113.92 c. $12,598.48 d. $12,248 (iii) What is the annual tax saving? a. $1,600 b. $1,000 c. $1,333.33 d. $1,533.33 (iv) What is the nominal after-tax terminal value? a. $61,120 b. $65,193.47 c. $75,200 d. $72,929.69 (v) What is the present value of the nominal after-tax terminal value? a. $42,135.10 b. $51,831.62 c. $44,470.20 d. $50,276.51 (vi) What is the NPV of this investment? a. -$2,331 b. -$6,988 c. $2,331 d. $6,988
(i) a. 13.6% (ii) b. $12,113.92 (iii) a. $1,600 (iv) b. $65,193.47 (v) c. $44,470.20 (vi) b. -$6,988
Nominal Initial Cost = $90,500; Nominal Before-tax Net Return = $7,000 Marginal Tax Rate = 20%; Required rate of return = 11% Real Terminal Value = $110,500; Investment Life = 5 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 12 years and the inflation rate is 5%. (i) What is the nominal terminal value? a. $116,205 b. $141,029 c. $148,452 d. $134,313 (ii) What is the annual depreciation expense? a. $7,542 b. $7,919 c. $8,100 d. $7,905 (iii) What is the nominal after-tax terminal value? a. $103,378 b. $123,382 c. $87,510 d. $82,958
(i) b. $141,029 (ii) a. $7,542 (iii) b. $123,382
A farmer expects irrigation system will increase real operating receipts by $12,000 per year but will also increase real operating expenses by $4,000. Suppose that the inflation rate is 2% and the marginal tax rate is 18%. (i) What is the nominal net return at the end of year 5? a. $7,840 b. $8,833 c. $9,440 d. $9,009 (ii) Calculate the nominal after-tax net return at the end of year 6. a. $9,440 b. $7,243 c. $9,251 d. $7,388
(i) b. $8,833 (ii) d. $7,388
A farmer expects irrigation system will increase real operating receipts by $32,000 per year but will also increase real operating expenses by $8,000. Suppose that the inflation rate is 5% and the marginal tax rate is 20%. (i) What is the nominal net return at the end of year 3? a. $29,172 b. $22,800 c. $27,783 d. $24,000 (ii) Calculate the nominal after-tax net return at the end of year 4. a. $28,800 b. $27,360 c. $34,560 d. $23,338
(i) c. $27,783 Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3 Nominal Expenditure for year 3 = Real Expenditure ( 1 + Inflation rate )3 Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3 = $ 32,000 ( 1.05 )3 = $ 32,000 ( 1.1576 ) = $ 37,044 Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3 = $ 8000 ( 1.05 )3 = $ 8000 ( 1.1576) = $ 9261 Nominal net return = Nominal receipts - Nominal Expenditure = $ 37,044 - $ 9,261 = $ 27,783 (ii) d. $23,338 Nominal receipts for year 4 = Real receipts ( 1 + Inflation rate )4 = $ 32,000 ( 1.05 )4 = $ 32,000 ( 1.2155 ) = $ 38,896 Nominal receipts for year 4 = Real receipts ( 1 + Inflation rate )4 = $ 8000 ( 1.05 )4 = $ 8000 ( 1.2155) = $ 9724 Nominal net return = Nominal receipts - Nominal Expenditure = $ 38,896 - $ 9,724 = $ 29,712 After Tax net return = Nominal net return ( 1 - tax rate ) = $ 29,712 ( 1 - 0.2) = $ 29,712 (0.8) = $ 23,338
Given the following information : Nominal Initial Cost = $25,000; Nominal Before-tax Net Return = $5,000 Marginal Tax Rate = 15%; Required rate of return = 10% Real Terminal Value = $0; Investment Life = 8 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 10 years and the inflation rate is 4%. (i) What is the annual depreciation expense? a. $3,250 b. $2,600 c. $3,125 d. $2,500 (ii) What are the tax savings from depreciation? a. $250 b. $100 c. $175 d. $375
(i) d. $2,500 $ 25,000/10= $ 2500 (ii) d. $375 2,500*15% = $375
Nominal Initial Cost = $30,000; Nominal Before-tax Net Return = $4,000 Marginal Tax Rate = 15%; Required rate of return = 10% Real Terminal Value = $20,000; Investment Life = 8 years Suppose that IRS will allow the investor to depreciate the investment using straight-line over 10 years and the inflation rate is 4%. (i) What is the annual depreciation expense? a. $3,450 b. $3,750 c. $3,120 d. $3,000 (ii) What are the tax savings from depreciation? a. $450 b. $300 c. $120 d. $600
(i) d. $3,000 Nominal initial cost / No. of years = $30,000 / 10 (ii) a. $450
A farmer requires a pre-tax risk free rate of return of 10%, there is a marginal tax rate of 20%, and there is a risk premium of 3%. What is the discount rate? 5.6% 10.4% 8.75% None of the answers are correct
10.4%
Before-tax, risk free discount rate = 10%; Risk premium = 3% Marginal tax rate = 20% What is the after-tax, risk adjusted discount rate? 5.6% 15.6% 10.4% 8.4%
10.4% (10+3)(1-.20) (13)(1-.20) (13)(.80) 18
A farmer requires a pre-tax rate of return 12%, there is a marginal tax rate of 25% and there is a risk premium of 2%. What is the discount rate? 10.5% 18.67% 21.59% None of the answers are correct
10.5% (12+2) (1-.25) 14 (1-.25) 14(.75) 10.5
Before-tax risk free discount rate = 13%; Risk premium = 3% Marginal tax rate = 20% What is the after-tax, risk adjusted discount rate? 12.8% 19.2% 8% 12%
12.8% (13+3)(1-.20) (16)(1-.20) (16)(.80) 12.8
A farmer requires a pre-tax risk free rate of return of 10%, there is a marginal tax rate of 23%, and there is a risk premium of 4%. What is the discount rate? 8.47% 24.68% 14.63% None of the answers are correct
14.63%
Before-tax, risk free discount rate = 15% risk premium = 4% Marginal tax rate = 18% What is the after-tax, risk adjusted discount rate? 9.02% 12.98% 15.58% 22.42%
15.58%
Given the following information: Before-tax, risk free discount rate = 11% After-tax, risk-adjusted discount rate = 11.48% Marginal tax rate = 15% What is the risk premium? 7.23% 9.76% 2.5% None of the answers are correct
2.5%
Before-tax, risk free discount rate = 13% After-tax, risk-adjusted discount rate = 12.8% Marginal tax rate = 20% What is the risk premium? 3% 12% 8% None of the answers are correct
3%
Before-tax, risk free discount rate = 10%; After-tax, risk adjusted discount rate = 10.4% Marginal tax rate = 20% What is the risk premium? 3% 15.6% 10.4% 8.4%
3% (10+x)(1-.20) = 10.4 (10+x)(.80) = 10.4 (13)(.8) = 10.4
Before- tax, risk free discount rate = 15% After-tax, risk adjusted discount rate = 15.58% Marginal tax rate = 18% What is the risk premium? 9.02% 12.98% 4% None of the answers are correct
4%
A risk-adjusted discount rate has three components: inflation premium, risk premium and _______________. Nominal interest rate Real interest rate Risk-free time preference rate None of the above Higher variability means _____________ risk. Lower Steady Higher Minimum The annual rate of inflation is 1.5%. What is the real value of the projected payment in three years? $104.57 $104.50 $101.50 $106.57 When the purchasing power of a projected constant payment increases or the nominal value of the projected constant payment decreases, inflation is _____________. Positive Negative Neither Positive nor Negative It depends on other factors Why is it more common to analyze investments using nominal values? Debt servicing requirements are specified in nominal terms Income tax obligation are in nominal terms The payments may have different items that respond differently to inflation All of the above Effective risk measures reflect how investors perceive risk. True False The basis for probabilistic values may be ___________________________. A hunch Future performance Historic data Both a. & c. Real values = ___________________ Nominal Values x Inflation Rate Nominal Values x Discount Rate Nominal Values x Interest Rate None of the above Investment A has a standard deviation of 2,500 and an expected value of 18,650. Investment B has a standard deviation of 1,500 and an expected value of 15,000. Based on the criteria of coefficient of variation which investment is less risky? Investment A Investment B Not enough information None of above In both the Certainty-Equivalent and Risk-Premium approaches the investor must express the risk adjustment by a numerical measure based on limited judgement or data. True False
A risk-adjusted discount rate has three components: inflation premium, risk premium and _______________. Selected Answer: Risk-free time preference rate Higher variability means _____________ risk. Selected Answer: Higher The annual rate of inflation is 1.5%. What is the real value of the projected payment in three years? Selected Answer: $104.57 When the purchasing power of a projected constant payment increases or the nominal value of the projected constant payment decreases, inflation is _____________. Selected Answer: Negative Why is it more common to analyze investments using nominal values? Selected Answer: All of the above Effective risk measures reflect how investors perceive risk. Selected Answer: True The basis for probabilistic values may be ___________________________. Selected Answer: Both a. & c. Real values = ___________________ Selected Answer: None of the above Investment A has a standard deviation of 2,500 and an expected value of 18,650. Investment B has a standard deviation of 1,500 and an expected value of 15,000. Based on the criteria of coefficient of variation which investment is less risky? Selected Answer: Investment A In both the Certainty-Equivalent and Risk-Premium approaches the investor must express the risk adjustment by a numerical measure based on limited judgement or data. true
A simple method to account for risk in capital budgeting is to ______ a risk premium to the risk free rate. Add Subtract Create None of the above
Add
How is inflation typically measured? Via indices (i.e. GNP deflator) As percentage changes in the price level By changes in the purchasing power of a constant payment All of the above
All of the above Via indices (i.e. GNP deflator) As percentage changes in the price level By changes in the purchasing power of a constant payment
Why is it more common to analyze investments using nominal values? Debt servicing requirements are specified in nominal terms Income tax obligation are in nominal terms The payments may have different items that respond differently to inflation All of the above
All of the above debt servicing requirements are specified in nominal terms Income tax obligation are in nominal terms The payments may have different items that respond differently to inflation
Risk aversion is __________________________________________________. An attitude toward risk in which the investor requires compensation for taking risk. An investment strategy in which the investor prefers more risk to less risk. A method used to project future cash flows. None of the above
An attitude toward risk in which the investor requires compensation for taking risk.
Which is a component of investment analysis affected by inflation? Flow of payments Discount Rates Current Income Both a. & b.
Both a. & b. Flow of payments Discount Rates
What is a way the risk premium may be quantified in investment analysis? Investor's risk aversion Degree of financial leverage Future cash flow payments Both a. & b.
Both a. & b. Investor's risk aversion Degree of financial leverage
The basis for probabilistic values may be ___________________________. A hunch Future performance Historic data Both a. & c.
Both a. & c. A hunch Historic data
The unanticipated variability of the investment's returns and how these returns are correlated with other business enterprises is known as _______________. Business risk Financial risk Operational risk Enterprise risk
Business risk
_____________ is an amount that makes you indifferent between playing and not playing the game. Certainty equivalent Certainty income Annuity equivalent IRR equivalent
Certainty equivalent
Real values are the same thing as present values.
FALSE
Investment A has a standard deviation of 2,500 and an expected value of 18,650. Investment B has a standard deviation of 1,500 and an expected value of 15,000. Based on the criteria of coefficient of variation which investment is less risky? Investment A Investment B Not enough information None of above
Investment A
What does α represent in the Certainty-Equivalent approach? Level of risk associated with future returns Net cash flow from future returns Risk-free rate None of the above
Level of risk associated with future returns
A higher coefficient of variation indicates _______________________. Less relative dispersion of potential outcomes Greater relative dispersion of potential outcomes Constant predicted outcomes None of the above
Greater relative dispersion of potential outcomes
Investments that ______ the firm's leverage position may warrant ______ risk premium. Increase, Lower Decrease, higher Decrease, lower Increase, higher
Increase, higher
Fernando is a veterinarian and is has recently opened up a new clinic. After a year of operation, Fernando has decided that he needs to invest in a Digital Radiography (X-ray) system. The cost associated with a new high-quality machine is $50,000, which includes the panels, software and x-ray scintillator material. With the new machine, Fernando will be able to diagnose injuries more quickly and therefore increase his real operating receipts by $20,000 per year. However, his real operating expenses will increase by 7,000 per year. With an investment life of 5 years, a real terminal value of $30,000, straight-line depreciation over 7 years, marginal tax rate of 20%, inflation rate of 3%, risk premium of 1.5%, and a return to capital of 10%, answer the following questions. What is the nominal pre-tax terminal value? a.$30,000 b.$34,778.22 c.$50,000 d.$34,127.83 What is the after-tax, risk adjusted discount rate? a.6.02% b.8% c.9.2% d.10% What are the real net returns? a.$10,000 b.$7,000 c.$20,000 d.$13,000 What are the tax savings from depreciation? a.$1,428.57 b.$7,142.86 c.$9,000 d.$5,000 What is the after-tax terminal value? a.$30,000 b.$30,679.72 c.$34,778.22 d.$32,893.52 What is the nominal after-tax net return in year 3? a.$11,364.36 b.$13,000 c.$11,033.36 d.$14,205.45 What is the net present value? a.$16,985.54 b.$21,701.61 c.($19,071.16) d.$19,071.16
Specified Answer for: A c Specified Answer for: B c Specified Answer for: C d Specified Answer for: D a Specified Answer for: E b Specified Answer for: F c Specified Answer for: G d 21/30 pts
Madeliene has been operating a restaurant and café in an old building downtown. Because of her café's popularity and the café's old kitchen, she has had trouble keeping up with demand for her famous croissants. Due to the success of her business, Madeleine has been approved for a loan of $60,000 to cover the cost of a new oven, walk-in freezer, industrial refrigerator, and industrial coffee machine. The new kitchen appliances will drastically lower her operating costs and will raise receipts by making the café more efficient. Consequently, real net returns will increase by $14,000 per year. Madeleine has assumed an investment life of 5 years, straight-line depreciation of 8 years, an inflation rate of 2.5%, a risk premium of 2%, a required rate of return of 12%, a marginal tax rate of 24% and a real terminal value of $30,000. What is the nominal pre-tax terminal value? a.$30,000 b.$34,778.22 c.$60,000 d.$33,942.25 What is the after-tax, risk adjusted discount rate? a.12% b.9.12% c.10.64% d.7.94% What is the accumulated depreciation after 5 years? a.$60,000 b.$30,000 c.$37,500 d.$40,000 What are the tax savings from depreciation? a.$1,428.57 b.$7,142.86 c.$7,500 d.$1,800 What is the after-tax terminal value? a.$30,000 b.$30,679.72 c.$31,196.11 d.$32,893.52 What is the nominal after-tax net return in year 4? a.$11,364.36 b.$13,000 c.$11,033.36 d.$11,744.57 What is the net present value? a.$16,985.54 b.$21,701.61 c.$8,077.89 d.$19,071.16
c b b b c d b
is expressed by greater variability of returns to equity capital and reductions in liquid reserves of credit and assets.
financial risk
Risk premium does not depend on : individual's risk preference individual's return preference individual's perception of risk individual's budget
individual's budget
A basic principle of investment analysis is to account consistently for the effects of ____________ on the flow of payments and on the discount rates. Depreciation Inflation Tax rate None of the above
inflation
When the purchasing power of a projected constant payment declines or the nominal value of the projected constant payment increases, inflation is _____________. Positive Negative Neither Positive nor Negative It Depends on other Factors
positive
Risk-adjusted Discount Rate is established by adding a risk premium to the ____ rate when investments are known to be risky and the investor is risk averse. interest market nominal risk-free
risk-free
A simple method to account for risk in capital budgeting is to add a risk premium to the risk free rate.
true
Adding the risk premium increases the discount rate thus reducing an investment's present value holding everything else constant.
true
Certainty-equivalent is defined by the certain amount of cash return that gives the same utility as a risky amount of cash return.
true
Effective risk measures reflect how investors perceive risk.
true
In terms of accountability for taxes and financial feasibility, nominal cash flows are more accurate than real cash flows.
true
Inflation will not affect the annual depreciation a farmer can claim as a tax deduction after a tractor is purchased.
true
Investments that increase the firm's leverage position may warrant higher risk premium.
true
Nominal cash flows are discounted with a nominal discount rate.
true
Nominal values the actual amount of currency that make up the cash flows.
true
One method to account for risk in capital budgeting is to adjust the discount rate to a risk free rate and converting payments to certainty equivalents.
true
Real cash flows can be discounted by a real discount rate only.
true
Real cash flows should be discounted with a real discount rate.
true
Risk aversion is defined by the attitude toward risk in which the investor requires compensation for taking risks.
true
Risk-adjusted discount rate is the rate established by adding a risk premium to the risk-free rate when investments are known to be risky and the investor is risk averse.
true
