F365 - Exam 2
New Tours last annual dividend was $2 a share. The company plans to lower the dividend by $.30 each year for the next 3 years. In Year 5, it will pay a final liquidating dividend of $17 a share. If the required return is 22 percent, what is the current per share value of this stock?
$9.23 P0 = $1.70 / 1.22 + $1.40 / 1.22^2 + $1.10 /1.22^3 + $17 / 1.22^5 P0 = $9.23
What is the internal rate of return on an investment that has an initial cost of $63,100 and projected cash inflows of $18,700, $38,600, and $34,100 for Years 1 to 3, respectively?
19.10%
Which one of the following will decrease a firm's net working capital?
A decrease in accounts receivable
Which one of these statements is correct?
Costs incurred prior to deciding whether or not to produce a new product are sunk costs.
Bloomfield's has some idle equipment that is debt-free and also fully depreciated. If the company decides to use this equipment for a new project, what cost, if any, should be included for this equipment in the project's start-up costs?
Current market value of the equipment
All else equal, an increase in which one of the following will increase the operating cash flow?
Equipment depreciation
The sale of an asset creates an aftertax cash flow in an amount equal to the
Sale price - Tax rate × (Sale price - Book value).
The net present value of a project is projected at $210. How should this amount be interpreted?
The project is earning $210 in addition to the project's required rate of return.
A project has an initial cost of $51,900 and cash flows of $18,700, $56,500, and -$9,100 for Years 1 to 3, respectively. If the required rate of return for this investment is 17 percent, should you accept it based solely on the internal rate of return rule? Why or why not?
You cannot apply the IRR rule in this case because there are multiple IRRs.
The book value of an asset is primarily used to compute the
amount of tax due on the sale of that asset.
Changes in net working capital
can affect the cash flows of a project every year of the project's life.
When compiling the relevant cash flows for a project, the after-tax value of any asset sold any time during the life of the project should be treated as a
cash flow in the year of sale.
Based on the dividend growth model, an increase in investors' overall level of required returns will
cause the market values of all stocks to decrease, all else held constant.
A stock that pays a constant annual dividend will have a market price that
decreases when the market rate of return increases.
Two key weaknesses of the internal rate of return rule are the
failure to correctly analyze mutually exclusive projects and the multiple rate of return problem.
An investment is acceptable if the profitability index (PI) of the investment is
greater than one.
Assume a project has normal cash flows. Given this, you should accept the project
if the NPV is positive and reject it if the NPV is negative.
The payback method
ignores the time value of money.
Assume an asset costs $38,700 and has a current book value of $18,209. The asset is sold today for $15,000 cash. The tax rate is 34 percent. As a result of this sale, the company's net cash flow will
increase by more than $15.000.
The cash flows of a project include the
incremental operating cash flow, as well as any changes in capital spending and net working capital.
The discount rate that makes the net present value of an investment exactly equal to zero is called the
internal rate of return.
The payback method is a convenient and useful tool because
it provides a quick estimate of how rapidly an initial investment will be recouped.
Analysis using the profitability index
is useful as a decision tool when investment funds are limited.
The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the
payback period.
An independent, financing type project has an IRR of 11.4 percent and a required rate of return of 10.6 percent. Given this, you know the
project should be rejected.
One advantage of the payback method of project analysis is the method's
simplicity.
The underlying assumption of the dividend growth model is that a stock is worth
the present value of the future income provided by that stock.
Differential growth refers to the stock of a firm that increases its dividend by
varying rates over a period of time.
The internal rate of return
will provide the same accept/reject decision as NPV when cash flows are conventional and projects are independent.
A project is expected to create operating cash flows of $37,600 a year for 3 years. The initial cost of the fixed assets is $98,000. These assets will be worthless at the end of the project. Also, $3,200 of net working capital will be required throughout the life of the project. What is the project's net present value if the required rate of return is 14 percent?
−$11,746.73
Projects A and B require an initial investment of $48,000 and $98,000, respectively. The projects are mutually exclusive, and you know the smaller project has a positive NPV. Which one of these methods is probably the best method to use to determine which project to accept?
Incremental internal rate of return
Assume a project has normal cash flows. According to the accept/reject rules, the project should be accepted if the
IRR exceeds the required return.
What is the key reason why a positive NPV project should be accepted?
The project is expected to increase shareholder value.
A project has a net present value of $1,200 and a project life of 4 years. Which one of these statements must be true?
The project is expected to return $1,200 in Time 0 dollars over and above the discount rate.
You are considering a project with conventional cash flows. The IRR is 12.6 percent, NPV is -$198, and the payback period is 2.87 years. Which one of the following statements is correct given this information?
The required rate of return must be greater than 12.6 percent.
The incremental cash flows of a project are best defined as
any change in a firm's cash flows resulting from the addition of the project including opportunity costs.
All else equal, a project's operating cash flow will increase when the
depreciation expense increases.
Net working capital
requirements generally, but not always, create a cash outflow at the beginning of a project.
The Olde Mill just paid an annual dividend of $.38 a share and plans on decreasing this amount by 1 percent annually. What is the expected dividend for Year 6?
$.3578
Mario's is going to pay $1, $2.65, and $4 a share over the next 3 years, respectively. After that, the company plans to pay annual dividends of $1.65 per share indefinitely. If your required return is 14 percent, how much are you willing to pay for one share today?
$13.57
Mario's is going to pay $1, $2.65, and $4 a share over the next 3 years, respectively. After that, the company plans to pay annual dividends of $1.65 per share indefinitely. If your required return is 14 percent, how much are you willing to pay for one share today?
$13.57 P3 = $1.65 / 0.14 = $11.79; P0 = $1 / 1.14 + 2.65 / 1.14^2 + ($4 + 11.79) / 1.14^3 = $13.57
The ELL common stock pays an annual dividend of $2.23 a share and is committed to maintaining a constant dividend. How much are you willing to pay for one share of this stock if your required return is 16 percent?
$13.94
Global Enterprises has spent $134,000 on research developing a new type of shoe. For this shoe to now be manufactured, the firm will need to expand into an empty building that it currently owns. The firm was offered $229,000 last week for that building. An additional $342,000 will be required for new equipment and building improvements. Labor and material costs are estimated at $4.98 per pair of shoes. Interest expense on the loan needed to finance the production of this new shoe will be $17,800 a year. Which one of these correctly identifies the sunk costs?
$134,000 for research
Blasco just paid an annual dividend of $1.63 a share. What is one share of this stock worth to you if the dividends increase by 3 percent annually and you require a rate of return of 14 percent?
$15.26
Wilton's Market just announced its next annual dividend will be $1.62 a share with future dividends increasing by 2.2 percent annually. How much will one share of this stock be worth 6 years from now if the required return is 12.5 percent?
$17.92
Uptown Furniture purchased a corner lot 5 years ago at a cost of $670,000. The lot was recently appraised at $640,000. At the time of the purchase, the company spent $45,000 to grade the lot and another $100,000 to pave the lot for commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.6 million. What amount should be used as the initial cash flow for this building project?
$2,240,000
Uptown Furniture purchased a corner lot 5 years ago at a cost of $670,000. The lot was recently appraised at $640,000. At the time of the purchase, the company spent $45,000 to grade the lot and another $100,000 to pave the lot for commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.6 million. What amount should be used as the initial cash flow for this building project?
$2,240,000 CF0 = $640,000 + $1,600,000 = $2,240,000
Ernst Electrical increases its annual dividend by 1.8 percent annually. The stock commands a market rate of return of 18 percent and sells for $19.07 a share. What is the expected amount of the next dividend?
$3.09
Lefty's just purchased some equipment that is classified as 7-year property for MACRS. The equipment cost $123,940. The MACRS table values are 0.1429, 0.2449, 0.1749, 0.1249, and 0.0893, for Years 1 to 5, respectively. What will the book value of this equipment be at the end of 4 years?
$38,718.86
Lefty's just purchased some equipment that is classified as 7-year property for MACRS. The equipment cost $123,940. The MACRS table values are 0.1429, 0.2449, 0.1749, 0.1249, and 0.0893, for Years 1 to 5, respectively. What will the book value of this equipment be at the end of 4 years?
$38,718.86 Book value Year4 = $123,940 × ( 1 − 0.1429 − 0.2449 − 0.1749 − 0.1249)] = $38,718.86
Winslow Brothers common stock sells for $36.60 a share and pays an annual dividend that increases by 1.8 percent annually. The market rate of return on this stock is 14.7 percent. What is the amount of the last dividend paid?
$4.64
Webster preferred stock pays an annual dividend of $6.20 a share. What is the maximum price you should pay today to purchase this stock if you desire a rate of return of 14.25 percent?
$43.51
JJ Companies will pay an annual dividend of $4.20 a share on its common stock next year. Last week, the company paid a dividend of $4.00 a share. The company adheres to a constant rate of growth dividend policy. What will one share of this stock be worth 8 years from now if the applicable discount rate is 14 percent?
$68.95
Farris Industrial purchased a machine 5 years ago at a cost of $229,380. The machine is being depreciated using the straight-line method over 8 years. The tax rate is 35 percent and the discount rate is 16 percent. If the machine is sold today for $74,500, what will be the after-tax salvage value?
$78,531.13
Farris Industrial purchased a machine 5 years ago at a cost of $229,380. The machine is being depreciated using the straight-line method over 8 years. The tax rate is 35 percent and the discount rate is 16 percent. If the machine is sold today for $74,500, what will be the after-tax salvage value?
$78,531.13 Book value = $229,380 − 5 × ($229,380 / 8) = $86,017.50 After-tax salvage value = $74,500 − 0.35 × ($74,500 − $86,017.50) = $78,531.13
XanEx is a new firm that just paid an annual dividend of $1 a share. The firm plans to increase its dividend by 10 percent a year for the next 4 years and then decrease the growth rate to 2 percent annually. If the required rate of return is 18.25 percent, what is one share of this stock worth today?
$8.05
XanEx is a new firm that just paid an annual dividend of $1 a share. The firm plans to increase its dividend by 10 percent a year for the next 4 years and then decrease the growth rate to 2 percent annually. If the required rate of return is 18.25 percent, what is one share of this stock worth today?
$8.05 P4 = ($1 x 1.1^4 x 1.02) / (0.1825 - 0.02) = $9.19 P0 = ($1 x 1.1) / 1.1825 + ($1 x 1.1^2) / 1.1825^2 + ($1 x 1.1^3) / 1.1825^3 + [($11 x 1.1^4) + $9.19] / 1.1825^4. P0 = $8.05
New Tours last annual dividend was $2 a share. The company plans to lower the dividend by $.30 each year for the next 3 years. In Year 5, it will pay a final liquidating dividend of $17 a share. If the required return is 22 percent, what is the current per share value of this stock?
$9.23
A project requires an initial investment of $59,600 and will produce cash inflows of $21,200, $44,500, and $11,700 over the next 3 years, respectively. What is the project's NPV at a required return of 16 percent?
-$757.69
Shares of ABBO stock are currently selling for $14.43 a share. The last annual dividend paid was $1.61 a share, and dividends increase at a constant rate. If the market rate of return is 14 percent, what is the dividend growth rate?
2.56%
Baxter's Market is considering opening a new location with an initial cost of $139,200. This location is expected to generate cash flows of $22,400, $61,500, $37,800, and $21,000 in Years 1 to 4, respectively. What is the payback period?
3.83 years
You are considering two independent projects. The required rate of return is 13.75 percent for Project A and 14.25 percent for Project B. Project A has an initial cost of $51,400 and cash inflows of $21,400, $24,900, and $22,200 for Years 1 to 3, respectively. Project B has an initial cost of $38,300 and cash inflows of $23,000 a year for 2 years. Which project(s), if either, should you accept?
Accept A and reject B
You know that two mutually exclusive projects are of different sizes. The smaller project is known to have a positive NPV. Which one of these accurately describes a method of properly determining which one, if either, project should be accepted?
Accept the larger project if the incremental IRR exceeds the discount rate
Which one of these statements related to depreciation is correct for a firm with taxable income of $121,600 and after-tax income of $74,200?
Depreciation is a noncash expense that increases the firm's cash flows.
Which of the following are correct methods of computing the operating cash flow of a project assuming that the interest expense is equal to zero? I. EBIT + Depreciation − Taxes II. EBIT − Depreciation + Taxes III. Net Income − Depreciation IV. [(Sales − Costs) × (1 − Tax rate)] + [Depreciation × Tax rate]
I and IV only
Uptown Developers is considering two projects. Project A consists of building a wholesale book outlet on the firm's downtown lot. Project B consists of building a sit-down restaurant on that same lot. The lot can only accommodate one of the projects. When trying to decide whether to build the book outlet or the restaurant, management should rely most heavily on the analysis results from which one of these methods?
Net present value
In project analysis, which one of these is a common assumption regarding net working capital?
Net working capital will be returned to its preproject level at the end of a project.
A project has an initial cash inflow of $40,800 and a cash outflow of $44,900 in Year 1. The discount rate is 10 percent. Should this project be accepted or rejected based on IRR? Why?
Rejected, because the IRR is greater than the discount rate.
Alto stock pays an annual dividend of $1.10 a share and has done so for the past 6 years. No changes in the dividend amount are expected. The relevant market rate of return is 7.8 percent. Given this, one share of this stock
is valued as a perpetuity.
Julian's has spent $47,200 to design a new airline carryon bag. It spent another $56,500 testing various materials for their durability. An additional $75,000 was spent on test marketing to determine both the market demand and color preference. Since the test marketing proved successful, the firm is now compiling data to evaluate the addition of this bag to its production runs. The estimated production start up costs are $932,300 with annual costs thereafter of $57,000. The discount rate is 11 percent and the estimated life of the project is 5 years. What value should be used for the Time 0 cash flow?
−$932,300
