FINA 3313 - FInal Exam Review

10.1 - Identifying Relevant Cash Flows 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

9.9 - Problem Mastery What are advantages of payback period?

-Does not require complex calculations -Does not require discount rate -Measures liquidity, easy to communicate

9.9 - Problem Mastery The disadvantages of the IRR period method is that it:

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

10.8 - BNSF Capital Budgeting Process Part 2 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

10.8 - BNSF Capital Budgeting Process Part 2 What types of analyses do the BNSF strategic studies team conduct?

-discounted cash flow -sensitivity

10.5 - After-tax Operating Cash Flows 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 - expenses - (depreciation) = EBIT EBIT - taxes + depreciation = OCF

9.9 - Problem Mastery List steps of the capital budgeting process:

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

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

The cost of capital exceeds the IRR

9.9 - Problem Mastery Match those following concepts for first principle:

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

9.8 - Profitability Index (PI) 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

1.33 https://www.chegg.com/homework-help/questions-and-answers/profitability-index-project-cost-capital-8-year-project-project-b-0-42-00000-45-00000-1-14-q53823758

9.9 - Problem Mastery 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

103.67 (check iPad notes)

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

14.23% https://www.chegg.com/homework-help/questions-and-answers/considering-following-three-mutually-exclusive-projects-required-rate-return-three-project-q54389695

9.9 - Problem Mastery Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $397 at the end of the next three years and then $1,750 per year for the three years after that. If the discount rate is 4.8% then what is the NPV?

241.15 (Check iPad notes)

9.2 - Net Present Value (NPV) 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 8.04%?

28,761.9 =-100000 + 50000/(1+0.0804)^1 + 50000/(1+0.0804)^2 + 50000/(1+0.0804)^3

9.7 - Payback Period Compute the payback period for a project that requires an initial outlay of $153,425 that is expected to generate $40,000 per year for 9 years.

3.84 https://www.chegg.com/homework-help/questions-and-answers/compute-payback-period-project-requires-initial-outlay-153-425-expected-generate-40-000-pe-q54032565

10.3 - Capital Spending 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​ $27,676,645 (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.

30,276,645 (current market value + inital cost)

10.4 - Changes in Net Working Capital What is the net effect on a firm's working capital if a new project requires: $31,060 increase in inventory, $42,469 increase in accounts receivable, $35,000.00 increase in machinery, and a $40,343 increase in accounts payable? Round to nearest dollar amount.

33,186 (current assets - current liabilities) (increase in inventory + increase in A/R - increase in A/P)

9.3 - The Internal Rate of Return (IRR) 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% (Calculator) https://www.chegg.com/homework-help/questions-and-answers/internal-rate-return-project-initial-outlay-10-000-expected-generate-cash-flows-2-000-per--q53822766

10.7 - Robustness of NPV estimates 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

10.1 - Identifying Relevant Cash Flows 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.

9.9 - Problem Mastery 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

9.9 - Problem Mastery 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

9.9 - Problem Mastery 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

9.1 - Capital Budgeting Projects 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

9.2 - Net Present Value (NPV) The "gold standard" of investment criteria refers to:

NPV

10.5 - After-tax Operating Cash Flows What is the amount of the operating cash flow for a firm with $352,703 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

Profit before taxes - taxes + depreciation

9.5 - The Multiple IRR Problem The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

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

True

9.9 - Problem Mastery The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

10.7 - Robustness of NPV estimates 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.

10.8 - BNSF Capital Budgeting Process Part 2 What types of projects does the BNSF strategic studies team evaluate?

discretionary

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

increase bank executive turnover

9.1 - Capital Budgeting Projects The primary purpose of capital budgeting is to:

maximize the shareholders' wealth.

9.8 - Profitability Index (PI) Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs.