Fina Exam 3

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 8.42%?

-100000 + 50000/(1+0.0842) + 50000/(1+0.0842)^2 + 50000/(1+0.0842)^3 -100000+ 46116.95+ 42535.47+ 39232.12 27884.54

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 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

Generally, increases in leverage result in______________ return and _____________________ risk.

increased; increased

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth

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

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

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 investments that make your minimum acceptable rate, return the cash to owners of your business

What is the operating cash flow​ @ t=2? Round to nearest whole dollar value.

3212500

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%?

CF0=-50,000 CO1=-10,000 FO1=4 I=10% CPT NPV NPV=-81,698.65 PV= -81,698.65 N=4 I=10 CPT PMT PMT=25,773.54

What are advantages of payback period?

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

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

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? % terms to 2 decimal places and without the % sign.

IRR =15.95%

____________________ 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

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 disadvantages of the IRR period method is that it

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

Mavericks Cosmetics buys $3,276,921 of product (net of discounts) on terms of 6/10, net 60, and it currently pays on the 10th day and takes discounts. Mavericks plans to expand, and this will require additional financing. If Mavericks decides to forego discounts, what would the effective percentage cost of its trade credit be, based on a 365-day year?

1+(.06/1-.06)]^(365/10)-1 =1.06^36.5-1 =8.5683 =856.83

A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 39.39% of sales, while fixed cost will be $450,000. The first year's sales estimates are $744,959. Calculate the firm's operating breakeven level of sales.

1-39.39%= .6061 450,000/ .6061= 742,451.741

What are the after tax proceeds from the sale of the factory​ (i.e., ATSV)? Round to nearest whole dollar value.

3800000

Mahrouq Technologies buys $16,115,771 of materials (net of discounts) on terms of 7/30, 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.

(.07/1-.07)*(365/30) =.0753*12.1667 =0.9158 =91.58

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 $94. What is the economic order quantity (EOQ)?

(2*average inventory*buying cost/carrying cost)^(1/2) (2*2000*94/150)^1/2 =50.07 =50

Libscomb Technologies' annual sales are $6,922,215 and all sales are made on credit, it purchases $3,313,432 of materials each year (and this is its cost of goods sold). Libscomb also has $581,092 of inventory, $547,364 of accounts receivable, and $469,836 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Period (in days)?

(inv/cogs)*365 (581092/3313432)* 365 =64

What is the​ project's NPV? Round to nearest whole dollar value.

-2920460.5

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

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $483 at the end of the next three years and then $1,245 per year for the three years after that. If the discount rate is 8.04% then what is the NPV?

1. npv calulator = $1,213.82 PI=(NPV+Potential project)/Potential project =(1212.82+5000)/5000 =1.242564 =124.26%

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% (900/1.08) + (900/(1.08)^2) + (900/(1.08)^3) + (1400/(1.08)^4) + (1400/(1.08)^5) + (1400/(1.08)^6) = (833.33 + 771.60 + 714.45 + 1029.04 + 952.82 + 882.24) = 5183.485183.48 / 5000 = 1.036696 = 103.67%

What is the total cash flow at​ t=10? Round to nearest whole dollar value.

10712500

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. What is the IRR of the best project? % terms to 2 decimal places w/o % sign

14.23

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;

25,860.64

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.

3212500

What is the amount of the operating cash flow for a firm with $391,685 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

391,685- (391,685*35%)= 254,595.25 + 100,000= 354,595

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 irr calculator

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.

5.78

Maverick Technologies has sales of $3,000,000. The company's fixed operating costs total $501,147 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)?

= 3,000,000*(1-60%)/[(3,000,000*(1-60%)-501,147-500,000] =1,200,000/ 198,853 =6.0346

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 $410,724. What is the company's degree of financial leverage (DFL)?

= 700,000/(700,000-410,724) = 2.4198

What is the profitability index for Project A with a cost of capital of 8%?

=(14000/1.08)+(14000/ (1.08)^2+(14000/(1.08)^3+(14000/(1.08)^4+(14000/(1.08)^5) =(12962.96+ 12002.74+11113.65+10290.41+9528.16) =55898 =[55898/42000] =1.33

Hammond Supplies expects sales of 114,629 units per year with carrying costs of $3.76 per unit and ordering cost of $3.34 per order. Assuming the level of inventory is stable, what is the optimal average number of units in inventory?

=(sq. root) 2*annual sales*ordering cost/carrying cost (sq. root) 2*114629*3.34/3.76 (sq. root) 765,721.72/3.76 =451.28 =451

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 is the net effect on a firm's working capital if a new project requires: $45,808 increase in inventory, $40,466 increase in accounts receivable, $35,000.00 increase in machinery, and a $46,003 increase in accounts payable? Round to nearest dollar amount.

A/R +40,466 Inventory +45,808 A/P +46,003 40,466+45,808-46,003= 40,271

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $91,520,186 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?

Number of years 0, 1, 2, 3 Cash flows -100000000, -20000000, 80000000, 90000000 Present value @11% -100000000, 18018018.02, 64929794.66, 65807224.32 Therefore, Net Present value =12719000.96 or 12.72 million

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

True

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​ $22,367,744 (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

Project cash outflow = Current market value of land + Project initial cost = 2600000 + 22367744 = 24967744

Revenues generated by a new fad product are forecast as follows: Year Revenues 1- $43,447 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? Answer to nearest whole dollar amount.

Revenue (43447) -Expenses (21723.5) -Depreciation (40000/5= 8000) = 13723.5 - 8689.4 = 5034 +Depreciation (8000) =13,034

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.

Sales collected = 40% of March sales + 50% of February sales + 10% of January sales = 0.4 x 402,285 + 0.5 x 379,000 + 0.1 x 352,000 = $385,614 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 = 385614- 400,000 = -14386

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.

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

The cost of capital exceeds the IRR

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 $460,335. The first year's sales estimates are $1,250,000. Calculate the firm's degree of operating leverage (DOL).

VC = 1,250,000×40% = 500,000 = (1,250,000 - 500,000)/(1,250,000 - 500,000 - 460,335) = 750,000/ 289,665 = 2.589

Libscomb Technologies' annual sales are $5,701,762 and all sales are made on credit, it purchases $4,386,005 of materials each year (and this is its cost of goods sold). Libscomb also has $554,826 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)?

accounts recievable/total credit sales*365 1475000/5701762* 365 =94.42

Libscomb Technologies' annual sales are $5,349,022 and all sales are made on credit, it purchases $3,007,992 of materials each year (and this is its cost of goods sold). Libscomb also has $524,063 of inventory, $574,331 of accounts receivable, and beginning and ending of year $468,033 and $421,179 accounts payables (respectively). Assume a 365 day year. What is Libscomb's Cash Cycle (in days)?

average payables= (468033+421179)/2 = 444,606 days of inv =inv/cogs*365 524063/3007992* 365 =63.59 days of sales= recievables/credit sales*365 =574331/5349022* 365 =39.19 days payable= average payable/cogs*365 =444606/3007992*365 =53.95 cash cycle= days inv+ days sales-payable =63.59+39.19-53.95 =48.83

Carlisle Transport had $4,049 cash at the beginning of the period. During the period, the firm collected $1,508 in receivables, paid $2,096 to supplier, had credit sales of $6,059, and incurred cash expenses of $500. What was the cash balance at the end of the period?

balance= cash+ recievables-paid-expenses =4049+1508-2096-500 =2961

Libscomb Technologies' annual sales are $6,178,922 and all sales are made on credit, it purchases $4,049,369 of materials each year (and this is its cost of goods sold). Libscomb also has $512,426 of inventory, $521,617 of accounts receivable, and $476,609 of accounts payable. Assume a 365 day year. What is Libscomb's Inventory Turnover?

cogs/Inv =4049369/512426 =7.90

Libscomb Technologies' annual sales are $6,464,546 and all sales are made on credit, it purchases $3,297,427 of materials each year (and this is its cost of goods sold). Libscomb also has $505,907 of inventory, $527,731 of accounts receivable, and $472,959 of accounts payable. Assume a 365 day year. What is Libscomb's Receivables Turnover?

credit sales/accounts recievable 6464546/527731 = 12.25

Libscomb Technologies' annual sales are $6,401,661 and all sales are made on credit, it purchases $4,129,417 of materials each year (and this is its cost of goods sold). Libscomb also has $510,866 of inventory, $493,188 of accounts receivable, and $467,513 of accounts payable. Assume a 365 day year. What is Libscomb's Operating Cycle (in days)?

inv turnover=purchases/inventory 4129417/510866= 8.08 inv period=365/8.08 =45.17 receivable turnover= credit sales/recievables 6401661/493188=12.98 rec period=365/12.98=28.12 operating cycle 45.17+28.12=73.29

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.