Unit Quizzes (FINANCE FINAL)
A firm that uses its weighted average cost of capital as the required return for all of its investments will:
Increase the risk level of the firm over time.
You find a zero coupon bond with a par value of $10,000 and 13 years to maturity. The yield to maturity on this bond is 5 percent. Assume semiannual compounding periods. What is the price of the bond?
$ 5,262.35
Blue Water bonds have a face value of $1,000, a coupon rate of 6.5 percent, semiannual interest payments, and mature in 11.5 years. What is the current price of these bonds if the yield to maturity is 6.36 percent?
$1,011.30
What is the NPV of the following set of cash flows at a discount rate of zero percent? What if the discount rate is 15 percent? Year 0 $-21,400 Year 1 $11,600 Year 2 $13,500 Year 3 $12,200
$15,900; $6,916.59
Yan Yan Corp. has a $3,000 par value bond outstanding with a coupon rate of 5 percent paid semiannually and 14 years to maturity. The yield to maturity of the bond is 3.9 percent. What is the price of the bond?
$3,201
Suppose you know that a company's stock currently sells for $65.20 per share and the required return on the stock is 10 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield. If it's the company's policy to always maintain a constant growth rate in its dividends, what is the current dividend per share?
$3.26 = D0(1 + .050) D0 = $3.26 / 1.050 D0 = $3.10
Sugar Cookies will pay an annual dividend of $1.23 a share next year. The firm expects to increase this dividend by 8 percent per year the following four years and then decrease the dividend growth to 2 percent annually thereafter. Which one of the following is the correct computation of the dividend for Year 7?
($1.23) ×(1.08)4×(1.02)2
Which statement is true? (A) A bondholder has the right to determine when his or her bond is called. (B) Bonds are generally called at par value. (C) An indenture is a contract between a bond's issuer and its holders. (D) Collateralized bonds are called debentures. E) A current list of all bondholders is maintained whenever a firm issues bearer bonds.
(C)
Of these choices, a risk-adverse investor who prefers to minimize interest rate risk is most apt to invest in: (A) 3-year, zero coupon bonds. (B) 20-year, 6 percent coupon bonds. (C) 5-year, 7 percent coupon bonds. (D) 2-year, 7 percent coupon bonds. (E) 20-year, zero coupon bonds.
(D) 2-year, 7% Coupon Bonds
AB Builders has 15-year bonds outstanding with a face value of $1,000 and a market price of $974. The bonds pay interest annually and have a yield to maturity of 4.03 percent. What is the coupon rate?
3.8%
The $1,000 face value bonds of Galaxies International have coupon of 6.45 percent and pay interest semiannually. Currently, the bonds are quoted at 103.4 and mature in 4 years. What is the yield to maturity?
5.49%
The Toy Chest will pay an annual dividend of $2.64 per share next year and currently sells for $48.30 a share based on a market rate of return of 11.67 percent. What is the capital gains yield?
6.2% g = .1167- ($2.64/$48.30) = .0620
Smiley Industrial Goods has $1,000 face value bonds on the market with semiannual interest payments, 13.5 years to maturity, and a market price of $1,023. At this price, the bonds yield 6.4 percent. What must be the coupon rate on these bonds?
6.66%
A bond has a $1,000 face value, a market price of $1,045, and pays interest payments of $74.50 every year. What is the coupon rate?
7.45%
A stock is priced at $38.24 a share and has a market rate of return of 9.65 percent. What is the dividend growth rate if the company plans to pay an annual dividend of $.48 a share next year?
8.39%
Whitts BBQ would like to issue some 10-year, semiannual coupon bonds at par. Comparable bonds have a current yield of 9.16 percent, an effective annual yield of 9.68 percent, and a yield to maturity of 9.50 percent. What coupon rate should Whitts BBQ set on its bonds?
9.5%
Volbeat Corporation has bonds on the market with 14.5 years to maturity, a YTM of 10.2 percent, a par value of $1,000, and a current price of $953. The bonds make semiannual payments. What must the coupon rate be on the bonds?
9.57%
An engineer is evaluating three new production lines. While each of these lines appear to have a positive NPV, their total cost would be $39 million. Her capital budget cannot exceed $30 million. The designs on each line have been optimally engineered, so no further design changes will be possible: these projects are not divisible. Given her discount rate of 8%, what projects should she invest in? Project Initial NPV Investment A $12 $1.250 B $15 $1.150 C $12 $1.640
A and C
Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?
Ace Builders' cost of capital
The current yield on a bond is equal to the annual interest divided by the:
Current market price
The common stock of GT Enterprises is selling for $63.09 a share. The company pays a constant annual dividend and has a total return of 11.64 percent. What is the amount of the dividend?
D = .1164 ×$63.09 = $7.34
The price of a stock at Year 4 can be expressed as:
D5/(R - g)
The capital gains yield equals which one of the following?
Dividend Growth Rate
Flo is considering three mutually exclusive options for the additional space she plans to add to her specialty women's store. The cost of the expansion will be $148,000. She can use this additional space to add children's clothing, an exclusive gifts department, or a home décor section. She estimates the present value of the cash inflows from these projects are $121,000 for children's clothing, $178,000 for exclusive gifts, and $145,000 for decorator items. Which option(s), if any, should she accept?
Exclusive gifts only
Which term applies to a junk bond that was originally issued with a bond rating of AA?
Fallen Angel
A company originally issued bonds that were rated investment grade. These bonds have now been downgraded to junk status. These bonds are referred to as:
Fallen angels
You want to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?
Firm operations
Kolby's Korndogs is looking at a new sausage system with an installed cost of $753,000. This cost will be depreciated straight-line to zero over the project's six-year life, at the end of which the sausage system can be scrapped for $96,000. The sausage system will save the firm $184,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $42,000. If the tax rate is 35 percent and the discount rate is 7 percent, what is the NPV of this project?
First, we will calculate the annual depreciation of the new equipment. It will be: Annual depreciation = $753,000 / 6 Annual depreciation = $125,500 Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or plus) the taxes on the sale of the equipment, so: Aftertax salvage value = MV + (BV - MV)TC Very often, the book value of the equipment is zero, as it is in this case. If the book value is zero, the equation for the aftertax salvage value becomes: Aftertax salvage value = MV + (0 - MV)TC Aftertax salvage value = MV(1 - TC) We will use this equation to find the aftertax salvage value since we know the book value is zero. So, the aftertax salvage value is: Aftertax salvage value = $96,000(1 - .35) Aftertax salvage value = $62,400 Using the tax shield approach, we find the OCF for the project is: OCF = $184,000(1 - .35) + .35($125,500) OCF = $163,525 Now we can find the project NPV. Notice we include the NWC in the initial cash outlay. The recovery of the NWC occurs in Year 6, along with the aftertax salvage value. NPV = -$753,000 - 42,000 + $163,525(PVIFA7%,6) + [($62,400 + 42,000) / 1.076] NPV = $54,014.53
Your firm is contemplating the purchase of a new $787,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $57,000 at the end of that time. You will be able to reduce working capital by $52,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 40 percent. Suppose your required return on the project is 7 percent and your pretax cost savings are $207,000 per year. What is the NPV of the project?
First, we will calculate the annual depreciation of the new equipment. It will be: Annual depreciation charge = $787,500 / 7 Annual depreciation charge = $112,500 The aftertax salvage value of the equipment is: Aftertax salvage value = $57,000(1 - .40) Aftertax salvage value = $34,200 To evaluate the project with a $207,000 cost savings, we need the OCF to compute the NPV. Using the tax shield approach, the OCF is OCF = $207,000(1 - .40) + .40($112,500) OCF = $169,200 NPV = -$787,500 + 52,000 + $169,200(PVIFA7%,7) + [($34,200 - 52,000) / (1.07)7] NPV = $165,282.82
Wesen Corp. will pay a dividend of $4.50 next year. The company has stated that it will maintain a constant growth rate of 5.25 percent a year forever. If you want a return of 18 percent, how much will you pay for the stock?
Here, we need to value a stock with two different required returns. Using the constant growth model and a required return of 18 percent, the stock price today is: P0 = D1 / (R - g) P0 = $4.50 / (.18 - .0525) P0 = $35.29
An investment has an installed cost of $576,382. The cash flows over the four-year life of the investment are projected to be $205,584, $249,318, $197,674, and $165,313. If the discount rate is infinite, what is the NPV?
If the required return is infinite, future cash flows have no value. Even if the cash flow in one year is $1 trillion, at an infinite rate of interest, the value of this cash flow today is zero. So, if the future cash flows have no value today, the NPV of the project is simply the cash flow today. At an infinite interest rate: NPV = -$576,382
Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?
Kurt's division is less risky than the other divisions.
Professional Properties is considering remodeling the office building it leases to Heartland Insurance. The remodeling costs are estimated at $2.8 million. If the building is remodeled, Heartland Insurance has agreed to pay an additional $820,000 a year in rent for the next five years. The discount rate is 12.5 percent. What is the benefit of the remodeling project to Professional Properties?
NPV = -$2,800,000 + $820,000 ×{1 - [1 / (1 + .125)5]} / .125 NPV = $119,666.04
Corner Restaurant is considering a project with an initial cost of $211,600. The project will not produce any cash flows for the first three years. Starting in Year 4, the project will produce cash inflows of $151,000 a year for three years. This project is risky, so the firm has assigned it a discount rate of 18.6 percent. What is the project's net present value?
NPV = -$211,600 + $151,000 / 1.1864 + $151,000 / 1.1865 + $151,000 / 1.1866 NPV = -$16,670.67
Consider the following cash flows: Year Cash Flow 0 -$ 34,000 1 13,600 2 18,100 3 11,000 What is the NPV at a discount rate of 8 percent?
NPV = -$34,000 + $13,600 / 1.08 + $18,100 / 1.082 + $11,000 / 1.083 NPV = $2,842.58
Consider the following cash flows: Year Cash Flow 0 -$ 34,000 1 13,600 2 18,100 3 11,000 What is the NPV at a discount rate of 18 percent?
NPV = -$34,000 + $13,600 / 1.18 + $18,100 / 1.182 + $11,000 / 1.183 NPV = -$2,780.50
Consider the following cash flows: Year Cash Flow 0 -$ 34,000 1 13,600 2 18,100 3 11,000 What is the NPV at a discount rate of 28 percent?
NPV = -$34,000 + $13,600 / 1.28 + $18,100 / 1.282 + $11,000 / 1.283 NPV = -$7,082.43
Consider the following cash flows: Year Cash Flow 0 -$ 34,000 1 13,600 2 18,100 3 11,000 What is the NPV at a discount rate of zero percent?
NPV = -$34,000 + 13,600 + 18,100 + 11,000 NPV = $8,700
An investment has an installed cost of $576,382. The cash flows over the four-year life of the investment are projected to be $205,584, $249,318, $197,674, and $165,313. If the discount rate is zero, what is the NPV?
NPV = -$576,382 + 205,584 + 249,318 + 197,674 + 165,313 NPV = $241,507
You are considering an investment for which you require a rate of return of 8.5 percent. The investment costs $67,400 and will produce cash inflows of $25,720 for three years. Should you accept this project based on its internal rate of return? Why or why not?
NPV = 0 = -$67,400 + $25,720 / (1 + IRR) + $25,720 / (1 + IRR)2 + $25,720 / (1 + IRR)3 IRR = 7.08 percent The project should be rejected because the IRR is less than the required rate.
A project has the following cash flows. What is the internal rate of return? Year 0 $-68,700 Year 1 $19,600 Year 2 $22,300 Year 3 $27,500 Year 4 $15,300
NPV = 0 = -$68,700 + $19,600 / (1 + IRR) + $22,300 / (1 + IRR)2 + $27,500 / (1 + IRR)3 + $15,300 / (1 + IRR)4 IRR = 9.08 percent
Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities?
Net Present Value
A nine-year project is expected to generate annual revenues of $137,800, variable costs of $82,600, and fixed costs of $11,000. The annual depreciation is $23,500 and the tax rate is 34 percent. What is the annual operating cash flow?
Operating cash flow = ($137,800 -82,600 -11,000) ×(1 -.34) + ($23,500 ×.34) = $37,162
The Outpost currently sells short leather jackets for $369 each. The firm is considering selling long coats also. The long coats would sell for $719 each and the company expects to sell 820 a year. If the company decides to carry the long coat, management feels that the annual sales of the short jacket will decline from 1,120 to 1,040 units. Variable costs on the jacket are $228 and $435 on the long coat. The fixed costs for this project are $23,100, depreciation is $10,400 a year, and the tax rate is 34 percent. What is the projected operating cash flow for this project?
Operating cash flow = {[820 ×($719- 435)] + [(1,040 - 1,120) ×($369 -228)] - $23,100} ×{1 -.34} + {$10,400 ×.34} = $134,546
The Management of Premium Manufacturing Company is evaluating two automated forklift systems to use in its plant that produces the towers for windmill power farms. The costs and the cash flows from these systems are shown below. If the company uses a 12 percent discount rate for all projects, determine which forklift system should be purchased using the net present value (NPV) approach. Cash flows for Otis Forklifts: Cash flows for Craigmore Forklifts: Period Cash flow Cash flow 0 -$3,123,450 -$4,137,410 1 $979,225 $875,236 2 $1,358,886 $1,765,225 3 $2,111,497 $2,865,110
Otis Forklifts
Breakfast Hut pays a constant annual dividend of $1.39 per share. How much are you willing to pay for one share if you require a rate of return of 14.6 percent?
P = $1.39 /.146 = $9.52
Solar Energy will pay an annual dividend of $1.93 per share next year. The company just announced that future dividends will be increasing by 1.6 percent annually. How much are you willing to pay for one share of this stock if you require a rate of return of 11.75 percent?
P0 = $1.93 / (.1175 - .016) = $19.01
Wesen Corp. will pay a dividend of $4.50 next year. The company has stated that it will maintain a constant growth rate of 5.25 percent a year forever. If you want a return of 11 percent, how much will you pay for the stock?
P0 = D1 / (R - g) P0 = $4.50 / (.11 - .0525) P0 = $78.26
Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus one percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project?
Perceived risk level of project
Gnomes R Us is considering a new project. The company has a debt-equity ratio of .85. The company's cost of equity is 14.5 percent, and the aftertax cost of debt is 7.8 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent. What discount rate should the firm use for the project?
Project discount rate = .1142 + .02 Project discount rate = .1342, or 13.42%
Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which term applies to this granting of authority?
Proxy
Sweet Treats pays a constant annual dividend of $2.38 a share and currently sells for $52.60 a share. What is the rate of return?
R = $2.38/$52.60 = .0452, or 4.52 percent
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with ten years to maturity that is quoted at 111.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 8.8 percent annually. If the tax rate is 35 percent, what is the aftertax cost of debt?
RD = .0717(1 - .35) RD = .0466, or 4.66%
The market rate of return is 11.8 percent and the risk-free rate is 3.45 percent. Galaxy Co. has 36 percent more systematic risk than the overall market and has a dividend growth rate of 3.5 percent. What is the firm's cost of equity?
RE = .0345 + 1.36(.118 -.0345)] = .14806 or 14.81 percent
Trendsetters has a cost of equity of 14.6 percent. The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent. The company is acquiring a competitor, which will increase the company's beta to 1.4. What effect, if any, will the acquisition have on the firm's cost of equity capital?
RE= .039 + 1.4(.084) = .1566, or 15.66 percent Increase in cost of equity = 15.66 percent -14.6 percent = 1.06 percent
The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent. The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent. What is the cost of equity for this firm?
RE= .041 + 1.13 ×(.127-.041) = .1382, or 13.82 percent
Custom Tailored Shirts is a specialty retailer offering T-shirts, sweatshirts, and caps. Its most recent annual sales consisted of $21,000 of T-shirts, $18,000 of sweatshirts, and $2,900 of caps. The company is adding polo shirts to the lineup and projects that this addition will result in sales next year of $18,000 of T-shirts, $16,000 of sweatshirts, $11,500 of Polo shirts, and $2,100 of caps. What sales amount should be used when evaluating the Polo shirt project?
Sales = ($18,000 + 16,000 + 11,500 + 2,100) - ($21,000 + 18,000 + 2,900) = $5,700
Which one of the following principles refers to the assumption that a project will be evaluated based on its incremental cash flows?
Stand-alone principle
The analysis of a new project should exclude:
Sunk Costs
A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as a(n):
Sunk cost
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 421,000 -$ 38,000 1 46,000 20,000 2 60,000 13,700 3 77,000 16,600 4 536,000 13,400 The required return on these investments is 12 percent. What is the IRR for each project?
The IRR for each project is: A: $421,000 = $46,000 / (1 + IRR) + $60,000 / (1 + IRR)2 + $77,000 / (1 + IRR)3 + $536,000 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 16.69% B: $38,000 = $20,000 / (1 + IRR) + $13,700 / (1 + IRR)2 + $16,600 / (1 + IRR)3 + $13,400 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 26.19% The IRR decision rule implies we accept Project B because the IRR for B is greater than the IRR for A.
Reece Company is presented with the following two mutually exclusive projects. The required return for both projects is 17 percent. Year Project M Project N 0 -$ 145,000 -$ 360,000 1 64,000 150,000 2 82,000 185,000 3 73,000 135,000 4 59,000 115,000 What is the IRR for each project?
The IRR for each project is: M: $145,000 = $64,000 / (1 + IRR) + $82,000 / (1 + IRR)2 + $73,000 / (1 + IRR)3 + $59,000 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 32.73% N: $360,000 = $150,000 / (1 + IRR) + $185,000 / (1 + IRR)2 + $135,000 / (1 + IRR)3 + 115,000 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 24.12% The IRR decision rule implies we accept Project M because the IRR for M is greater than the IRR for N.
Consider the following cash flows: Year Cash Flow 0 -$ 33,000 1 14,400 2 17,300 3 11,800 What is the IRR of the above set of cash flows?
The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is: 0 = -$33,000 + $14,400 / (1 + IRR) + $17,300 / (1 + IRR)2 + $11,800 / (1 + IRR)3 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 15.68%
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 421,000 -$ 38,000 1 46,000 20,000 2 60,000 13,700 3 77,000 16,600 4 536,000 13,400 The required return on these investments is 12 percent. What is the NPV for each project?
The NPV for each project is: A: NPV = -$421,000 + $46,000 / 1.12 + $60,000 / 1.122 + $77,000 / 1.123 + $536,000 / 1.124 NPV = $63,347.83 B: NPV = -$38,000 + $20,000 / 1.12 + $13,700 / 1.122 + $16,600 / 1.123 + $13,400 / 1.124 NPV = $11,110.19 The NPV criterion implies we accept Project A because Project A has a higher NPV than Project B.
Reece Company is presented with the following two mutually exclusive projects. The required return for both projects is 17 percent. Year Project M Project N 0 -$ 145,000 -$ 360,000 1 64,000 150,000 2 82,000 185,000 3 73,000 135,000 4 59,000 115,000 What is the NPV for each projcet?
The NPV for each project is: M: NPV = -$145,000 + $64,000 / 1.17 + $82,000 / 1.172 + $73,000 / 1.173 + $59,000 / 1.174 NPV = $46,667.37 N: NPV = -$360,000 + $150,000 / 1.17 + $185,000 / 1.172 + $135,000 / 1.173 + $115,000 / 1.174 NPV = $49,009.92 The NPV criterion implies we accept Project N because Project N has a higher NPV than Project M.
Your firm is contemplating the purchase of a new $787,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $57,000 at the end of that time. You will be able to reduce working capital by $52,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 40 percent. Suppose your required return on the project is 7 percent and your pretax cost savings are $147,000 per year. What is the NPV of the project?
The NPV with a $147,000 cost savings is: OCF = $147,000(1 - .40) + .40($112,500) OCF = $133,200 NPV = -$787,500 + 52,000 + $133,200(PVIFA7%,7) + [($34,200 - 52,000) / (1.07)7] NPV = -$28,731.60
What condition must exist if a bond's coupon rate is to equal both the bond's current yield and its yield to maturity? Assume the market rate of interest for this bond is positive.
The bond must be priced at par.
An investment has an installed cost of $576,382. The cash flows over the four-year life of the investment are projected to be $205,584, $249,318, $197,674, and $165,313. At what discount rate is the NPV just equal to zero?
The interest rate that makes the NPV of a project equal to zero is the IRR. The equation for the IRR of this project is: 0 = -$576,382 + $205,584 / (1 + IRR) + $249,318 / (1 + IRR)2 + $197,674 / (1 + IRR)3 + $165,313 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 16.37%
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 421,000 -$ 38,000 1 46,000 20,000 2 60,000 13,700 3 77,000 16,600 4 536,000 13,400 The required return on these investments is 12 percent. What is the payback period for each project?
The payback period for each project is: A: 3 + ($238,000 / $536,000) = 3.44 years B: 2 + ($4,300 / $16,600) = 2.26 years The payback criterion implies accepting Project B, because it pays back sooner than Project A.
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with ten years to maturity that is quoted at 111.5 percent of face value. The issue makes semiannual payments and has an embedded cost of 8.8 percent annually. What is the company's pretax cost of debt?
The pretax cost of debt is the YTM of the company's bonds, so: P0 = $1,115 = $44(PVIFAR%,20) + $1,000(PVIFR%,20) R = 3.585% YTM = 2 × 3.585% YTM = 7.17%
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 421,000 -$ 38,000 1 46,000 20,000 2 60,000 13,700 3 77,000 16,600 4 536,000 13,400 The required return on these investments is 12 percent. What is the profitability index for each project?
The profitability index for each project is: A: PI = ($46,000 / 1.12 + $60,000 / 1.122 + $77,000 / 1.123 + $536,000 / 1.124) / $421,000 PI = 1.150 B: PI = ($20,000 / 1.12 + $13,700 / 1.122 + $16,600 / 1.123 + $13,400 / 1.124) / $38,000 PI = 1.292 The profitability index criterion implies accepting Project B because its PI is greater than Project A's.
Six years ago, China Exporters paid cash for a new packaging machine that cost $347,000. Three years ago, the firm spent $14,300 on repairs and modifications to the machine. The machine is now fully depreciated and has just sat idly in a back corner of the shop for the past seven months. The estimated value of the machine today is $157,500. The firm is considering using this machine in a new project. If it does so, what value should be assigned to this machine and included in the initial costs of the new project?
The relevant cost is the opportunity cost of $157,500.
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?
The relevant cost is the opportunity cost of $480.
Mitchell, Inc., is expected to maintain a constant 5.6 percent growth rate in its dividends, indefinitely. If the company has a dividend yield of 4.1 percent, what is the required return on the company's stock?
The required return of a stock is made up of two parts: The dividend yield and the capital gains yield. So, the required return of this stock is: R = Dividend yield + Capital gains yield R = .0410 + .0560 R = .0970, or 9.70%
Gnomes R Us is considering a new project. The company has a debt-equity ratio of .85. The company's cost of equity is 14.5 percent, and the aftertax cost of debt is 7.8 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent . What is the company's WACC?
To find the required return for the project, we need to adjust the company's WACC for the level of risk in the project. A debt-equity ratio of .85 implies a weight of debt of .85 / 1.85 and a weight of equity of 1 / 1.85, so the company's WACC is: WACC = (.85 / 1.85)(.0780) + (1 / 1.85)(.1450) WACC = .1142, or 11.42%
Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of .45. The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?
Weight of equity = 1/1.45 = .6897, or 68.97 percent
All else held constant, the present value of a bond increases when the:
YTM decreases
Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. Given this, the firm should probably:
assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions.
When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that:
best matches the risk level of the proposed investment
The net present value of an investment represents the difference between the investment's:
cost and market value
The internal rate of return is the:
discount rate that results in a zero net present value for the project.
Net present value involves discounting an investment's:
future cash flows
The stock price of Baskett Co. is $53.90. Investors require a return of 13 percent on similar stocks. If the company plans to pay a dividend of $3.60 next year, what growth rate is expected for the company's stock price?
g = R - (D1 / P0) g = .13 - ($3.60 / $53.90) g = .0632, or 6.32%
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
When a bond's yield to maturity is less than the bond's coupon rate, the bond:
is selling at a premium.
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
The dividend yield is defined as:
next year's expected dividend divided by the current market price per share.
Thrill Rides is considering adding a new roller coaster to its amusement park. The addition is expected to increase its overall ticket sales. In particular, the company expects to sell more tickets for its current roller coaster and experience extremely high demand for its new coaster. Sales for its boat ride are expected to decline but food and beverage sales are expected to increase significantly. All of the following are side effects associated with the new roller coaster with the exception of the:
ticket sales for the new coaster
All else constant, an increase in a firm's cost of debt:
will result in an increase in the firm's cost of capital.
