FINA 3313 EXAM III

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

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

discretionary

The investment decision

invest in assets that earn a return greater than the minimum acceptable hurdle rate

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

leverage

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

maximizes the owner's wealth

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?

14.23

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

The financing decision

find the right kind of debt for your firm and the right mix of debt and equity to fund your operations

What are advantages of payback period?

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

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth.

The disadvantages of the IRR period method is that it

- Only works for normal cash flows - Requires a lot of data (estimates of all CFs) - Requires complex calculations

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 types 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

The "gold standard" of investment criteria refers to:

NPV

What is the profitability index for Project A with a cost of capital of 8%? YearProject AProject B0($42,000.00)($45,000.00)1$14,000.00$28,000.002$14,000.00$12,000.003$14,000.00$10,000.004$14,000.00$10,000.005$14,000.00$10,000.00

1.33

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

The cost of capital exceeds the IRR

Grill Master Johnnys is thinking about purchasing a new, energy-efficient grill. The grill will cost $53,000.00 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $11,750.00. The grill will have no effect on revenues but will save Johnny's $23,500.00 per year in energy expenses. The tax rate is 40%. The 3-year MACRS schedule; Year Depr % 1. 33.33 2. 44.45 3. 14.81 4. 7.41 What is the total cash flow in year 3?

25,860.64

What is the NPV of a project that costs $100,000.00 and returns $50,000.00 annually for three years if the opportunity cost of capital is 8.93%?

26,722.8

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.

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?

103.67

Mahrouq Technologies buys $17,341,625 of materials (net of discounts) on terms of 1/30, net 60, and it currently pays within 30 days and takes discounts. Mahrouq plans to expand, and this will require additional financing. If Mahrouq decides to forego discounts and thus to obtain additional credit from its suppliers, calculate the nominal cost of that credit.

12.29% Nominal cost of credit = Discount%/(1-Discount%) * (365/(Full payment days - Discount days) = (1%/(1-1%))*(365/(60-30) = 0.0101010101*12.1666667 = 12.28956

It should not usually be clear whether 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

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

The dividend decision

if you can't find investments that make your minimum acceptable rate, return the cash to owners of your business

Gillstrap Promotions has projected the following values for the next three months: January Sales $352,000 Purchases on Trade Credit $218,000 Cash Expenses $88,000 Taxes, interest, and dividends $18,000 Capital Expenditures $50,0000 February Sales $379,000 Purchases on Trade Credit$240,000 Cash Expenses $91,000 Taxes, interest, and dividends $20,000 Capital Expenditures $0 March Sales $440,807 Purchases on Trade Credit $260,000 Cash Expenses $94,000 Taxes, interest, and dividends $41,000 Capital Expenditures $25,000 All sales are credit sales with 40% collected in the month of sale, 50% collected the following month, and the remainder collected in the second month after the sale. Credit purchases are paid in 30 days and all other items require immediate payment. compute the net cash inflow for march

1022.8 Sales collected = 40% of March sales + 50% of February sales + 10% of January sales = 0.4 x 440,807 + 0.5 x 379,000 + 0.1 x 352,000 = $389,560.4 Cash out flows in March: Purchases on Trade credit for Feb = $240,000 + Cash Expenses = $94,000 + Taxes, interest and dividends = $41,000 + Capital expenditures = $25,000 Net Cash outflows = $400,000 Net Cash inflows = 401022.8 - 400,000 = $1,022.9

What is the net effect on a firm's working capital if a new project requires: $34,867 increase in inventory, $42,427 increase in accounts receivable, $35,000.00 increase in machinery, and a $42,993 increase in accounts payable?

34,301 working capital = current assets - current liabilities 34867 + 42427 - 42993

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.

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?

15.95% Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) = 80/1.11^2+90/1.11^3 = $130.737million Present value of outflows=$100+20/1.11 = $118.018million. Hence NPV=Present value of inflows-Present value of outflows = $130.737million-$118.018million = $12.72 million(Approx). 100+20/1.0x=80/1.0x^2+90/1.0x^3 Hence x=IRR=15.945%

Davis Supply maintains an average inventory of 2,000 dinosaur skulls for sale to filmmakers. The carrying cost per skull per year is estimated to be $150.00 and the fixed order cost is $53. What is the economic order quantity (EOQ)? (Round to the nearest whole number.)

38 EOQ = ((2*annual qty*fixed cost per order)/annual holding cost per unit)^(1/2) ((2*2000*53)/150)^(1/2)

A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 66.3% of sales, while fixed cost will be $450,000. The first year's sales estimates are $905,373. Calculate the firm's operating breakeven level of sales.

1,335,311.57 1 - 0.663 = 0.337 450000/0.337

list steps of the capital budgeting process

1. proposal generation 2. review and analysis 3. decision making 4. implementation 5. follow-up

A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 40% of sales, while fixed cost will be $429,056. The first year's sales estimates are $1,250,000. Calculate the firm's degree of operating leverage (DOL).`

2.34 Sales S = $1,250,000 Variable cost VC = 40% of sales = 1,250,000×40% = $500,000 Fixed cost FC = $429,056 DOL = (S - VC) / (S - VC - FC) DOL = (1,250,000 - 500,000)/(1,250,000 - 500,000 - 429,056) DOL = 750,000 / 320,944 DOL = 2.34

What is the equivalent annual cost for a project that requires a $50,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

25,773.54

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $65,791 2 40,000 3 20,000 4 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?

27,916.4 Revenue: $65,791 - expense (revenue * 50%): - 32,985.5 - depreciation (40000/5): -8,000 income before tax: 24,895.5 - tax at 20%: -4,979.1 net income: 19,916.4 + depreciation: + 8,000 OCF 1 = $27,916.4

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​ $26,012,469 (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?

28612469 Project cash outflow = Current market value of land + Project initial cost= 2,600,000 + 26,012,469

What is the amount of the operating cash flow for a firm with $303,534 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

297,297.1 (303534)(.65) = 197297.1 + 100000 = 297,297.1

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $75,902,842 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?

36,816,159 NPV = -75,902,842 - 20,000,000/(1 + 0.11)^1 + 80,000,000/(1 + 0.11)^2 + 90,000,000/(1 + 0.11)^3 = 36,816,158.95

Carlisle Transport had $4,520 cash at the beginning of the period. During the period, the firm collected $1,654 in receivables, paid $1,961 to supplier, had credit sales of $6,916, and incurred cash expenses of $500. What was the cash balance at the end of the period?

3713 4520 + 1654 - 1961 - 500

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the 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 a 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​ $20,000,000 (excluding​land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​$2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• 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). What is the operating cash flow​ @ t=1?

3,300,000

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the 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 a 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​ $20,000,000 (excluding​land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​$2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• 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). What is the operating cash flow​ @ t=2?

3,300,000

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the 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 a 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​ $20,000,000 (excluding​land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​$2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• 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). What are the after tax proceeds from the sale of the factory​ (i.e., ATSV)?

3,625,000

Compute the payback period for a project that requires an initial outlay of $138,098 that is expected to generate $40,000 per year for 9 years.

3.45

Maverick Technologies has sales of $3,000,000. The company's fixed operating costs total $455,689 and its variable costs equal 60% of sales. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)?

4.91 3,000,000*(1-60%)/[(3,000,000*(1-60%)-455689-500,000]

Suppose the capital budget in the lecture example worksheet in $WIKI_REFERENCE$/pages/capital-budgeting-and-cash-flows-the-lectures?module_item_id=g9a89e790298905497957e6a4658e2a67Video #11 was $100,000. What is the NPV of the best project(s)?

45,000

Libscomb Technologies' annual sales are $5,859,958 and all sales are made on credit, it purchases $3,973,475 of materials each year (and this is its cost of goods sold). Libscomb also has $501,436 of inventory, $538,953 of accounts receivable, and $448,702 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Period (in days)?

46.06

Hammond Supplies expects sales of 235,254 units per year with carrying costs of $4.98 per unit and ordering cost of $9.98 per order. Assuming the level of inventory is stable, what is the optimal average number of units in inventory? Round to the nearest whole number.

486 EOQ = ((2*annual qty*fixed cost per order)/annual holding cost per unit)^(1/2) ((2*240796*3.9)/2.84)^(1/2) Average inventory level = EOQ/2 = 485.51

Libscomb Technologies' annual sales are $5,866,577 and all sales are made on credit, it purchases $3,127,308 of materials each year (and this is its cost of goods sold). Libscomb also has $592,470 of inventory, $561,258 of accounts receivable, and $408,886 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Turnover?

5.28

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 $2,000 per year for 6 years?

5.47%

Maverick Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60% of sales, so the company's current operating income is $700,000. The company's interest expense is $583,829. What is the company's degree of financial leverage (DFL)?

6.03 700,000/(700,000-583829)

Libscomb Technologies' annual sales are $6,696,300 and all sales are made on credit, it purchases $3,695,114 of materials each year (and this is its cost of goods sold). Libscomb also has $598,250 of inventory, $502,850 of accounts receivable, and $410,475 of accounts payable. Assume a 365 day year. What is Libscomb's Operating Cycle (in days)?

86.5

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the 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 a 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​ $20,000,000 (excluding​land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​$2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• 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). What is the total cash flow at​ t=10?

9,925,000

Libscomb Technologies' annual sales are $5,228,580 and all sales are made on credit, it purchases $4,187,322 of materials each year (and this is its cost of goods sold). Libscomb also has $510,071 of inventory, $531,088 of accounts receivable, and $476,033 of accounts payable. Assume a 365 day year. What is Libscomb's Receivables Turnover?

9.85

Libscomb Technologies' annual sales are $5,418,497 and all sales are made on credit, it purchases $3,704,463 of materials each year (and this is its cost of goods sold). Libscomb also has $512,308 of inventory, $1,475,000 of accounts receivable, and $1,400,000 of accounts payable. Assume a 365 day year. What is Libscomb's Receivables Period (in days)?

99.36

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.

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.

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

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 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 signs of a project's cash flows change more than once.

true

Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs.