Module 7
A company has retained earnings of $94,000 as of December 31, 2014. The Pro-forma income statement projects net income of $22,000 for 2015. The company expects to declare their annual dividend on March 15, 2015 of $0.70 per share and has a total of 100,000 shares outstanding. What will the projected retained earnings account be as of December 31, 2015?
$46,000 To calculate the projected retained earnings, you add the projected 2015 net income of $22,000 to the beginning balance of $94,000 carried over from 2014. Then you must subtract $70,000 for the dividend of $0.70 per share times the 100,000 shares outstanding. $94,000 + $22,000 - $70,000 = $46,000
Which of the following statements is NOT true in relation to the Gordon Growth Model?
A higher discount rate results in a higher terminal value. This statement is not true. A higher discount rate results in a lower terminal value.
Present Value of Infinite Cash Flows
Cash flows in the final year of our projection / discount rate - growth rate
Which of the following is INCORRECT in determining free cash flows?
Subtract depreciation This is the correct answer! It is NOT true. You ADD BACK depreciation in determining free cash flows.
A project has the estimated cash flows shown below. The discount rate is 8%. Calculate the NPV of this project.
The correct answer is $41,511. The correct answer formula is: =NPV(E4,B3:B9)+B2 (E4 is the rate, B3to9 is the cash flow numbers only positive) and B2 is the negative cash flow
Company A estimates that it needs 30% of sales in net working capital. In year 1, sales were $1 million and in year 2, sales were $2 million. Associated with the change in net working capital from year 1 to year 2 is a cash:
outflow of $300,000.
Free Cash Flows
(1-tax rate) x Earnings before Interest and Taxes + Depreciation and Amortization - Capital Expenditures - Change in Net Working Capital
Donegan's Deli had the following account balances as of December 31, 2014: and the following account balances as of December 31, 2015: Which of the following represents the Change in Net Working Capital from 2014 to 2015?
Change in Net Working Capital is calculated as the current year's net of current assets (excluding cash) and current liabilities less the prior year's net of current assets and current liabilities. The Net Working Capital for 2015 was $1,600. The Net Working Capital for 2014 was $1,375. The difference, the change in NWC, is 225.
The primary costs that make up the cost of sales for Medtronic Inc. are employee costs, chemical costs, and supplies costs. Employee costs are forecast to be 15% of revenue, chemical costs are forecast to be 10% of revenue, and supplies costs are forecast to be 5% of revenue, for a total of 30%. With forecasted sales revenue of $175 million for 2015, what will be the forecasted cost of sales for 2015?
Cost of sales is forecast to be 30% of net sales (sum of employee cost, 15% + chemical cost, 10% + supplies cost, 5%). In order to calculate, multiply 2015 sales by 30%. Calculation: (175.0 * 0.30) = 52.5
Bob's Burgers had the following account balances as of December 31, 2014: Accounts Receivable $1,825 Accumulated Depreciation$200 Inventory $750 Building $2,000 Equipment $500 Accounts Payable $400 Salaries/Wages Payable$925 Which of the following represents the Net Working Capital for the business?
Current assets (excluding cash) less current liabilities equals Net Working Capital. In this case, currents assets total $2,575 (accounts receivable and inventory) and current liabilities total $1,325. (salaraies and wages payable and accounts payable) The difference, NWC, is $1,250.
The founders of a business are interested in investing in a project in the coming year, and they have two different projects to choose from. The estimated cash flows of the two projects are shown below. The company's Weighted Average Cost of Capital (WACC) is 9%. Calculate the IRR of each project.
For Project 1, the correct answer is 10.62% The correct answer formula, which should be entered into cell E4, is the following: =IRR(B3:B10) For Project 2, the correct answer is 9.43% The correct answer formula, which should be entered into cell E16, is the following: =IRR(B15:B22)
The founders of a business are interested in investing in a project in the coming year, and they have two projects to choose from. The estimated cash flows of the two projects are shown below. The company's Weighted Average Cost of Capital (WACC) is 9%. Calculate the IRR of each project.
For Project 1, the correct answer is 12.52% The correct answer formula, which should be entered into cell E4, is the following: =IRR(B3:B10) (B3to 10 is all cahs flows) For Project 2, the correct answer is 16.50% The correct answer formula, which should be entered into cell E16, is the following: =IRR(B15:B22)
You have just reviewed the financial statements of Penelope's Candy Store (PCS). You have determined that PCS has a Profit Margin of 19%. How do you explain this to owner Penelope Hassey?
For every $100 in sales, $19 ended up in Net Income. Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period. A Profit Margin of 19% tells us that for every $100 in sales, $19 ended up in Net Income.
When projecting financial statements, which of the following accounts is difficult to forecast using the percent of sales method?
Interest Expense Normally, Accounts Receivable, Accounts Payable, and Cost of Sales will trend in a direct relationship with sales. However, Interest Expense is more dependent upon the level of borrowings which does not necessarily track with sales.
What is free cash flow?
It is the amount of cash that a business could be expected to generate from its normal operations.
An automotive parts company that sells to automotive manufacturers is forecasting revenue as part of its internal budgeting and planning process. Which of the following is LEAST likely to be important in its forecasting assumptions?
Level of long-term debt The level of long-term debt would not likely impact the revenue forecast.
On which financial statements would you be most likely to find information about capital expenditures related to the purchase of equipment during the past year?
Look at the investing section in the statement of cash flows
A CFO of a start-up company is evaluating the timing of a significant capital expenditure. He was previously at a mature company that used a discount rate of 8% so he used the same rate at the start-up company. Which of the following would be impacted if the discount rate were raised to reflect the risk of the start-up company?
Net present value NPV is the only one of the answer choices that is impacted by the discount rate.
Which of the following options is true in regards to financial forecasts?
Odds are, forecasts will differ from actual results. Because of the assumptions that need to be made when creating forecasts and the subjectivity involved in making those assumptions, a financial forecast may be good base idea of the company's future operations, but they will most likely not be exactly correct.
Blueridge Vet Clinic buys a diagnostic piece of equipment for $115,000. The machine will be depreciated on a straight-line basis for 10 years with a salvage value of $12,000. The company expects the machine to be able to generate after-tax cash flows of $44,000 in each of the 10 years, and then it will sell the machine for $12,000 at the end of 10 years. What are the cash flows related to this purchase for each of the next 10 years? Ignore taxes.
The annual cash flows will commence at the beginning of year 1 when the piece of equipment is purchased. This will be a negative cash flow of $-115,000. In the next 9 years, the company will benefit from the $44,000 of after-tax cash flow generated each year. In year 10 the company will also benefit from the salvage value of $12,000 bringing that year's cash flow to $56,000. tCash Flow0-115,000144,000244,000344,000444,000544,000644,000744,000844,000944,0001056,000
Applied Medical Services buys a diagnostic piece of equipment for $326,000. The machine will be depreciated on a straight-line basis for 10 years with a salvage value of $75,000. The company expects the machine to be able to generate after-tax cash flows of $64,000 in each of the 10 years, and then it will sell the machine for $75,000 at the end of 10 years. What are the cash flows related to this purchase for each of the next 10 years? Ignore taxes.
The annual cash flows will commence at the beginning of year 1 when the piece of equipment is purchased. This will be a negative cash flow of $326,000. In the next 9 years, the company will benefit from the $64,000 of after-tax cash flow generated each year. In year 10 the company will also benefit from the salvage value of $75,000 bringing that year's cash flow to $139,000.
Which of the following cash flows should be used in an NPV calculation to determine which project to pursue? (Select all that apply.)
The cash inflows expected as a result of the project This is correct! It is an incremental cash flow that would only be received if the project were undertaken. Investment needed to be made by the company to undertake the project This is correct! It is an incremental cash flow that would only be incurred if the project is undertaken.
Net Working Capital
The cash that is tied up in a business' operations. Usually calculated as current assets less current liabilities. The change in net working capital is part of the free cash flow equation.
A company is considering buying a diagnostic piece of equipment for $250,000. The machine will be depreciated on a straight-line basis for 10 years with a salvage value of $40,000. The company expects the machine to be able to generate after-tax revenues of $33,000 in each of the 10 years, and then it will sell the machine for $40,000 at the end of 10 years. The sum of the undiscounted cash flows is $370,000. The discount rate is 7%. The net present value is calculated to be $2,112. Which of the following statements is true?
The company should buy the equipment because the NPV is positive. As long as the NPV is positive, even if it is a very small positive number, it means the company will earn a return greater than its discount rate, so it is a good investment.
Clean Air Systems buys a diagnostic piece of equipment for $270,000. The machine will be depreciated on a straight-line basis for 10 years with a salvage value of $50,000. The company expects the machine to be able to generate after-tax cash flows of $43,000 in each of the 10 years, and then it will sell the machine for $50,000 at the end of 10 years. The discount rate is 7%. What is the Net Present Value?
The correct answer is $57,431. The correct answer formula, which should be entered into cell E5, is the following: =NPV(E4,B3:B12)+B2 - E4 is the rate, B3ro12 is positive cash flows) B2is negative cahs flow Remember, for NPV you have to manually add the negative outflow from time zero related to the initial investment.
A project has the estimated cash flows shown as indicated below. The discount rate is 7%. Calculate the NPV of this project.
The correct answer is -$7,124 The correct answer formula, which should be entered into cell E5, is the following: NPV(E4,B3:B7)+B2 Remember, for NPV you have to manually add the negative outflow from time zero related to the initial investment.
A project has the estimated cash flows shown as indicated below. The discount rate is 8% and the NPV is $17,924. Calculate the IRR of this project.
The correct answer is 18.97%. The correct answer formula, which should be entered into cell E6, is the following: =IRR(B2:B7) - Bs are all cash flows
A project has the estimated cash flows shown below. The discount rate is 8% and the NPV is $41,511. Calculate the IRR of this project
The correct answer is 21.23%. The correct answer formula is: =IRR(B2:B9) (the Bs are all the numbers for cash Flows)
A project has an initial cost of $25,000. Expected cash flows as a result of this project are as follows: $6,000 in 2015 $6,000 in 2016 $8,000 in 2017 $10,000 in 2018 What is the payback period for this project?
The correct answer is 3.5 years. At the end of year 3 the project has returned $20,000 ($6,000 + $6,000 + $8,000). This leaves $5,000 to be returned to hit payback. Assuming that the $10,000 projected for year 4 comes in a steady stream, this would mean it would take half of that year.
A project has an initial cost of $44,000. Expected cash flows as a result of this project are projected as indicated below. Calculate the payback period for this project. Assume a discount rate of 9%.
The correct answer is 3.5 years. At the end of year 3 the project has returned $35,000 ($10,000 + $10,000 + $15,000). This leaves $9,000 to be returned to hit payback. Assuming that the $18,000 projected for year 4 comes in a steady stream, this would mean it would take half of that year.
The founders of a business are interested in investing in a project in the coming year. The two projects are mutually exclusive. The estimated cash flows of the two projects are shown below. The company's Weighted Average Cost of Capital (WACC) is 9%. The table below shows the data from the previous spreadsheet exercise and the correct IRR calculation
The correct answer is Project 2. Project 2 has the higher IRR and the IRR for Project 1 is below the WACC of 9%.
Cybertrex, a manufacturing facility, rented a new piece of equipment on January 1st and agreed to pay an annual rental fee of $18,000 at the end of each of the next 10 years. The weighted average cost of capital of the company is 8%. The present value of $1 for 10 years at 8% is 0.46319 The present value of an ordinary annuity of $1 for 10 years at 8% is 6.71008 What is the Present Value of the rental payments over 10 years?
The correct answer is: $120,781 It is calculated by multiplying the annual payment by the present value of an annuity factor. $18,000 * 6.71008 = $120,781
Metafacturing Inc. rented a new piece of equipment on January 1st and agreed to pay an annual rental fee of $24,000 at the end of each of the next 10 years. The weighted average cost of capital of the company is 8%. The present value of $1 for 10 years at 8% is 0.46319 The present value of an ordinary annuity of $1 for 10 years at 8% is 6.71008 What is the Present Value of the rental payments over 10 years?
The correct answer is: $161,042 It is calculated by multiplying the annual payment by the present value of an annuity factor. $24,000 * 6.71008 = $161,042
