finance exam ch9-14

You are an upcoming designer and are considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated costs of $57,000. The project has a 5-year life. Your accountant advises you to use straight-line depreciation and depreciate the fixed asset to a zero-book value over the life of the project. The tax rate is 30 percent. What is the operating cash flow for this project?

$17,820

You are considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated costs of $57,000 each year. The project has a 5-year life. You are advised to use straight-line depreciation to a zero-book value over the life of the project. The tax rate is 30 percent. What is the operating cash flow for this project?

$17,820

For #6, what is the correct answer if the government lowers the tax rate to 20%?

$17,880

At the accounting break-even point, Utah Alta sells 14,600 ski masks for $10 each. At this level of production, the depreciation is $58,000 and the variable cost per unit is $4. What is the amount of the fixed costs at this production level?

$29,600

Spartan cafe is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets at the beginning (this investment does require depreciation but is worthless in the end with zero cash flow implication). In addition, the project requires $3,000 of net working capital, 100% of which will be recovered at the end of the project. What is the net present value of this expansion project at a required rate of return of 16 percent?

$32,409.57

Your successful food truck business is expanding and now you operate on a yearly basis. You expect operating cash flows of $26,000 a year for 4 years. This expansion requires $39,000 in new fixed assets. These assets will be worthless after 4 years. In addition, the project requires $3,000 of net working capital, 100% of which will be recovered at the end of the project. What is the net present value of this expansion project if the required rate of return of 16 percent?

$32,409.57

Please calculate NPV for the expansion project in #8 if your new estimate indicates that yearly operating cash flows should be $26,000 for the first two years and increase to $36,000 for the remaining two years.

$44,339.06

You purchased 200 shares of MSU stock for $18.97 a share. The stock pays an annual dividend of $1.42 per share. When you sold your shares for $17.86 per share, what is your total dollar return on this investment?

$62

The return of a portfolio of stocks depends primarily on:

The amount of systematic risk

You won a lottery and purchased a lot in Happy City 6 years ago for $280,000. Today, that lot has a market value of $340,000. At the time of the purchase, you spent $15,000 to level the lot and another $20,000 to install storm drains. You now want to build a new facility on that site. The building cost is estimated at $1.47 million. What amount should be used as the initial cash flow for this project?

-$1,810,000

Your food truck business is now a restaurant chain. You purchased a lot in Lansing 6 years ago for $280,000. Today, that lot has a market value of $340,000. At the time of the purchase, you also spent $15,000 to level the lot and another $20,000 to install storm drains. You now want to build a new restaurant on that site. The building cost is estimated at $1.47 million. What amount should be used as the initial cash flow for this project?

-$1,810,000

Using historical arithmetic average as an estimated expected return tends to overestimate the expected return for the long term. Using historical geometric average tends to underestimate the expected return for the short term.

true

You purchased 400 shares of MSU stock for $12.92 a share. When you sold all your shares, you received a total of $136 in dividends and $4,301 in proceeds from selling the shares. What is your capital gains yield on this stock?

-16.78%

For #5, what is the beta coefficient of your portfolio if the remainder of the portfolio is in a risk-free asset developed by Goldman Sachs rather than the treasury bills?

0.3

Your portfolio is composed of 25% in Superhealthy, Inc. which has a beta coefficient of 1.2 and an expected return of 18%. The remainder of the portfolio is in treasury bills that return 7%. What is the beta coefficient of your portfolio?

0.3

For #5, what is the beta coefficient of your portfolio if the remainder of the portfolio is in market portfolio rather than the treasury bills?

1.05

Asset A has an expected return of 20%. The market risk premium is 10% and the risk-free rate is 5%. What is Asset A's beta?

1.5

Asset A has an expected return of 20%. The market risk premium is 10% and the risk-free rate is 5%. What is Asset A's beta?

1.5%

French Corporation has 500,000 shares of common stock that sell for $25 per share and has a beta of 1.5. The risk-free rate is 4% and the market return is expected to be 12%. The company has 10,000 bonds outstanding with a $1,000 face value, a $1,100 market price, and YTM of 4.5%. There are 100,000 shares of preferred stock outstanding. The preferred stock pays a $3 annual dividend and sells for $30 per share. Assuming a 20% tax rate, what is the French Corporation's WACC?

10.2%

For #6, what is your answer if the government decides that French Corporation is exempt from taxes?

10.5%

Please calculate internal rate of return for the project in #8

10.89

Company OK's stock currently pays a dividend of $2.4. The price of the stock today is $30. What is the required rate of return for the stock if the dividend is expected to grow at a constant rate of 8% ?

13.4

Company OK's preferred stock pays a dividend of $2 forever. The price of the preferred stock is $12. What is the required rate of return for the preferred stock?

16.7%

As a new store manager, you project the cash flows for this new project as follows: Year 0 investment of $30,000, Year 1 inflow of $8,000, Year 2 inflow of $10,000, Year 3 inflow of $11,000, Year 4 inflow of $17,000, Year 5 inflow of $12,000. What is the discounted payback period if the required return is 10%?

3.53 yrs

For #4, what is your answer if the government changes the tax rate to 20%?

7%

Golding Enterprises has 50,000 shares outstanding, of which 20% are preferred shares and 80% are common shares. The preferred shares pay $2.00 per year in dividends and are priced at $40 per share. The last dividend paid to common stockholders was $5.80 and the company expects no further growth. The current price of the common stock is $80. The company currently has no long-term debt. What is the average cost of capital for Golding Enterprises? Tax rate is 30%.

7%

What is the standard deviation of this stock over the five-year period? The stock's Year 1 through 4 return is 8%, −3%, 12%, and 17%. Please first calculate the return in Year 5 by using this information: the average return of the stock for the five-year period was 6%.

9.25

As a new store manager, you project the cash flows for this new project as follows: Year 0 investment of $250,000, Year 1 inflow of $41,000, Year 2 inflow of $48,000, Year 3 inflow of $63,000, Year 4 inflow of $79,000, Year 5 inflow of $88,000, Year 6 inflow of $64,000, Year 7 inflow of $41,000. As management, you decide that the project's required payback period must be 5 years. After much deliberation, you believe the decision rule should be payback period despite its ignoring time value of money. Should you accept or reject this new project for your store?

Accept. It takes 4.22 years to get the investment back according to payback period rule.

When you perform the calculations for Questions #2 and #3, you realize that these calculations relate to the first step of project valuation (cash flow projection). Which of the following statements is/are true? I. For #2, you are given the project's operation-related information and you start with constructing the project's cash flows. The project is 5 years, and the operating cash flows are the same for all five years from the information given. II. For #2, you make an income statement for a given year (it doesn't matter which year as all years share the same information). You start with sales, then take care of costs including depreciation. After getting taxable income, you take care of taxes (government as the stakeholders). You don't consider debtholders as the cash flows are projected assuming all equity financing. Once you get net income, you adjust for operating cash flow by adding back depreciation. III. For #3, you get the operating cash flows in a similar fashion to #2. Afterwards, there are two additional steps. First, there is investing related cash flow in Year 0. Second, there are operation related cash flow adjustments (related to net working capital) in Year 0 and then Year 4. IV. For #3, you notice the simplicity compared to assignment 2. The problem indicates that the fixed asset is worthless in the end. Hence, you can skip the step of calculating the salvage value and its tax implications.

All are correct

Which of the following statements is/are true? I. Total risk includes both systematic and unsystematic risk. II. The standard deviation of returns is a measure of total risk. III. Variance is a measure of total risk. IV. The expected return on a risky asset depends only on that asset's systematic risk since unsystematic risk can be diversified away.

All are correct

You, as the Spartan engineer, are considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, $10,000 in additional net working capital will be needed. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 after-tax cash flow. What is the net present value of this project given a required return of 14.5 percent? Which of the following statements is/are true? I. This problem is very similar to #2 and #3. It is worth noting that the equipment in the end does generate an investment related cash flow. Although the book value of the equipment is zero, it is to be salvaged and resulting in a $48,000 after-tax cash flow. II. The $48,000 after-tax cash flow is labeled as after-tax salvage value of selling the equipment in Ch10's model. III. The problem is simplified in the sense that the after-tax salvage value is given. IV. To calculate the operating cash flows, I need to outline the depreciation table or at least the depreciation amount each year.

All are correct

You are analyzing two mutually exclusive projects for your summer food truck project. The required rate of return for Italian street food is a bit riskier, and your estimate is 14.6% per month. If you opt for traditional pizza, the risk is lower, and your estimate is 13.8% per month. Your friends in the food industry help predict the cash flows for both projects. Although both projects require an initial $50,000 investment on the truck in Month 0 (now), the month 1 through 3 cash inflows are different. For the Italian street food project, month 1 through 3 cash inflows are $24,800, $36,200, and $21,000. For the traditional pizza project, month 1 through 3 cash inflows are $41,000, $20,000, and $10,000. Which project should you choose?

ITALIAN FOOD

Which method should NEVER be used as a decision-making method?

NONE OF THEM

Which method's result always takes precedence over other methods?

NPV

Please calculate the net present value of a project that is associated with the following cash flows: Year 0 through Year 3 cash flows are $-42,398, $13,407, $21,219, $17,800.

NPV cannot be calculated as you need a required rate of return to do the NPV calculation

Which of the following statements is/are true for capital budgeting? I. The goal of capital budgeting is to facilitate project valuation, hence project selection. II. Discounted cash flow valuation methodology is used for capital budgeting. III. Cash flows are projected assuming the project is funded with both debt and equity. IV. Tax deductibility of interest is taken into consideration in the cash flow projection process.

Only I and II are correct

In general, NPV and IRR rules provide the same conclusion. However, some situations will present challenges and only one rule is problematic in these challenging conditions. Which of the following statements is/are true? I. Nonconventional cash flows present challenges for IRR rule, i.e., the result can be misleading if you use IRR rule. II. Nonconventional cash flows present challenges for NPV rule, i.e., the result can be misleading if you use NPV rule. III. Mutually exclusive projects present challenges for NPV rule, i.e., the result can be misleading if you use NPV rule.

Only I is correct

Which of the following statements is/are true? I. Payback period rule adjust for both time value of money and risk. II. Discounted payback period rule adjust for both time value of money and risk. III. Both payback period rule and discounted payback period rule are problematic in terms of judging whether the project creates value for the firm. The reason is that the choice of an arbitrary cut-off date ignores the cash flows beyond that date.

Only II and III are correct

You face a project with the following cash flows: Year 0 investment of $42,398, Year 1 inflow of $13,407, Year 2 inflow of $21,219, Year 3 inflow of $17,800. Your advisor indicates that the required rate of return on this project is 12%. Which of the following statements is/are true? I. The project should be rejected using the NPV rule as the NPV of this project is positive ($842.12 to be specific). II. The project should be rejected using the NPV rule as the NPV of this project is negative ($-842.12 to be specific). III. The project should be rejected using the IRR rule as the IRR of this project is larger than the required rate of return.

Only II is correct

You are evaluating four project options while working with the marketing department. For each project, the marketing department already estimated the expected return. You use your knowledge from a finance class and are quite confident of the beta you estimate for each project (these beta values are depicted in the multiple choices). Which project's expected return estimated by the marketing department corresponds to the risk adjusted return calculated by you? T-bills currently yield 7% and the long-term return of the S&P 500 Index is 12%.

Project C, expected return 12%, beta 1

Accounting break-even is the sale volume where net income is equal to zero.

TRUE

Cash break-even is the sale volume where operating cash flow is equal to zero. Here is the condition (Sales - VC - FC - D)*(1 - T) + D = 0

TRUE

Financial break-even is the sale volume where NPV of the project is equal to zero. This requires complex calculations. But it will be easy if you are given the operating cash flow associated with zero NPV.

TRUE

In capital budgeting, sunk costs should be excluded.

TRUE

Asset A has an expected return of 20%. The market risk premium is 10%. What is Asset A's beta?

You need the risk-free rate to finish the calculation

In capital budgeting, you have to consider the cash flow implications from selling a piece of equipment. For this calculation, you need the market value/book value of the equipment when it is to be sold, and the firm's tax rate.

true

Standard deviation is a measure of volatility and total risk.

true

The beta of a portfolio is the weighted average of the beta for each individual asset.

true

A stock has annual returns of 5 percent, 21 percent, −12 percent, 7 percent, and 6 percent for the past five years. Which of the following statements is/are true in terms of evaluating this stock? I. The arithmetic average of these returns is 5.40 percent while the geometric average return for the period is 4.86 percent. II. As an investment manager, your investment period under consideration is very long. You decide that geometric average return should be the criterion to judge this stock. III. Both arithmetic average and geometric average return have uses when it comes to evaluating the performance of this stock. IV. The arithmetic average is overly optimistic for long horizons. The geometric average is overly pessimistic for short horizons. So, the answer depends on the planning period under consideration.

all are correct

Which of the following statements is/are true? I. Strong form of market efficiency indicates that prices reflect all public and private information II. Weak form of market efficiency is supported by empirical research evidence. III. Semi strong form of market efficiency indicates that prices reflect all publicly available information such as trading information and press releases. IV. Weak form of market efficiency indicates that prices reflect all past market information such as price and volume.

all are correct

Which of the following statements is/are true? I. The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted. II. Only incremental cash flows should be included in the capital budgeting analysis. III. Sunk costs should not be included in the capital budgeting analysis. IV. Opportunity costs should be included in the capital budgeting analysis.

all are correct

Which of the following statements is/are true? I. To evaluate risk and return, we need to define terminologies such as expected return, variance, and standard deviation. These terminologies are based on the probabilities of possible outcomes. II. Expected return helps capture the average outcome. III. Variance and standard deviation measure the volatility of returns. IV. One of the roles that portfolios play is to illustrate/visualize the effect of diversification. The risk embedded in each security can be systematic or unsystematic. The unsystematic part can be diversified away.

all are correct

Which of the following costs should be included in the capital budgeting analysis?

all should be included

NPV is most sensitive to? I. Sales. II. Variable costs. III. Fixed costs. IV. Net working capital.

only I and II

T-bills returned 2.8 percent while your investment in large-company stocks earned an average of 7.6 percent. What is the definition for the difference between these two rates of return?

risk premium

As a project manager, you learnt that a new project you are in charge of is very different from the firm's core business, hence the project risk is different from the firm's risk. You decide to opt for a pure play approach, i.e., find comparable projects.

true

Capital gains yield and total return can both be negative. Yet, dividend yield cannot be negative.

true

Dividend yield is next year's annual dividend divided by the current stock price.

true

If a project risk is different from the firm's risk, a manual adjustment to the firm's WACC is needed. Industry experience is important in making the adjustment. A subjective adjustment is ok, whereas flip a coin is not.

true