Finance Exam Three
Empire Industries is considering adding a new product to its lineup. This product is expected to generate sales for four years after which time the product will be discontinued. What is the project's net present value at a required rate of return of 14.8 percent? 0 / -62,000 1 / 16,500 2 / 23,800 3 / 27,100 4 / 23,300
$1,758.71 NPV = -$62,000 + $16,500 / 1.148 + $23,800 / 1.1482 + $27,100 / 1.1483 + $23,300 / 1.1484 NPV = $1,758.71
What is the net present value of a project that has an initial cost of $42,700 and produces cash inflows of $9,250 a year for 9 years if the discount rate is 14.65 percent?
$1,992.43 NPV = -$42,700 + $9,250 × {1 - [1 / (1 + .1465)9]} / .1465 NPV = $1,992.43
The Green Tomato purchased a parcel of land six years ago for $389,900. At that time, the firm invested $128,000 grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $48,000 a year. The Green Tomato is now considering building a hotel on the site as the rental lease is expiring. The current value of the land is $415,000. The firm has no loans or mortgages secured by the property. What value should be included in the initial cost of the hotel project for the use of this land?
$415,000 - only relevant cost is cost of land
What is the net present value of a project with the following cash flows if the discount rate is 15 percent? 0 / -48,100 1 / 15,600 2 / 28,900 3 / 15,200
-$2,687.98 NPV = - $48,100 + $15,600 / 1.15 + $28,900 / 1.152 + $15,200 / 1.153 NPV = -$2,687.98
Molly is considering a project with cash inflows of $811, $924, $638, and $510 over the next four years, respectively. The relevant discount rate is 11.2 percent. What is the net present value of this project if it the start-up cost is $2,700?
-$425.91 calculator: cf0 = -2,700 co1 = 811 fo1 = 1 co2 = 924 fo2 = 1 co3 = 638 fo3 = 1 co4 = 510 fo4= 1 I = 11.2% CPT NPV
Green Woods sells specialty equipment for mountain climbers. Its sales for last year included $387,000 of tents and $718,000 of climbing gear. For next year, management has decided to sell specialty sleeping bags also. As a result of this change, sales projections for next year are $411,000 of tents, $806,000 of climbing gear, and $128,000 of sleeping bags. How much of next year's sales are derived from the side effects of adding the new product to its sales offerings?
112,000 Side effects = ($411,000 + 806,000) - ($387,000 + 718,000) = $112,000
What was the average annual risk premium on small-company stocks for the period 1926-2014?
13.2 percent
A project has the following cash flows. What is the payback period? 0 / -28,000 1 / 11,600 2 / 11,600 3 / 6,500 4 / 6,500
2.74 years Payback = 2 + ($28,000 -11,600 -11,600)/$6,500 = 2.74 years
The Golden Goose is considering a project with an initial cost of $46,700. The project will produce cash inflows of $10,000 a year for the first two years and $12,000 a year for the following three years. What is the payback period?
4.23 years
A project has the following cash flows. What is the internal rate of return? 0 / -89,300 1 / 32,900 2 / 64,200 3 / 5,800
8.57 percent NPV = 0 = -$89,300 + $32,900 / (1 + IRR) + $64,200 / (1 + IRR)2 + $5,800 / (1 + IRR)3IRR = 8.57%
You are considering an equipment purchase costing $167,000. This equipment will be depreciated straight-line to zero over its three-year life. What is the average accounting return if this equipment produces the following net income? 1 / 15,600 2 / 14,200 3 / 13,500
AAR = [($15,600 + 14,200 + 13,500)/3]/[($167,000 + 0)/2] = .1729, or 17.29 percent
Which statement is correct? A portfolio that contains at least 30 diverse individual securities will have a beta of 1.0. Any portfolio that is correctly valued will have a beta of 1.0. A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph. A risk-free security plots at the origin on a security market line graph. An underpriced security will plot above the security market line.
An underpriced security will plot above the security market line.
Over the past six years, a stock had annual returns of 18 percent, -6 percent, 2 percent, 27 percent, -11 percent, and 13 percent, respectively. What is the standard deviation of these returns?
Average return = (.18-.06 + .02 + .27 -.11 + .13)/6 = .071667 σ2 = [(.18-.071667)2 + (-.06-.071667)2 + (.02 -.071667)2 + (.27 -.071667)2 + (-.11 -.071667)2 + (.13-.071667)2]/ (6 - 1) = .021497 σ = .021497.5 = .1466, or 14.66 percent
The internal rate of return is the:
Discount rate that results in a zero net present value for the project
operating cash flow
EBIT + Depreciation - Taxes
S&S stock is expected to return 17.5 percent in a booming economy, 12.4 percent in a normal economy, and 1.2 percent in a recession. The probabilities of an economic boom, normal state, or recession are 2 percent, 90 percent, and 8 percent, respectively. What is the expected rate of return on this stock?
Expected return = (.02 ×.175) + (.90 ×.124) + (.08 ×.012)= .1161, or 11.61 percent
Which one of the following statements is correct? The net present value is a measure of profits expressed in today's dollars. The net present value is positive when the required return exceeds the internal rate of return. If the initial cost of a project is increased, the net present value of that project will also increase. If the internal rate of return equals the required return, the net present value will equal zero. Net present value is equal to an investment's cash inflows discounted to today's dollars.
If the internal rate of return equals the required return, the net present value will equal zero.
Which one of these represents systematic risk? Major layoff by a regional manufacturer of power boats Increase in consumption created by a reduction in personal tax rates Surprise firing of a firm's chief financial officer Closure of a major retail chain of stores Product recall by one manufacturer
Increase in consumption created by a reduction in personal tax rates
Based on the most recent survey information presented in your textbook, CFOs tend to use which two methods of investment analysis the most frequently?
Internal rate of return and net present value
The average accounting return:
Measures profitability rather than cash flow.
Which one of the following is specifically designed to compute the rate of return on a project that has a multiple negative cash flows that are interrupted by one or more positive cash flows? Average accounting return Profitability index Internal rate of return Indexed rate of return Modified internal rate of return
Modified internal rate of return
The Tattle Teller has a printing press sitting idly in its back room. The press has no market value to another printer because the machine utilizes old technology. The firm could get $480 for the press as scrap metal. The press is six years old and originally cost $174,000. The current book value is $3,570. The president of the firm is considering a new project and feels he can use this press for that project. What value, if any, should be assigned to the press as an initial cost of the new project?
Opportunity cost of $480
Turner Industries started a new project three months ago. Sales arising from this project are significantly less than anticipated. Given this, which one of the following is management most apt to implement?
Option to abandon
Which one of the following methods of analysis ignores the time value of money?
Payback
You were recently hired by a firm as a project analyst. The owner of the firm is unfamiliar with financial analysis and wants to know only what the expected dollar return is per dollar spent on a given project. Which financial method of analysis will provide the information that the owner requests?
Profitability index
Which one of the following indicates that a project should be rejected? Assume the cash flows are normal, i.e., the initial cash flow is negative.
Profitability index less than 1.0
Assume that last year, Isaac earned 13.6 percent on his investments while U.S. Treasury bills yielded 2.7 percent, and the inflation rate was 2.2 percent. What real rate of return did he earn on his investments last year?
Real return = (1.136/1.022) - 1 = .1115, or 11.15 percent
Which one of the following is the best example of an announcement that is most apt to result in an unexpected return? A news bulletin that the anticipated layoffs by a firm will occur as expected on December 1 Announcement that the CFO of the firm is retiring June 1 as previously announced Announcement that a firm will continue its practice of paying a $3 a share annual dividend Statement by a firm that it has just discovered a manufacturing defect and is recalling its product The verification by senior management that the firm is being acquired as had been rumored
Statement by a firm that it has just discovered a manufacturing defect and is recalling its product.
Which one of the following statements is correct? A longer payback period is preferred over a shorter payback period. The payback rule states that you should accept a project if the payback period is less than one year. The payback period ignores the time value of money. The payback rule is biased in favor of long-term projects. The payback period considers the timing and amount of all of a project's cash flows.
The payback period ignores the time value of money.
Which statement is true? The expected rate of return on any portfolio must be positive. The arithmetic average of the betas for each security held in a portfolio must equal 1.0. The beta of any portfolio must be 1.0. The weights of the securities held in any portfolio must equal 1.0. The standard deviation of any portfolio must equal 1.0.
The weights of the securities held in any portfolio must equal 1.0.
Which one of the following best exemplifies unsystematic risk?
Unexpected increase in the variable costs for a firm
A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock?
a decrease in the probability of an economic boom
Lake City Plastics currently produces plastic plates and silverware. The company is considering expanding its product offerings to include plastic serving trays. All of the following are relevant costs to this project with the exception of:
a percentage of current operating overhead
An efficient capital market is best defined as a market in which security prices reflect which one of the following?
all available information
Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best fits the situation facing the firm?
capital rationing
The capital asset pricing model:
considers the relationship between the fluctuations in a security's returns versus the market's returns.
The net present value:
decreases as the required rate of return increases.
Forecasting risk is best defined as:
estimation risk.
The security market line is a linear function that is graphed by plotting data points based on the relationship between the:
expected market return and beta
Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate?
expected returns
Scenario analysis:
helps determine the reasonable range of expectations for a project's anticipated outcome.
The operating cash flows of a project:
include erosion effects.
Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as:
incremental cash flows
Which one of the following is a correct value to use if you are conducting a best-case scenario analysis?
lowest expected value for fixed costs.
Unsystematic risk can be defined by all of the following except:
market risk
The addition of a risky security to a fully diversified portfolio:
may or may not affect the portfolio beta.
The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as:
multiple rates of return
Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?
portfolio weight
Which one of the following can be defined as a benefit-cost ratio?
profitability index
The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:
recoup its initial cost
The net working capital invested in a project is generally:
recouped at the end of the project
Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following?
reduce the portfolio's unique risks
On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called?
risk premium
Kate is analyzing a proposed project to determine how changes in the sales quantity would affect the project's net present value. What type of analysis is being conducted?
sensitivity analysis
Over the period of 1926-2014, which one of the following investment classes had the highest volatility of returns?
small-company stocks
Which one of the following is the most apt to have the largest risk premium in the future based on the historical record for 1926-2014?
small-company stocks
Which one of the following is the positive square root of the variance?
standard deviation
One year ago, you purchased 600 shares of a stock. This morning you sold those shares and realized a total return of 3.1 percent. Given this information, you know for sure the:
sum of the dividend yield and the capital gains yield is 3.1 percent.
Weston Steel purchased a new coal furnace six years ago at a cost of $2.2 million. Last year, the government changed the emission requirements and this furnace cannot meet those standards. Thus, the company can no longer use the furnace, nor has it been able to locate anyone willing to purchase the furnace. Given the current situation, the furnace is best described as which type of cost?
sunk
The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation:
tax shield
Standard deviation measures _____ risk while beta measures _____ risk.
total, systematic
The standard deviation measures the _____ of a security's returns over time.
volatility
Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security?
zero