FINA 3313 EXAM 3 FLR quiz review

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format with 2 number after the decimal point

- Compute NPV of project NPV = 183.48 PI = (183.48+5000)/5000 = 1.03669 as a percent 103.67%

What is the profitability index for Project A with a cost of capital of 8%? Year. Project A. Project B 0. ($42,000.00). ($45,000.00) 1 $14,000.00 $28,000.00 2 $14,000.00 $12,000.00 3 $14,000.00 $10,000.00 4 $14,000.00 $10,000.00 5 $14,000.00 $10,000.00

- Compute NPV of project A using method above. PI = (NPV + CF0)/CF0 PI = (13,897.94+42,000)/42,000 = 1.33

Match those following concepts for first principle - The investment decision - The financing decision - The dividend decision

- Invest in assets that earn a return greater than the minimum acceptable hurdle rate - Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations - If you can't find investments that make your minimum acceptable rate, return the cash to owners of your business

The disadvantages of the IRR period method is that it

- Only works for normal cash flows - Requires a lot of data - Requires complex calculations

Compute the payback period for a project that requires an initial outlay of $231,091 that is expected to generate $40,000 per year for 9 years.

- Simple solution: 231,091/40,000 = 5.78 -Other method subtract each years cash flow from original amount in this case would be 5 full years of cash flow. Take the remaining amount left to pay and divided it by the next years cash flow in this case 31,091/40,000 = .78 add that to full year = 5.78

Which of the following statements is correct?

The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales.

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

True

The multiple IRR problem occurs when the sign of a project's cash flows change more than once.

True

The multiple IRR problem occurs when the signs of a project's cash flows change more than once

True

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

deemphasizing that variable as a critical factor

What type of projects does the BNSF strategic studies team evaluate?

discretionary

According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?

increase bank executive turnover

Generally, increases in leverage result in __________ return and __________ risk.

increased; increased

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth

In theory, a firm should maintain financial leverage consistent with a capital structure that __________

maximizes the owner's wealth

Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs

A corporation is contemplating an expansion project. The CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the corporation's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

-Any opportunity costs associated with the project

What are advantages of payback period?

-Measures Liquidity, Easy to communicate -Does not require discount rate -Does not require complex calculations

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14% Year. A. B. C 0. $(1,000). $(5,000). $(50,000) 1. $300. $1,700. $0 2. $300. $1,700. $15,000 3. $600. $1,700. $28,500 4. $300. $1,700. $33,000 What is the IRR of the best project?

-Using IRR calculations on calculator like previous question A = 17.49% B = 13.54% C = 14.23% Correct answer = 14.23%

Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as

-a means to ensure regulatory compliance -a balancing act that requires careful evaluation of the costs and benefits of each project

What type of analyses do the BNSF strategic studies team conduct?

-discounted cash flow -sensitivity

Identify which of these are the relevant cash flows when considering a capital budgeting project.

-lost rent from retail facility -remodeling expenses for new store -increase in inventory -expected salvage value of manufacturing equipment

List the steps of the capital budgeting process

1. Proposal generation 2. Review and analysis 3. Decision making 4. Implementation 5. Follow-up

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet demand for a new line of solar charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features; ​• The firm just spent​ $300,000 for marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $27,818,263 (excluding​ land, hint: land is not subject to​ depreciation). ​​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for ​$4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes) .0 What is the​ project's outflow at​ t=0? Answer to the nearest whole dollar value.

2,600,000 + 27,818,263 = 30,418,263

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A decrease in the fixed costs

Which of the following statements is correct for a project with a negative NPV?

The cost of capital exceeds the IRR

It should not usually be clear weather we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent

False

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital

False

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.

False

What is the net effect on a firm's working capital if a new project requires: $38,051 increase in inventory, $43,701 increase in accounts receivable, $35,000.00 increase in machinery, and a $41,032 increase in accounts payable? Round to nearest dollar amount.

Increase in Inventory: $38,051 Increase in Accounts Receivable: $43,701 Increase in Accounts Payable: $41,032 38,051+43,701-41,032 = 40,720

__________ results from the use of fixed - cost assets or funds to magnify returns to a firm's owners.

Leverage

Projects that compete with one another, so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

Mutually Exclusive

The "gold standard" of investment criteria refers to:

NPV (Net Present Value)

What is the internal rate of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000per year for 6 year?

On Financial Calculator - CF - CF0 = -10,000 - C01 = 2000 - F01 = 6 IRR -> CTP -> = 5.47

What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 6.93%

On Financial Calculator - CF -> CF0 = -100,000 - C01 = 50,000 - F01 = 3 - NPV -> I = 6.93 CPT -> NPV = 31,383.80

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $100 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's IRR?

On Financial Calculator -CF -> CF0 = -100,000,000 -C01 = -20,000,000 -F01 = 1 -C02 = 80,000,000 -F02 = 1 -C03 = 90,000,000 -F03 = 1 CPT -> IRR = 15.95

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $114,999,055 now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's NPV?

On Financial Calculator -CF -> CF0 = -114,999,055 -C01 = -20,000,000 -F01 = 1 -C02 = 80,000,000 -F02 = 1 -C03 = 90,000,000 -F03 = 1 NPV -> I = 11 CPT -> NPV = -2,280,054.04

Revenues generated by a new fad product are forecast as follows: Year: 1 Revenues: $28,842 Year:2 Revenues: $40,000 Year: 3 Revenues: $20,000 Year: 4 Revenues: $10,000 Thereafter 0 Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an Immediate Investment of $40,000 in plant and equipment that will be depreciated using the straight line method over 5 years. The firm recently spent $2.000 on a study to estimate the revenues of the new product. The tax rate is 20% What is the operating cash flow in year 1? Answer to nearest whole dollar amount

Revenue: $28,842 Expense: (28,842 * .5) = 14,421 Depreciation: (40,000/5) = 8000 EBIT : (28,842-14,421-8,000) = 6,421 Tax: (6421 * .2) = 1284.2 Net Income: (6421-1284.2) = 5136.8 OCF = (5136.8 + 8000) = 13,136.8

What is the amount of the operating cash flow for a firm with $367,563 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

Tax: (367,563 * .35) = 128,647.05 OCF = 367,563 + 100,000 -128,647 = 338,915.95

The degree of operating leverage has which of the following characteristics?

The DOL relates the change in sales to the change in net operating income