FNCE Exam 3

Which one of the following statements is correct?

A project can create a positive operating cash flow without affecting sales.

Theresa is analyzing a project that currently has a projected NPV of zero. Which one of the following changes that she is considering is most apt to cause that project to produce a positive NPV instead? Consider each change independently.

Decrease the labor hours per unit produced

The profitability index is most closely related to which one of the following?

NPV

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?

Opportunity cost

Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?

The payback decision rule could override the net present value decision rule should cash availability be limited.

The depreciation tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense.

Ignoring bonus depreciation, the net book value of equipment will:

decrease slower under straight-line depreciation than under MACRS.

The operating cash flow for a project should exclude which one of the following?

interest expense

average accounting rate of return (AAR)

is similar to the return on assets ratio.

The bottom-up approach to computing the operating cash flow applies only when

the interest expense is equal to zero.

The base case values used in scenario analysis are the values considered to be the most:

likely to occur.

Which of the following values will be equal to zero when a firm is operating at the accounting break-even level of output?

IRR and net income

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0?

Initial investment in inventory to support the project

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

Tax due on the current salvage value of that asset

Why is payback often used as the sole method of analyzing a proposed small project?

The benefits of payback analysis usually outweigh the costs of the analysis.

The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:

crossover rate

A strength of the average accounting return (AAR) method of project analysis is the fact that AAR:

is easy to calculate

Webster Iron Works started a new project last year. As it turns out, the project has been operating at its accounting break-even level of output and is now expected to continue at that level over its lifetime. Given this, you know that the project:

is operating at a higher level than if it were operating at its cash break-even level.

Which one of the following is an example of a sunk cost?

$1,200 paid to repair a machine last year

Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows?

Discounted cash flow valuation

Mutually exclusive projects are best defined as competing projects that:

both require the total use of the same limited resource.

Sensitivity analysis determines the:

degree to which the net present value reacts to changes in a single variable.

The key means of defending against forecasting risk is to:

identify sources of value within a project.

When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as:

worst-case scenario analysis.

A new project has an initial cost of $235,000. The equipment will be depreciated on a straight-line basis to a zero book value over the five-year life of the project. The projected net income each year is $13,100, $17,700, $19,880, $15,000, and $11,600, respectively. What is the average accounting return?

AAR = [$13,100 + 17,700 + 19,880 + 15,000+ 11,600)/5]/[$235,000 + 0)/2] AAR = .1315, or 13.15%

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be?

Accept Project B and reject Project A based on the NPVs

Power Manufacturing has equipment that it purchased 4 years ago for $2,800,000. The equipment was used for a project that was intended to last for 6 years. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $450,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,800,000/6 Annual depreciation = $466,667 Book value = $2,800,000 − 4($466,667) Book value = $933,333 Tax refund (due) = ($933,333 − 450,000)(.35) Tax refund (due) = $169,167 Aftertax salvage value = $450,000 + 169,167 Aftertax salvage value = $619,167

Operating leverage is the degree of dependence a firm places on its:

FC

At the accounting break-even point, Swiss Mountain Gear sells 22,940 ski masks at a price of $19 each. At this level of production, the depreciation is $67,000 and the variable cost per unit is $6. What is the amount of the fixed costs at this production level?

Fixed costs Accounting break-even = 22,940 ($19 − 6) − $67,000 Fixed costs Accounting break-even = $231,220

Bruno's Lunch Counter is expanding and expects operating cash flows of $24,900 a year for 4 years as a result. This expansion requires $55,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,200 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 10 percent?

NPV = −$55,000 − 3,200 + 24,900(PVIFA10%,4) + 3,200/1.104 NPV = $22,915

Windows and More is reviewing a project with sales of 6,200 units, ±2 percent, at a sales price of $29, ±1 percent, per unit. The expected variable cost per unit is $11, ±3 percent, and the expected fixed costs are $87,000, ±1 percent. The depreciation expense is $68,000 and the tax rate is 21 percent. What is the net income under the worst-case scenario?

Net incomeWorst Case = ({[$29 (.99) − $11 (1.03)] (6,200)(.98)} − $87,000 (1.01) − $68,000) (1 − .21) Net incomeWorst Case = −$39,713

King Nothing is evaluating a new 6-year project that will have annual sales of $450,000 and costs of $308,000. The project will require fixed assets of $550,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 34 percent. What is the operating cash flow for Year 3?

OCF = ($450,000 − 308,000)(1 − .34) + .34(.1920)($550,000) OCF = $129,624

Stellar Plastics is analyzing a proposed project with annual depreciation of $28,750 and a tax rate of 23 percent. The company expects to sell 16,500 units, ±3 percent. The expected variable cost per unit is $1.87, ±1 percent, and the expected fixed costs are $24,900, ±1 percent. The sales price is estimated at $7.99 a unit, ±2 percent. What is the operating cash flow for a sensitivity analysis using total fixed costs of $26,000?

OCF = [16,500 ($7.99 − 1.87) - $26,000] (1 − .23) + $28,750 (.23) OCF = $64,347

Go Fly A Kite is considering making and selling custom kites in two sizes. The small kites would be priced at $11.10 and the large kites would be $24.10. The variable cost per unit is $5.35 and $11.70, respectively. Jill, the owner, feels that she can sell 2,900 of the small kites and 1,790 of the large kites each year. The fixed costs would be $2,120 a year and the depreciation expense is $1,200. The tax rate is 34 percent. What is the annual operating cash flow?

OCF = [2,900($11.10 − 5.35) + 1,790($24.10 − 11.70) − 2,120](1 − .34) + .34($1,200) Cash flow = $24,664

Kristi wants to start training her most junior assistant, Amy, in the art of project analysis. Amy has just started college and has no experience or background in business finance. To get her started, Kristi is going to assign the responsibility for all projects that have initial costs less than $1,000 to Amy to analyze. Which method is Kristi most apt to ask Amy to use in making her initial decisions?

Payback

A project that costs $20,000 today will generate cash flows of $6,500 per year for seven years. What is the project's payback period?

Payback period = $20,000/$6,500 Payback period = 3.08 years

A project has an accounting break-even point of 7,264 units. The fixed costs are $164,800 and the projected variable cost per unit is $24.57. The project will require $398,000 for fixed assets which will be depreciated straight-line to zero over the project's four-year life. What is the projected sales price per unit?

QAccounting break-even = 7,264 = [$164,800 + ($398,000/4)]/($P − 24.57) P = $60.95

The Motor Works is considering an expansion project with estimated fixed costs of $127,000, depreciation of $16,900, variable costs per unit of $41.08, and an estimated sales price of $79.90 per unit. How many units must the firm sell to break even on a cash basis?

QCash break-even = $127,000/($79.90 − 41.08) QCash break-even = 3,272 units

Spencer Tools would like to offer a special product to its best customers. However, the firm wants to limit its maximum potential loss on this product to the firm's initial investment. The fixed costs are estimated at $27,400, the depreciation expense is $1,700, and the contribution margin per unit is $6.75. What is the minimum number of units the firm should pre-sell to ensure its potential loss does not exceed the desired level?

QCash break-even = $27,400/$6.75 QCash break-even = 4,059 units

Precise Machinery is analyzing a proposed project that is expected to have sales of 2,450 units, ±8 percent. The expected variable cost per unit is $246 and the expected fixed costs are $309,000. Cost estimates are considered accurate within a ±3 percent range. The depreciation expense is $106,000. The sales price is estimated at $599 per unit, ±2 percent. What is the amount of the total costs per unit under the worst-case scenario?

Total costs per unitWorst-case = [2,450 (.92) ($246) (1.03) + $309,000 (1.03)]/[2,450 (.92)] Total costs per unitWorst-case = $394.58

Valerie just completed analyzing a project. Her analysis indicates that the project will have a six-year life and require an initial cash outlay of $120,000. Annual sales are estimated at $189,000 and the tax rate is 21 percent. The net present value is negative $120,000. Based on this analysis, the project is expected to operate at the:

cash break-even point.

A project's cash flow is equal to the project's operating cash flow:

minus both the project's change in net working capital and capital spending.

Swenson's is considering two mutually exclusive projects, Projects A and B, and has determined that the crossover rate for these projects is 11.7 percent and the required return for both projects is 9 percent. Given this you know that:

the project that is acceptable at a discount rate of 11 percent should be rejected at a discount rate of 12 percent.

A project is expected to provide cash flows of $12,900, $13,100, $16,200, and $10,700 over the next four years, respectively. At a required return of 8.1 percent, the project has a profitability index of .843. For this to be true, what is the project's cost at Time 0?

.843 = [$12,900/(1 + .081) + $13,100/(1 + .081)2 + $16,200/(1 + .081)3 + $10,700/(1 + .081)4]/Initial cost Initial cost = $51,962

There is a project with the following cash flows : Year Cash Flow 0 −$26,100 1 7,700 2 8,050 3 7,450 4 5,800 What is the payback period?

Amount short after 3 years = $26,100 − 7,700 − 8,050 − 7,450 Amount short after 3 years = $2,900 Payback period = 3 + $2,900/$5,800 Payback period = 3.50 years

A new project has an initial cost of $195,000. The equipment will be depreciated on a straight-line basis to a zero book value over the five-year life of the project. The projected net income each year is $12,700, $16,900, $18,920, $14,600, and $10,800, respectively. What is the average accounting return?

AAR = [$12,700 + 16,900 + 18,920 + 14,600+ 10,800)/5]/[$195,000 + 0)/2] AAR = .1516, or 15.16%

Which one of the following should not be included in the analysis of a new product

Money already spent for research and development of the new product

The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following?

NPV

Which two methods of project analysis are the most biased towards short-term projects?

Payback and discounted payback

Which one of the following best describes the concept of erosion?

The cash flows of a new project that come at the expense of a firm's existing cash flows

Scenario analysis is defined as the:

determination of changes in NPV estimates when what-if questions are posed.

The contribution margin per unit is equal to the:

sales price per unit minus the variable cost per unit.

The internal rate of return is:

tedious to compute without the use of either a financial calculator or a computer.