Finance test 3

farmer sows a certain crop. It costs $240,000 to buy the seed, prepare the ground, and sow the crop. In one yearʹs time it will cost $93,200 to harvest the crop. If the crop will be worth $350,000 , and the interest rate is 7%, what is the net present value (NPV) of this investment? A) $240,000 B) $87,103 C) $0 D) $567,103

$0

The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA) after the close of business on August 22, 2008. What is the difference between the opening and closing price of the stock on this date? A) $0.49 B) $0.27 C) $0.24 D) $0.03

$0.24

A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment? A) $10,048 B) $11,053 C) $16,077 D) $14,250

$10,048

NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowthʹs equity cost of capital is 10%, then the value of a share of NoGrowthʹs stock is closest to ________. A) $9.60 B) $14.40 C) $13.20 D) $12.00

$12.00

A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future? A) $14.88 B) $22.32 C) $29.76 D) $37.20

$14.88

Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owenʹs equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend? A) $11.20 B) $12.80 C) $16.80 D) $16.00

$16.00

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000 , given that the cost of capital is 9%? A) $45,000 B) $175,034 C) $201,289 D) $160,000

$175,034

JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow indefinitely at 4% per year and JRNʹs stock was trading at $25.50 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to ________. A) $19.32 B) $12.75 C) $38.63 D) $25.50

$19.32

An investor is considering a project that will generate $900,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000 . If the cost of capital is 4.4%, based on the MIRR, at what upfront costs does this project cease to be worthwhile? A) $2.62 million B) $2.91 million C) $3.21 million D) $3.50 million

$2.91 million

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport? A) $12.71 B) $14.83 C) $16.94 D) $21.18

$21.18

Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27 , and Rylanʹs equity cost of capital is 12%, what price would you expect Rylanʹs stock to sell for at the end of the four years? A) $21.96 B) $39.53 C) $17.57 D) $61.49

$21.96

Matilda Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 9%, which of the following would be closest to Matildaʹs stock price? A) $14.00 B) $18.66 C) $23.33 D) $29.16

$23.33

A stock is expected to pay $2.60 per share every year indefinitely and the equity cost of capital for the company is 11%. What price would an investor be expected to pay per share next year? A) $5.91 B) $11.82 C) $17.73 D) $23.64

$23.64

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price? A) $12.48 B) $24.96 C) $37.44 D) $49.92

$24.96

Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today? A) $20.62 B) $25.78 C) $33.96 D) $33.51

$25.78

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah stock is $22.60 , and Coolibahʹs equity cost of capital is 18%, what price would you expect Coolibahʹs stock to sell for at the end of three years? A) $28.87 B) $31.76 C) $33.20 D) $34.64

$28.87

Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain from the sale of this stock at the end of the coming year? A) $3.56 B) $56.88 C) $5.12 D) $58.44

$3.56

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefoodʹs stock if the firmʹs equity cost of capital is 12%? A) $24.00 B) $22.29 C) $30.86 D) $34.29

$34.29

Valorous Corporation will pay a dividend of $1.75 per share at this yearʹs end and a dividend of $2.35 per share at the end of next year. It is expected that the price of Valorousʹ stock will be $41 per share after two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today? A) $32.38 B) $36.19 C) $38.09 D) $39.99

$38.09

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 10%, then the price of a share of Beanʹs stock is closest to ________. A) $24.82 B) $16.54 C) $41.36 D) $66.18

$41.36

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBCʹs dividend to grow by 6% per year forever and VBCʹs equity cost of capital to be 13%, then the value of a share of VBS stock is closest to ________. A) $42.86 B) $15.79 C) $25.72 D) $17.14

$42.86

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship? A) $498,597 B) $747,896 C) $797,756 D) $847,615

$498,597

Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does not affect Sunnyfaxʹs equity cost of capital, what is the expected share price as a consequence of this decision? A) $36.67 B) $41.90 C) $52.38 D) $62.86

$52.38

A local government awards a landscaping company a contract worth $1.5 million per year for five years for maintaining public parks. The landscaping company will need to buy some new machinery before they can take on the contract. If the cost of capital is 6%, what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company? A) $5.69 million B) $6.00 million C) $6.32 million D) $6.63 million

$6.32 million

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price? A) $12.00 B) $24.00 C) $36.00 D) $60.00

$60.00

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $2.50 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 14% and their equity cost of capital is 11%. The value of a share of KTIʹs stock today is closest to ________. A) $75.00 B) $37.50 C) $62.50 D) $25.00

$62.50

A car dealership offers a car for $14,000 , with up to one year to pay for the car. If the interest rate is 5%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year? A) $667 B) $1333 C) $13,333 D) $14,000

$667

Assume that your capital is constrained, so that you only have $500,000 available to invest in projects. If you invest in the optimal combination of projects given your capital constraint, then the total net present value (NPV) for all the projects you invest in will be closest to ________. A) $111,000 B) $69,000 C) $80,000 D) $58,000

$69,000

Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firmʹs equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittendenʹs earnings are expected to grow at a constant 3% per year, what is Chittendenʹs share price? A) $3.74 B) $2.24 C) $7.47 D) $14.94

$7.47

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price? A) $11.27 B) $22.54 C) $60.10 D) $75.12

$75.12

A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is $18.90 , and the equity cost of capital for the company that released the shares is 7.9%, what price would an investor be expected to pay per share five years into the future? A) $8.86 B) $14.18 C) $14.62 D) $15.06

$8.86

Assume that your capital is constrained, so that you only have $600,000 available to invest in projects. If you invest in the optimal combination of projects given your capital constraint, then the total net present value (NPV) for all the projects you invest in will be closest to ________. A) $65,000 B) $80,000 C) $69,000 D) $111,000

$80,000

Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend will grow by 3% each year in the future. What will be the current value of a single share of Avrilʹs stock if the firmʹs equity cost of capital is 16%? A) $6.46 B) $6.92 C) $9.23 D) $10.15

$9.23

A manufacturer of video games develops a new game over two years. This costs $830,000 per year with one payment made immediately and the other at the end of two years. When the game is released, it is expected to make $1.20 million per year for three years after that. What is the net present value (NPV) of this decision if the cost of capital is 10%? A) $950,349 B) $1,045,384 C) $1,520,559 D) $1,805,663

$950,349

Jenkins Security has learned that a rival has offered to supply a parking garage with security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $60,000 and a separate yearly payment, by what maximum amount can this yearly payment be over $20,000, so that Jenkinsʹ offer matches the equivalent annual annuity of their rivalʹs offer? (Assume a cost of capital of 5%.) A) -$89 B) -$94 C) -$100 D) -$111

-$111

If the appropriate discount rate for this project is 13%, then the net present value (NPV) is closest to ________. A) $24,000 B) -$1846 C) -$3077 D) -$2154

-$3077

A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $30,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 5%? A) -$21,885 B) -$25,533 C) -$29,180 D) -$36,475

-$36,475

An orcharder spends $110,000 to plant pomegranate bushes. It will take four years for the bushes to provide a usable crop. He estimates that every year for 20 years after that he will receive a crop worth $10,500 per year. If the discount rate is 9%, what is the net present value (NPV) of this investment? A) -$42,098 B) -$21,049 C) $8420 D) $12,629

-$42,098

A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%? A) -$3155 B) -$3606 C) -$4057 D) -$4507

-$4507

A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $80 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $45 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.1%? A) -$860 B) -$229 C) -$574 D) $860

-$574

The Sisyphean Companyʹs common stock is currently trading for $25.50 per share. The stock is expected to pay a $2.80 dividend at the end of the year and the Sisyphean Companyʹs equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Companyʹs earnings is closest to ________. A) -1.96% B) -1.47% C) -0.98% D) -0.49%

-0.98%

A mining company plans to mine a beach for rutile. To do so will cost $14 million up front and then produce cash flows of $7 million per year for five years. At the end of the sixth year the company will incur shut-down and clean-up costs of $6 million. If the cost of capital is 13.0%, then what is the MIRR for this project? A) -60.97% B) -78.39% C) -87.10% D) -95.81%

-87.10%

A company has stock which costs $41.50 per share and pays a dividend of $2.50 per share this year. The companyʹs cost of equity is 7%. What is the expected annual growth rate of the companyʹs dividends? A) 0.98% B) 1.96% C) 2.94% D) 3.92%

0.98%

Kirkevue Industries pays out all its earnings as dividends and has a share price of $27. In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged? A) 1.48% B) 0.14% C) 0.17% D) 0.15%

1.48%

ʺround lotʺ consists of how many shares? A) 1 B) 10 C) 100 D) 1,000

100

Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of Gremlinʹs stock is $23.50 per share. What is Gremlinʹs equity cost of capital? A) 11% B) 12% C) 14% D) 16%

12%

Two mutually exclusive investment opportunities require an initial investment of $7 million. Investment A pays $2.0 million per year in perpetuity, while investment B pays $1.4 million in the first year, with cash flows increasing by 4% per year after that. At what cost of capital would an investor regard both opportunities as being equivalent? A) 3% B) 7% C) 13% D) 15%

13%

Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one yearʹs time, immediately after it pays a dividend of $0.28 . Which of the following is closest to Jumbuck Explorationʹs equity cost of capital? A) 7.17% B) 8.60% C) 14.33% D) 17.91%

14.33%

The Busby Corporation had a share price at the start of the year of $26.10 , paid a dividend of $0.59 at the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period? A) 14% B) 13% C) 12% D) 15%

15%

A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction? A) 3.48% B) 8.70% C) 13.91% D) 17.39%

17.39%

Assume the appropriate discount rate for this project is 13%. The payback period for this project is closest to ________. A) 2.88 years B) 2.40 years C) 1.92 years D) 3.60 years

2.40 years

A florist is buying a number of motorcycles to expand its delivery service. These will cost $78,000 but are expected to increase profits by $3000 per month over the next four years. What is the payback period in this case? A) 10.40 months B) 15.60 months C) 19.50 months D) 26.00 months

26.00 months

Martin is offered an investment where for $6000 today, he will receive $6180 in one year. He decides to borrow $6000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment? A) 1% B) 2% C) 3% D) 4%

3%

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what discount rate does her decision to renovate become untenable? A) 3.0% B) 3.3% C) 4.0% D) 4.8%

3.3%

The owner of a number of gas stations is considering installing coffee machines in his gas stations. It will cost $270,000 to install the coffee machines, and they are expected to boost cash flows by $120,536 per year for their five-year working life. What must the cost of capital be if this investment has a profitability index of 1? A) 1.89% B) 3.78% C) 7.55% D) 9.44%

3.78%

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industriesʹ dividends are expected to grow at a constant rate indefinitely. The growth rate of Lutherʹs dividends is closest to ________. A) 5.5% B) 14.5% C) 11.0% D) 5.0%

5.5%

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTIʹs dividends is closest to ________. A) 11.3% B) 9.8% C) 5.9% D) 3.9%

9.8%

Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

Which of the following situations can lead to IRR giving a different decision than NPV? A) delayed investment B) multiple IRRs C) differences in project scale D) All of the above can lead to IRR giving a different decision than NPV.

All of the above can lead to IRR giving a different decision than NPV.

Which of the following statements is FALSE? A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B) An internal rate of return (IRR) will always exist for an investment opportunity. C) A net present value (NPV) will always exist for an investment opportunity. D) In general, there can be as many internal rates of return (IRRs) as the number of times the projectʹs cash flows change sign over time.

An internal rate of return (IRR) will always exist for an investment opportunity.

Which of the following is true regarding the profitability index? A) It does not use the net present value (NPV) to assess benefits. B) It is very simple to compute. C) Attention must be taken when using it to make sure that all of the constrained resource is utilized. D) It is unreliable when used for choosing between different projects.

Attention must be taken when using it to make sure that all of the constrained resource is utilized

A small department store in a mall has the opportunity to rent an additional 20,000 square feet of space for five years. It can divide up this space between the above new departments. Each department will require a different amount of space, and each department is expected to make a yearly profit as shown, for each of the next five years. The discount rate is 10%. Based on this information, what departments should be added? A) Pet, Fabrics, Hardware, and Shoe Repair B) Fabrics, Luggage, Hardware, Watches, and Shoe Repair C) Pets, Fabrics, Books, and Luggage D) Pet, Fabrics, Luggage, Hardware, and Shoe Repair

B) Fabrics, Luggage, Hardware, Watches, and Shoe Repair

Which of the following statements is FALSE about dividend payout and growth? A) A common approximation is to assume that in the long run, dividends will grow at a constant rate. B) The dividend each year is the firmʹs earnings per share (EPS) multiplied by its dividend payout rate. C) There is a tremendous amount of uncertainty associated with any forecast of a firmʹs future dividends. D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor. T or F

False

Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects. T or F

False

Preference for cash today versus cash in the future in part determines net present value (NPV). T or F

False

Stocks that do not pay a dividend must have a value of $0. T or F

False

The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows. T or F

False

When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project. T or F

False

When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment. T or F

False

A garage is comparing the cost of buying two different car hoists. Hoist A will cost $20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist? A) Hoist A, since it has a greater present value (PV). B) Hoist B, since it has a greater present value (PV). C) Hoist A, since it has a greater equivalent annual annuity. D) Hoist B, since it has a greater equivalent annual annuity

Hoist B, since it has a greater equivalent annual annuity

Which of the following will be a source of cash flows for a shareholder of a certain stock? I. Sale of the shares at a future date II. The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split A) I only B) II only C) I and II D) II and III

I and II

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cash flow model A) I only B) II only C) III only D) II and III

II only

According to Graham and Harveyʹs 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________. A) NPV, IRR, MIRR B) MIRR, IRR, Payback period C) IRR, NPV, Payback period D) Profitability index, NPV, IRR

IRR, NPV, Payback period

Which of the following statements is FALSE regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must diversify. B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting a firmʹs dividend to increase investment will raise the stock price if the new investment has a positive net present value (NPV).

If a firm wants to increase its share price, it must diversify.

Which of the following statements is FALSE? A) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. B) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate. D) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.

If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive

The following show four mutually exclusive investments. Which one is the best investment? A) Initial investment: $1.1 million; Cash flow in year 1: $160,000; Annual Growth Rate: 2%; Cost of Capital: 9.1% B) Initial investment: $1.2 million; Cash flow in year 1: $150,000; Annual Growth Rate: 2%; Cost of Capital: 7.2% C) Initial investment: $1.3 million; Cash flow in year 1: $160,000; Annual Growth Rate: 1%; Cost of Capital: 5.6% D) Initial investment: $1.4 million; Cash flow in year 1: $150,000; Annual Growth Rate: 2%; Cost of Capital: 8.4%

Initial investment: $1.3 million; Cash flow in year 1: $160,000; Annual Growth Rate: 1%; Cost of Capital: 5.6%

An investor has the opportunity to invest in four new retail stores. The amount that can be invested in each store, along with the expected cash flow at the end of the first year, the growth rate of the concern, and the cost of capital is shown for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose? A) Initial investment: $100,000; Cash flow in year 1: $12,000; Growth Rate: 1.25%; Cost of Capital: 9.1% B) Initial investment: $90,000; Cash flow in year 1: $10,000; Growth Rate: 1.50%; Cost of Capital: 9.3% C) Initial investment: $80,000; Cash flow in year 1: $8,000; Growth Rate: 1.75%; Cost of Capital: 8.0% D) Initial investment: $60,000; Cash flow in year 1: $6,000; Growth Rate: 2.50%; Cost of Capital: 7.2%

Initial investment: $60,000; Cash flow in year 1: $6,000; Growth Rate: 2.50%; Cost of Capital: 7.2%

Which of the following will NOT increase a companyʹs dividend payments? A) It can issue more shares. B) It can increase its earnings. C) It can decrease the number of shares outstanding. D) It can increase its dividend payout rate.

It can issue more shares.

Which of the following is a limitation of the dividend-discount model? A) It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible. C) It requires that the growth rate always be higher than the required rate of return, which is not realistic. D) It does not consider past earnings and performance

It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible.

Which of the following is NOT a limitation of the payback period rule? A) It does not account for the time value of money. B) It is difficult to calculate. C) It ignores cash flows after payback. D) It does not account for changes in the discount rate.

It is difficult to calculate

Which of the following is NOT a limitation of the payback rule? A) It does not consider the time value of money. B) Lacks a decision criterion that is economically based. C) It is difficult to calculate. D) It does not consider cash flows occurring after the payback period

It is difficult to calculate.

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 6%, should she accept the project? A) Yes, because the NPV is positive at that rate. B) No, because the NPV is negative at that rate. C) No, because the NPV is positive at that rate. D) Cannot be determined from the information given

No, because the NPV is negative at that rate

A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract? A) Yes, since net present value (NPV) is positive. B) It does not matter whether the contract is taken or not, since NPV = 0. C) Yes, since net present value (NPV) is negative. D) No, since net present value (NPV) is negative

No, since net present value (NPV) is negative

A convenience store owner is contemplating putting a large neon sign over his store. It would cost $50,000, but is expected to bring an additional $24,000 of profit to the store every year for five years. Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%? A) Yes, since it will pay back its initial investment in two years. B) Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment. C) Yes, since the cash flows after two years are greater than the initial investment. D) No, since the value of the cash flows over the first two years are less than the initial investment

No, since the value of the cash flows over the first two years are less than the initial investment

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners? A) Option A, since it has a lower equivalent annual annuity. B) Option B, since it has a lower equivalent annual annuity. C) Option A, since it has a greater equivalent annual annuity. D) Option B, since it has a greater equivalent annual annuity

Option B, since it has a greater equivalent annual annuity

Which of the following formulas is INCORRECT? A) Divt = EPSt × Dividend Payout Rate B) PN = (rE - g) × DivN+1 C) earnings growth rate = retention rate × return on new investment D) rE = (Divt / P0) + g

PN = (rE - g) × DivN+1

A company that creates education products is planning to create a suite of books to help customers prepare for high-stakes tests for entry into college and grad school. They have 33 in-house writers to create these books. Due to the expertise needed in creating this content it will not be possible to hire temporary writers within the planned time-frame. Which projects should be undertaken? A) Prep for the College Entry Test and Prep for the Law School Entry Test B) Prep for the College Entry Test and Prep for the Grad School Entry Test C) Prep for the Dental School Entry Test, Prep for the Grad School Entry Test, and Prep for the Medical School Entry Test D) Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A) Rule I only B) Rule III only C) Rule II and III D) Rule I and II

Rule I only

The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments. T or F

TRUE

Which of the following best describes the Net Present Value rule? A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV) C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.

Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.

Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today

A lawn maintenance company compares two ride-on mowersthe Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A) Fuel prices are expected to rise and raise the annual running costs of all mowers. B) The mower is only expected to be needed for three years. C) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate. D) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future

The mower is only expected to be needed for three years

Which of the following statements is FALSE? A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV). B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C) For most investment opportunities, expenses occur initially and cash is received later. D) Fifty percent of firms surveyed reported using the payback rule for making decisions

The payback rule is reliable because it considers the time value of money and depends on the cost of capital.

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis? A) $780,000 B) $1,000,000 C) Cannot be determined because inadequate information is given. D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.

The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity

Which of the following statements is FALSE? A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. B) Total return equals earnings multiplied by the dividend payout rate. C) Cutting the firmʹs dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

Total return equals earnings multiplied by the dividend payout rate.

A firm can either pay its earnings to its investors, or it can keep them and reinvest them. T or F

True

Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count. T or f

True

Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment. T or f

True

Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate. T or F

True

The Net Present Value rule implies that we should compare a projectʹs net present value (NPV) to zero. T or F

True

The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive. T or f

True

The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity. T or F

True

The profitability index can break down completely when dealing with multiple resource restraints. T or F

True

When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed. T or f

True

When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns. T or F

True

When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule. T or F

True

You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity. T or F

True

Which of the following is NOT a valid method of modifying cash flows to produce a MIRR? A) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. B) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project. C) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project. D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the projectʹs lifetime

Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the projectʹs lifetime

Which of the following statements is FALSE of the dividend-discount model? A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firmʹs future dividends states that they will grow at a constant rate, i.e., forever

We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth

The owners of a chain of fast-food restaurants spend $25 million installing donut makers in all their restaurants. This is expected to increase cash flows by $11 million per year for the next five years. If the discount rate is 5.3%, were the owners correct in making the decision to install donut makers? A) No, as it has a net present value (NPV) of -$4.45 million. B) No, as it has a net present value (NPV) of -$2.22 million. C) Yes, as it has a net present value (NPV) of $13.34 million. D) Yes, as it has a net present value (NPV) of $22.23 million.

Yes, as it has a net present value (NPV) of $22.23 million

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct? A) Yes, because it agrees with the Net Present Value rule. B) Yes, because it agrees with the payback rule. C) Yes, because it agrees with both the Net Present Value rule and the payback rule. D) Yes, because it disagrees with the Net Present Value rule.

Yes, because it agrees with the Net Present Value rule.

Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices? A) No, since the net present value (NPV) of the investment, should he take it, is less than the net present value (NPV) of the home repairs if he delays them for one year. B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan. C) Yes, since the net present value (NPV) of the investment is greater than zero he can invest the $10,000 in the business opportunity, and then next year use this money plus the benefit from this money to make the necessary home repairs. D) Yes, since the net present value (NPV) of the investment, should he take it, is greater than the net present value (NPV) of the home repairs if he delays them for one year.

Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan

A company has identified the following investments as looking promising. Each requires an initial investment of $1.2 million. Which is the best investment? A) a perpetuity that generates a cash flow at the end of year 1 of $100,000, has a growth rate of 1.25%, and a cost of capital of 11.0% B) a perpetuity that generates a cash flow at the end of year 1 of $800,000, has a growth rate of 2.25%, and a cost of capital of 11.8% C) an investment that generates a cash flow of $400,000 at the end of each of the next five years, when the cost of capital is 6.1% D) an investment that generates a cash flow of $200,000 at the end of each of the next ten years, when the cost of capital is 6.1%

a perpetuity that generates a cash flow at the end of year 1 of $800,000, has a growth rate of 2.25%, and a cost of capital of 11.8%

What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) incremental increases in the value of the stock held by an investor due to rises in share price C) the difference between the original cost price of a share and the price an investor receives when that share is sold D) a share of the profits paid to each shareholder on the basis of the number of shares they hold

a share of the profits paid to each shareholder on the basis of the number of shares they hold

Which of the following is NOT a way that a firm can increase its dividend? A) by increasing its retention rate B) by decreasing its shares outstanding C) by increasing its earnings (net income) D) by increasing its dividend payout rate

by increasing its retention rate

Assume that projects A and B are mutually exclusive. The correct investment decision and the best rationale for that decision is to ________. A) invest in project A, since NPVB < NPVA B) invest in project B, since IRRB > IRRA C) invest in project B, since NPVB > NPVA D) invest in project A, since NPVA > 0

invest in project A, since NPVB < NPVA

You placed an order to purchase stock where you specified the maximum price you were willing to pay. This type of order is known as a ________. A) maximum order B) limit order C) floor order D) market order

limit order

A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following? A) profitability index B) payback period C) net present value (NPV) D) internal rate of return (IRR

net present value (NPV)

You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is ________. A) net present value (NPV) B) profitability index C) internal rate of return (IRR) D) incremental internal rate of return (IRR)

net present value (NPV)

The cash flows for three projects are shown above. The cost of capital is 9.5%. If an investor decided to take projects with a payback period two years or less, which of these projects would he take? A) Investment A B) Investment B C) Investment C D) none of these investments

none of these investments

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment? A) internal rate of return (IRR) B) profitability index C) net present value (NPV) D) payback period

payback period

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A) profitability index B) MIRR C) equivalent annual annuity D) payback period

payback period

Most corporations measure the value of a project in terms of which of the following? A) discount value B) discount factor C) future value (FV) D) present value (PV)

present value (PV)

You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space? A) internal rate of return (IRR) B) payback period C) net present value (NPV) D) profitability index

profitability index

Which of the following formulas is INCORRECT? A) g = Retention Rate × Return on New Investment B) Divt = EPSt × Dividend Payout Rate C) P0 = Div1 / (rE - g) D) rE = (Div1 / P0) - g

rE = (Div1 / P0) - g

Which of the following is a disadvantage of the Net Present Value rule? A) can be misleading if inflows come before outflows B) not necessarily consistent with maximizing shareholder wealth C) ignores cash flows after the cutoff point D) relies on accurate estimate of the discount rate

relies on accurate estimate of the discount rate

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A) so that you can see which project has the greatest net present value (NPV) B) so that the projects can be compared on their cost or value created per year C) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe D) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered

so that the projects can be compared on their cost or value created per year

The present value (PV) of an investment is ________. A) the amount that an investment would yield if the benefit were realized today B) the difference between the cost of the investment and the benefit of the investment in dollars today C) the amount you need to invest at the current interest rate to re-create the cash flow from the investment D) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate

the amount that an investment would yield if the benefit were realized today