FINA CH 9-12

If the IRR is less than the cost of capital, accept project

FALSE

consider a project with an initial investment and positive future cash flows. as the discount rate decreases,

IRR remains constant and NPV increases

What are the decision criteria of NPV?

If NPV greater than 0, accept project If NPV is less than 0, reject the project

which of the following statements is correct?

If the PI of a project is less than 1, its NPV should be less than 0

The "gold standard" of investment criteria refers to

NPV

which of the following consider cost of financing in their computation?

NPV & Profitability Index

Scenario analysis

concerns what happens to a firm's NPV in different possible outcomes

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 types 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

investment decision

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

capital investment that is

long term benefits

Sensitivity analysis

looks specifically at how NPV changes when we change one of the variables that we input into out NPV calculations.

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth.

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.

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

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​ $25,500,273 (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+ 25,500,273 = 28100273

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

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? Group of answer choices

Any opportunity costs associated with the project.

Mutually Exclusive

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

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

which statement is correct?

Sunk costs is a cost that was incurred and expensed in the past and cannot. be recovered if the firm decides not to go forward with the project

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

The cost of capital exceeds the IRR

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

true

profitability index of .95 for a project means that

project returns 95 cents in present value for each current dollar invested

net working capital

short term liabilities and assets

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

true

capital budgeting analysis focuses on profits as opposed to cash flows

false

What are advantages of payback period?

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

The disadvantages of the IRR period method is that it

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

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? Round to nearest whole dollar value.

*salvage land - land = 4.5 mil - 2 mill = 2.5 mill *initial investment = 20 mil + 2.6 mil = 22.6 mil *NWC = 3.5 mil + 1.5 mil - 2 mil = 3 mil *each year depreciation = 20 mil - 2.5 mil / 10 = 1.75 mil Revenue 8,000,000 Expenses -4,000,000 (operating cost = 8 mil * .5 = 4 mil) Dep - 1,750,000 mil EBT 2,250,000 tax @ 35% -787,500 NI 1,462,500 Dep +1,750,000 OCF 3,212,500 at t=1-9 4.5 mill - after tax salvage value

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

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

financing decision

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

advantages of NPV

gives clear accept/reject use all cash flows adjust for TVM adjust for risk (with discount rate)

dividend decision

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

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​ $2,531,810. ​• 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​ project's NPV?

*NWC = 3 mil *initial investment = -20 mil - 2,531,810 = -22,531,810 * CF0 = -22,531,810 - 3,000,000 =-25,531,810 * CF1 = 3,212,500; F01 = 9; CO2 = 10,712,500; FO2 = 1; I = 10% CPT NPV = -2,900,813.50 = -2,900,814