BUSFIN 3120 Exam 3
What is the net present value of the following cash flows if the relevant discount rate is 8 percent? A. $1,587.61 B. $2,311.92 C. $2,900.15 D. $3,248.87 E. $3,545.60
A. $1,587.61 Use npv(8, -97,000,{46,900, 62,300, -24,600, 18300, 11500}) = $1,587.61
Fig Newton Industries is considering a project and has developed the following estimates: unit sales = 7,300, price per unit = $149, variable cost per unit = $91, fixed costs = $216,400. The depreciation is $94,700 a year and the tax rate is 40 percent. What effect would an increase of $1 in the selling price have on the operating cash flow? A. $4,380 B. $4,823 C. $5,316 D. $5,448 E. $7,300
A. $4,380 Change in operating cash flow by $1 price increase = (7,300 × $1) × (1 - 0.40) = $4,380
Consider a three-year project with the following information: initial fixed asset investment = $770,000; straight-line depreciation to zero over the three-year life; zero salvage value; price = $34.99; variable costs = $23.16; fixed costs = $245,000; quantity sold = 94,500 units; tax rate = 40 percent. How sensitive is OCF to an increase of one unit in the quantity sold? A. $7.10 B. $7.73 C. $8.67 D. $9.97 E. $11.83
A. $7.10 Change in OCF = (1)($34.99 - $23.16)(1 - 0.40) = $7.10
. A project has sales of $462,000, costs of $274,000, depreciation of $26,000, interest expense of $3,400, and a tax rate of 35 percent. What is the value of the depreciation tax shield? A. $9,100 B. $9,564 C. $10,650 D. $10,800 E. $11,350
A. $9,100 Depreciation tax shield = $26,000 × 0.35 = $9,100 Depreciation Tax Shield = (Depreciation) * (Tax Value)
The Black Horse is currently considering a project that will produce cash inflows of $12,000 a year for three years followed by $6,500 in year 4. The cost of the project is $38,000. What is the profitability index if the discount rate is 7 percent? A. 0.96 B. 0.99 C. 1.04 D. 1.09 E. 1.12
A. 0.96 Profitability Index = (12,000/(1.07)) + (12,000/(1.07)^2) + (12,000/(1.07)^3) + (6,500/(1.07)^4) --------------------------------------------------------- (38,000) =0.96
Birds of a Feather has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 110 percent of face value. What is the firm's pretax cost of debt? A. 6.20 percent B. 6.60 percent C. 7.34 percent D. 7.70 percent E. 8.23 percent
A. 6.20 percent In Calculator Solver: N= 7 I% = What we solve for PV = -1100 PMT = 80 FV = 1000 Go onto I% then hit Alpha, Enter to solve
Which one of the following is true if the managers of a firm accept only projects that have a profitability index greater than 1.5? A. The firm should increase in value each time the firm accepts a new project. B. The firm is most likely steadily losing value. C. The price of the firm's stock should remain constant. D. The net present value of each new project is zero. E. The internal rate of return on each new project is zero.
A. The firm should increase in value each time the firm accepts a new project. The greater above 1.0 a profitability index rises, the higher the future cash flows are in comparison to the initial cost. This means projects with a profitability index of 1.5 are increasing the total value of the firm.
Which of the following are cash inflows from net working capital? I. Increase in accounts payable II. Increase in inventory III. Decrease in accounts receivable IV. Decrease in fixed assets A. I, II, and III only B. I and III only C. II only D. III only E. III and IV only
B. I and III only
Which of the following costs tend to rise when a firm switches to a flexible financial policy from a restrictive financial policy? I. restocking costs II. lower prices to offset limited selection III. storage costs IV. current asset opportunity costs A. IandIIonly B. III and IV only C. I, III, and IV only D. I, II, and III only E. II, III, and IV only
B. III and IV only
The average accounting return: A. measures profitability rather than cash flow. B. discounts all values to today's dollars. C. is expressed as a percentage of an investment's current market value. D. will equal the required return when the net present value equals zero. E. is used more often by CFOs than the internal rate of return.
A. measures profitability rather than cash flow. *Average Accounting Return*: Measure of Accounting Profit/ Measure of Accounting Value
A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the debt-equity ratio B. Increasing the firm's beta C. Redeeming shares of common stock D. Issuing new bonds at par E. Increasing the firm's tax rate
B. Increasing the firm's beta
What is the net present value of the following set of cash flows at a discount rate of 7 percent? At 20 percent? A. $4,518.47; $628.30 B. $4,518.47; -$321.76 C. $4,518.47; -$525.13 D. $4,722.09; $504.21 E. $4,722.09; -$418.05
B. $4,518.47; -$321.76 Use npv(7, -17,000,{4,500, 8700, 11900}) = $4,518.47 Use npv(20, -17,000,{4,500, 8700, 11900}) = $-321.76
Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm? A. 10.28 percent B. 11.84 percent C. 12.29 percent D. 12.95 percent E. 13.42 percent
B. 11.84 percent RE = 0.042 + 1.09(0.126 - 0.042)] = 0.13356 RE = ($2.45 * (1 + .033))/ $36 + .033 = 0.103301 Average RE = (0.13356 + 0.103301)/2 = 11.84 percent
The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share? A. 5.35 percent B. 5.41 percent C. 14.42 percent D. 18.79 percent E. 19.98 percent
B. 5.41 percent Re = ($0.12 * (1.035))/ ($6.50) + 0.035 = 5.41%
The opportunities that a manager has to modify a project once it has started are called: A. sensitivity choices. B. managerial options. C. scenario adjustments. D. restructuring options. E. erosion control measures.
B. Managerial Options *Managerial Options*: Opportunities that managers can exploit if certain things happen in the future. Also known as "real" options
Which one of the following statements is correct? A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. B. The cost of preferred stock is unaffected by the issuer's tax rate. C. Preferred stock is generally the cheapest source of capital for a firm. D. The cost of preferred stock remains constant from year to year. E. Preferred stock is valued using the capital asset pricing model.
B. The cost of preferred stock is unaffected by the issuer's tax rate. Cost of preferred Stock = Rp = D/Po ... Tax does not fall into this equation
Which one of the following will occur when the internal rate of return equals the required return? A. The average accounting return will equal 1.0. B. The profitability index will equal 1.0. C. The profitability index will equal 0. D. The net present value will equal the initial cash outflow. E. The profitability index will equal the average accounting return.
B. The profitability index will equal 1.0. Profitability Index: Present Value of Future Cash Flows/ Initial Investment
Scenario analysis asks questions such as: A. How will changing the number of units sold affect the outcome of this project? B. What is the best outcome that should reasonably be expected? C. How much will a $1 increase in the variable cost per unit change the net present value? D. Will the net present value increase or decrease if the quantity sold increases by 100 units? E. How will the operating cash flow change if the depreciation method is changed?
B. What is the best outcome that should reasonably be expected? Scenario Analysis examines several possible situations: -Best Case -Base Case or Most Likely Case -Worst Case It provides a range of possible outcomes.
You are analyzing a project and have developed the following estimates. The depreciation is $7,600 a year and the tax rate is 34 percent. What is the worst-case operating cash flow? A. -$1,311 B. -$641 C. $274 D. $599 E. $1,206
C. $274 Worst-case operating cash flow = [2,500 × ($16 - $14) - $8,500] × [1 - 0.34] + [$7,600 × 0.34] = $274 The worst case would involve lower bound sales and price, with upper bound cost per unit and fixed costs. Depreciation and Tax rate are given
The Green Tomato purchased a parcel of land six years ago for $299,500. At that time, the firm invested $64,000 grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $28,000 a year. The Green Tomato is now considering building a hotel on the site as the rental lease is expiring. The current value of the land is $355,000. The firm has no loans or mortgages secured by the property. What value should be included in the initial cost of the hotel project for the use of this land? A. $0 B. $299,500 C. $355,000 D. $363,500 E. $419,000
C. $355,000 The relevant cost is the opportunity cost of $355,000.
Classic Cars is considering a project that requires $148,000 of fixed assets that are classified as five-year property for MACRS. What is the book value of these assets at the end of year 3? The MACRS allowance percentages are as follows, commencing with year 1: 20.00, 32.00, 19.20, 11.52, 11.52, and 5.76 percent. A. $34,210 B. $36,667 C. $42,624 D. $43,450 E. $44,504
C. $42,624 Book value3 = $148,000 × (1 - 0.20 - 0.32 - 0.192) = $42,624
. A project has an annual operating cash flow of $45,000. Initially, this four-year project required $3,800 in net working capital, which is recoverable when the project ends. The firm also spent $21,500 on equipment to start the project. This equipment will have a book value of $4,300 at the end of year 4. What is the cash flow for year 4 of the project if the equipment can be sold for $5,400 and the tax rate is 34 percent? A. $51,724 B. $52,038 C. $53,826 D. $53,862,900 E. $53,900
C. $53,826 CF4 = $45,000 + $3,800 + $5,400 - [($5,400 - $4,300) × 0.34] = $53,826
British Motor Works is reviewing its current accounts to determine how a proposed project might affect the account balances. The firm estimates the project will initially require $67,000 in additional current assets and $32,000 in additional current liabilities. The firm also estimates the project will require an additional $7,000 a year in current assets for each one of the four years of the project. How much net working capital will the firm recoup at the end of the project assuming that all net working capital can be recaptured? A. -$85,000 B. $25,000 C. $63,000 D. $68,000 E. $85,000
C. $63,000 Net working capital recovery = $67,000 - $32,000 + (4 × $7,000) = $63,000
A project has expected cash inflows, starting with year 1, of $2,200, $2,900, $3,500, and finally in year 4, $4,000. The profitability index is 1.14 and the discount rate is 12 percent. What is the initial cost of the project? A. $7,899.16 B. $8,098.24 C. $8,166.19 D. $9,211.06 E. $9,250.00
C. $8,166.19 PV = (2,200/(1.12)) + (2,900/(1.12)^2) + (3,500/(1.12)^3) + (4,000/(1.12)^4) = 9,309.45 Initial Cost = 9,309.45/ 1.14 = $8,166.19
Country Kitchen's cost of equity is 15.3 percent and its aftertax cost of debt is 6.9 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent? A. 8.94 percent B. 11.47 percent C. 12.21 percent D. 12.28 percent E. 13.01 percent
C. 12.21 percent WACC = (1/1.58)(0.153) + [(0.58/1.58)(0.069)] = 12.21 percent
The 7.5 percent preferred stock of Rock Bottom Floors is selling for $60 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? A. 7.50 percent B. 8.13 percent C. 12.50 percent D. 13.79 percent E. 14.14 percent
C. 12.50 percent Rp = (0.075 × $100)/$60 = 12.50 percent
All else held constant, which one of the following statements is correct concerning the accounts payable period? A. The accounts payable period is equal to 365/(Sales/Average accounts payable). B. A decrease in the accounts payable period will increase the operating cycle. C. An increase in the accounts payable period will decrease the cash cycle. D. A decrease in the accounts payable period will decrease the operating cycle. E. An increase in the accounts payable turnover rate decreases the cash cycle.
C. An increase in the accounts payable period will decrease the cash cycle.
. You are analyzing a project and have developed the following estimates: unit sales = 2,600, price per unit = $56, variable cost per unit = $39, fixed costs = $24,700. The depreciation is $15,800 a year and the tax rate is 35 percent. What effect would a decrease of $1 in the variable cost per unit have on the operating cash flow? A. -$2,600 B. -$1,742 C. -$912 D. $1,690 E. $2,600
D. $1,690 Change in operating cash flow by $1 decrease in variable cost per unit = (2,600 × $1) × (1 - 0.35) = $1,690
Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate C. Increase in the market value of the firm's common stock D. Increase in the market risk premium E. Increase in the firm's beta
C. Increase in the market value of the firm's common stock Value = Equity + Debt 100% = (Equity/ Value) + (Debt/Value) EX: If a total market value of stock were $200 million and total market value of debt were $50 million, then the combined value would be $250 million. Of this total, $200/250 = 80%, so 80% of the firm's financing would be equity and the remaining 20% would be debt.
Which one of the following is an indicator that an investment is acceptable? A. Modified internal rate of return equal to zero B. Profitability index of zero C. Internal rate of return that exceeds the required return D. Payback period that exceeds the required period E. Negative average accounting return
C. Internal rate of return that exceeds the required return *Based on the IRR rule, an investment is acceptable if the IRR exceeds the required return. (This means a positive NPV) It should be rejected otherwise*
Which one of the following can occur if the operating cycle decreases while both the accounts receivable and the accounts payable periods remain constant? A. Inventory period remains constant B. Cash cycle increases C. Inventory turnover rate increases D. Accounts receivable turnover rate increases E. Cash cycle remains constant
C. Inventory turnover rate increases
Which one of the following industries is most apt to have the shortest operating cycle? A. Toy store B. Car manufacturer C. Local restaurant D. Furniture store E. Plastics manufacturer
C. Local Restaurant
Jamie is analyzing the estimated net present value of a project under various what if scenarios. The type of analysis that Jamie is doing is best described as: A. sensitivity analysis. B. erosion planning. C. scenario analysis. D. benefit planning. E. opportunity evaluation
C. Scenario Analysis *Scenario Analysis*: The determination of what happens to NPV estimates when we ask what-if questions.
Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered. A. Management decides to issue new stock to finance the project. B. The initial cash outlay requirement is reduced. C. She learns the project is riskier than previously believed. D. The aftertax cost of debt just decreased. E. The project's life is shortened.
C. She learns the project is riskier than previously believed.
A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)? A. 12.4 percent because it is lower than 18.7 percent B. 18.7 percent because it is higher than 12.4 percent C. The arithmetic average of 12.4 percent and 18.7 percent D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent E. 13.5 percent
C. The arithmetic average of 12.4 percent and 18.7 percent
An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true? A. The internal rate of return exceeds the required rate of return. B. The investment never pays back. C. The net present value is equal to zero. D. The average accounting return is 1.0. E. The net present value is greater than 1.0
C. The net present value is equal to zero Profitablity Index = 1.0 means that the IRR is equal to the required return. When these values are equal, the NPV is equal to 0.
If an investment is producing a return that is equal to the required return, the investment's net present value will be: A. positive. B. greater than the project's initial investment. C. zero. D. equal to the project's net profit. E. less than, or equal to, zero.
C. zero. The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate. In other words, when the IRR is equal to the discount rate, the NPV will equal zero.
Outdoor Sports is considering adding a miniature golf course to its facility. The course would cost $138,000, would be depreciated on a straight-line basis over its five-year life, and would have a zero salvage value. The estimated income from the golfing fees would be $72,000 a year with $24,000 of that amount being variable cost. The fixed cost would be $11,600. In addition, the firm anticipates an additional $14,000 in revenue from its existing facilities if the golf course is added. The project will require $3,000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 12 percent and a tax rate of 34 percent? A. $11,309 B. $11,628 C. $12,737 D. $14,439 E. $14,901
D. $14,439 OCF = ($72,000 - $24,000 - $11,600 + $14,000) × (1 - 0.34) + ($138,000/5) × 0.34 = $42,648 *See study guide for NPV value equation*
A debt-free firm has net income of $228,400, taxes of $46,200, and depreciation of $21,300. What is the operating cash flow? A. $182,200 B. $103,500 C. $107,100 D. $249,700 E. $295,900
D. $249,700 Operating cash flow = $228,400 + $21,300 = $249,700 OCF = Net Income + Depreciation Net Income = EBIT - Taxes Therefore, taxes do not need to be subtracted from this problem
A project has annual depreciation of $16,200, costs of $87,100, and sales of $123,000. The applicable tax rate is 40 percent. What is the operating cash flow according to the tax shield approach? A. $21,540 B. $27,667 C. $27,458 D. $28,020 E. $29,878
D. $28,020 Operating cash flow = ($123,000 - $87,100) × (1 - 0.40) + ($16,200 × 0.40) = $28,020 OCF = (Sales - costs)(1 - Tax_Rate) + Depreciation* Tax_Rate
You are considering an equipment purchase costing $187,000. This equipment will be depreciated straight-line to zero over its three-year life. What is the average accounting return if this equipment produces the following net income? A. 12.29 percent B. 14.38 percent C. 15.67 percent D. 16.51 percent E. 21.00 percent
D. 16.51 percent * AAR = Average Net Income/Average Book Value AAR = [($16,300 + $17,800 + $12,200)/3]/[($187,000 + $0)/2] = 16.51 percent
Kim's Bridal Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in six years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the common stock? A. 24.20 percent B. 31.68 percent C. 53.15 percent D. 58.72 percent E. 66.23 percent
D. 58.72 percent Common Stock: 15,000*$11 = $165,000 Preferred Stock: 2,000*$34 = $68,000 Debt: 50 * .096 *$1000 = $48,000 ($165,000 + $68,000 + $48,000) = $281,000 Weight of common stock = $165k/$281k = 58.72 percent
Which one of the following statements is true, all else constant? A. A decrease in the accounts receivable turnover rate decreases the cash cycle. B. Paying a supplier within the discount period, rather than waiting until the end of the normal credit period, will decrease the cash cycle. C. The cash cycle can never be negative. D. An increase in the inventory turnover rate will decrease the cash cycle. E. The payables period must be shorter than the receivables period.
D. An increase in the inventory turnover rate will decrease the cash cycle.
Which one of the following will increase the operating cycle? A. Decreasing the accounts payable period B. Increasing the accounts payable turnover rate C. Increasing the cash cycle D. Decreasing the accounts receivable turnover rate E. Decreasing the inventory period
D. Decreasing the accounts receivable turnover rate
You need 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? A. Firm size B. Firm location C. Firm experience D. Firm operations E. Firm management
D. Firm operations *Pure Play Firm*: a company that focuses only on a single line of business. EX: Dell for personal computers
You are using a net present value profile to compare Project A and B, which are mutually exclusive. Which one of the following statements correctly applies to the crossover point between these two? A. The internal rate of return for Project A equals that of Project B, but generally does not equal zero. B. The internal rate of return of each project is equal to zero. C. The net present value of each project is equal to zero. D. The net present value of Project A equals that of Project B, but generally does not equal zero. E. The net present value of each project is equal to the respective project's initial cost.
D. The net present value of Project A equals that of Project B, but generally does not equal zero.
Which one of the following statements is correct? A. The net present value is a measure of profits expressed in today's dollars. B. The net present value is positive when the required return exceeds the internal rate of return. C. If the initial cost of a project is increased, the net present value of that project will also increase. D. If the internal rate of return equals the required return, the net present value will equal zero. E. Net present value is equal to an investment's cash inflows discounted to today's dollars
D. If the internal rate of return equals the required return, the net present value will equal zero. The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate.
Which one of the following statements is correct concerning capital structure weights? A. Target rates are less relevant to a project than are historical rates. B. The weights are unaffected when a bond issue matures. C. An increase in the debt-equity ratio will increase the weight of the common stock. D. The repurchase of preferred stock will increase the weight of debt. E. The issuance of additional shares of common stock will increase the weight of the preferred stock.
D. The repurchase of preferred stock will increase the weight of debt
The accounts receivable period is the time that elapses between the _____ and the ____. A. purchase of inventory, payment to the supplier B. purchase of inventory, collection of the receivable C. sale of inventory, payment to supplier D. sale of inventory, collection of the receivable E. sale of inventory, billing to customer
D. sale of inventory, collection of the receivable
You are analyzing a project and have developed the following estimates. The depreciation is $3,200 a year and the tax rate is 34 percent. What is the best-case operating cash flow? A. $13,473 B. $14,196 C. $15,280 D. $16,701 E. $17,423
E. $17,423 Best-case operating cash flow = [1,750 × ($33 - $16) - $5,000] × [1 - 0.34] + [$3,200 × 0.34] = $17,423 The best case would involve the upper bound sales and price, and lower bound cost per unit and fixed costs. Depreciation and Tax rate are given
A cost-cutting project will decrease costs by $58,500 a year. The annual depreciation on the project's fixed assets will be $10,300 and the tax rate is 34 percent. What is the amount of the change in the firm's operating cash flow resulting from this project? A. $24,552 B. $26,791 C. $25,805 D. $38,610 E. $42,112
E. $42,112 Change in operating cash flow = [$58,500 × (1 - 0.34)] + [$10,300 × 0.34] = $42,112 OCF = (Sales - costs)(1 - Tax Rate) + Depreciation* Tax Rate
You are analyzing a project and have developed the following estimates. The depreciation is $52,000 a year and the tax rate is 34 percent. What is the worst-case operating cash flow? A. -$32,509 B. -$19,288 C. -$4,225 D. $27,556 E. $48,106
E. $48,106 Worst-case operating cash flow = [5,900 × ($65 - $46) - $66,000] × [1 - 0.34] + [$52,000 × 0.34] = $48,106 The worst case would involve lower bound sales and price, with upper bound cost per unit and fixed costs. Depreciation and Tax rate are given
Kurt, who is a divisional manager, continually brags that his division's required return for its projects is 1 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? A. Kurt tends to overestimate the projected cash inflows on his projects. B. Kurt tends to underestimate the variable costs of his projects. C. Kurt has the most efficiently managed division. D. Kurt's division is less risky than the other divisions. E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.
D. Kurt's division is less risky than the other divisions.
Which one of the following commences on the day inventory is purchased and ends on the day the payment for that inventory is collected? Assume all sales and purchases are on credit. A. Inventory period B. Accounts receivable period C. Accounts payable period D. Operating cycle E. Cash cycle
D. Operating Cycle
You are considering the following two mutually exclusive projects. The required return on each project is 14 percent. Which project should you accept and what is the best reason for that decision? A. Project A, because it pays back faster B. Project A, because it has the higher internal rate of return C. Project B, because it has the higher internal rate of return D. Project A, because it has the higher net present value E. Project B, because it has the higher net present value
D. Project A, because it has the higher net present value Payback has several flaws and is not the best method of comparison. The profitability index should not be used to evaluate mutually exclusive projects. The decision should be made based on net present value. NPV A = $579.78 NPV B = $-131.91
The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? A. One of the time periods within the investment period has a cash flow equal to zero. B. The initial cash flow is negative. C. The investment has cash inflows that occur after the required payback period. D. The investment is mutually exclusive with another investment under consideration. E. The cash flows are conventional.
D. The investment is mutually exclusive with another investment under consideration. *The problems with the IRR come about when cash flows are not conventional or when we are trying to compare two or more investments to see which is best*
Which one of the following statements is correct? A. Firms should generally finance all of their assets with long-term debt. B. Firms that follow restrictive financial policies can generally avoid short-term debt financing. C. Short-term borrowing is generally more expensive than long-term borrowing. D. Long-term interest rates tend to be more volatile than short-term rates. E. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.
E. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.
Which one of the following activities is a source of cash? A. Decreasing long-term debt B. Increasing inventory C. Repurchasing shares of stock D. Increasing fixed assets E. Decreasing accounts receivable
E. Decreasing accounts receivable
Which of the following have the potential to increase the net present value of a proposed investment? I. Ability to immediately shut down a project should the project become unprofitable II. Ability to wait until the economy improves before making the investment III. Option to place the investment on hold until a more favorable discount rate becomes available IV. Option to increase production beyond that initially projected A. I only B. IandIVonly C. II and III only D. I, II, and IV only E. I, II, III, and IV
E. I, II, III, and IV
In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line? A. Produces a return that will be less than the market rate but higher than the risk-free rate B. Equals the market rate of return for all stocks C. Has a maximum cost equal to the market rate of return D. Decreases as the beta of the firm's stock increases E. Increases in direct relation to the stock's systematic risk
E. Increases in direct relation to the stock's systematic risk Systematic risk is the Beta variable. When this increases, so does the cost of equity.
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 which type of cost? A. Fixed B. Forgotten C. Variable D. Opportunity E. Sunk
Sunk *Sunk Cost*: A cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision.
Appalachian Mountain Goods has paid increasing dividends of $.0.12, $0.18, $0.20, and $0.25 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.60 a share. The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent. What is the cost of equity for this firm if its beta is 1.26? A. 14.34 percent B. 16.91 percent C. 19.78 percent D. 22.96 percent E. 24.03 percent
($0.18 - $0.12)/$0.12 = 0.50 ($0.20 - $0.18)/$0.18 = 0.111111 ($0.25 - $0.20)/$0.20 = 0.25 g = (0.50 + 0.111111 + 0.25)/3 = 0.287037 RE = 0.032 + 1.26(0.091) = 0.14666 RE= ($0.25 * (1.287037))/ $12.60 + 0.287037 = .312573 Average RE = (0.14666 + 0.312573)/2 = 22.96 percent
Beverly's is a retail chain selling the latest fashions through its outlets located in various neighborhood malls. Clothing Galore is a wholesaler that buys from textile mills and sells to retail outlets. Beverly's has a cost of capital of 13.6 percent, while Clothing Galore's cost of capital is 17.8 percent. Both firms are considering opening a retail outlet in a gigantic new mall. Both proposals are quite similar in design and have basically the following financial features: an initial cash outlay of $2.7 million, a projected five-year life with no salvage value, and cash inflows of $845,000 a year for the life of the project. Which firm or firms, if either, should open a retail outlet in the new mall? A. Both Beverly's and Clothing Galore B. Neither Beverly's nor Clothing Galore C. Beverly's only D. The answer cannot be determined based on the information provided. E. Clothing Galore only
A. Both Beverly's and Clothing Galore
Which one of the following is most closely related to the net present value profile? A. Internal rate of return B. Average accounting return C. Profitability index D. Payback E. Discounted payback
A. Internal rate of return Internal rate of return is the most closely related to the NPV.
Accounts receivable financing is the term used to describe which of the following types of loans that involve either the assignment or the factoring of a firm's accounts receivable? A. Secured short-term loan B. Unsecured short-term loan C. Secured long-term loan D. Unsecured long-term loan E. Trust receipt loan
A. Secured short-term loan
Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value. What type of analysis is Mark conducting? A. Sensitivity analysis B. Erosion planning C. Scenario analysis D. Benefit-cost analysis E. Opportunity cost analysis
A. Sensitivity Analysis *Sensitivity Analysis*: Investigation of what happens to NPV when only one variable is changed.
Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations. Thus, the project will be assigned a discount rate equal to the firm's cost of capital plus 3 percent. The proposed project has an initial cost of $17.2 million that will be depreciated on a straight-line basis over 20 years. The project also requires additional inventory of $687,000 over the project's life. Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life. After 20 years, the company plans to sell the facility for an estimated $1.3 million. The company has 60,000 shares of common stock outstanding at a market price of $49 a share. This stock just paid an annual dividend of $1.84 a share. The dividend is expected to increase by 3.5 percent annually. The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share. The preferred stock has a par value of $100. The company has a 9 percent, semiannual coupon bond issue outstanding with a total face value of $1.1 million. The bonds are currently priced at 102 percent of face value and mature in 16 years. The tax rate is 33 percent. Should the firm pursue the expansion project at this point in time? Why or why not? A. Accept, the NPV is $2.648 million. B. Accept, the NPV is $4.507 million. C. Reject, the NPV is -$3.241 million. D. Reject, the NPV is -$3.027 million. E. Reject, the NPV is -$1.040 million.
B. Accept, the NPV is $4.507 million
The ability to delay an investment: A. is commonly referred to as the best-case scenario. B. is valuable provided there are conditions under which the investment will have a positive net present value. C. ensures that the investment will have an expected net present value that is positive. D. offsets the need to conduct sensitivity analysis. E. is referred to as the option to abandon.
B. is valuable provided there are conditions under which the investment will have a positive net present value.
. Quattro, Inc. has the following mutually exclusive projects available. The company has historically used a fouryear cutoff for projects. The required return is 11 percent. The payback for Project A is ____ while the payback for Project B is ____. The NPV for Project A is _____ while the NPV for Project B is ____. Which project, if any, should the company accept? A. 3.92 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B B. 3.92 years; 3.79 years; -$211.60; $1,211.48; accept Project B only C. 3.92 years; 3.79 years; $780.85; -$7,945.93; accept Project A only D. 4.06 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B E. 4.06 years; 3.79 years; -$211.60; -$7,945.93; reject both projects
C. 3.92 years; 3.79 years; $780.85; -$7,945.93; accept Project A only Payback A = 3 + ($82,000 - $15,700 - $18,300 - $23,900)/$26,200 = 3.92 years Payback B = 3 + ($125,000 - $38,600 - $33,400 - $31,200)/$27,500 = 3.79 years Use npv( ) on calculator to find NPV values
Which one of the following statements is accurate for a levered firm? A. A firm's WACC will decrease whenever the firm's tax rate decreases. B. An increase in the market risk premium will decrease a firm's WACC. C. A reduction in the risk level of a firm will tend to decrease the firm's WACC. D. The subjective approach totally ignores a firm's own WACC. E. WACC should be used as the required return for all proposed investments.
C. A reduction in the risk level of a firm will tend to decrease the firm's WACC.
Dexter Companies has a conventional factoring arrangement with its local bank. Which one of the following would be a common characteristic of that type of financing arrangement? A. Dexter Companies will receive the full amount of the accounts receivable included in this arrangement on an agreed upon date sometime in the future. B. The responsibility for collecting the covered receivables lies with Dexter Companies. C. Any bad debt that results from an account receivable included in this arrangement will be a cost to the bank. D. Dexter Companies will pay a monthly fee to the bank and in turn will receive payment for the full amount of its accounts receivable. E. The arrangement keeps the receivables as an asset of Dexter Companies but places a lien on those accounts in favor of the lending bank.
C. Any bad debt that results from an account receivable included in this arrangement will be a cost to the bank.
The managers of H.R Construction are considering remodeling plans for an old building the firm currently owns. The building was purchased eight years ago for $689,000. Over the past eight years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $898,000. The firm is considering remodeling the building into a conference centre and sandwich bar at an estimated cost of $1.7 million. The estimated present value of the future income from this centre is $2.9 million. Which one of the following defines the opportunity cost of the remodeling project? A. Initial cost of the building B. Cost of the remodeling C. Current market value of the building D. Initial cost of the building plus the remodeling costs E. Current market value of the building plus the remodeling costs
C. Current market value of the building Because the building is valued at $898,000 today, then choosing to spend the $1.7 million to renovate costs the company the opportunity of selling the building for $898,000. *Opportunity Cost*: The most valuable alternative that is given up if a particular investment is undertaken.
Suppose that Martin Metal Products changes its policy and starts requiring all of its customers to pay within 20 days rather than the 30 days that it currently allows. Which one of the following will result from this change? A. Increase in receivables period B. Increase in inventory period C. Decrease in cash cycle D. Increase in operating cycle E. Increase in accounts payable period
C. Decrease in cash cycle
Isabella is considering three mutually exclusive options for the additional space she just added to her specialty women's store. The cost of the expansion was $127,000. She can use this additional space to add a fabric and quilting section, add an exclusive gifts department, or expand into imported decorator items for the home. She estimates the present value of these options at $114,000 for fabric and quilting, $163,000 for exclusive gifts, and $138,000 for decorator items. Which option(s), if any, should Isabella accept? A. None of these options B. Fabric and quilting only C. Exclusive gifts only D. Exclusive gifts and decorator items only E. All three options
C. Exclusive Gifts only The NPV for the exclusive gifts section is the highest and would allow Isabella to pay off the expansion as well as add the extra value.
Tri-City Grocers is a chain of grocery stores that just hired a new CFO. Which of the following actions would you expect this CFO to adopt given her statement that she wants to implement a more flexible financing policy for the firm? I. easing the credit terms given to customers II. increasing the amount of inventory carried by each grocery store III. borrowing funds to keep more cash available for store operations IV. decreasing the firms' investments in marketable securities A. I and III only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV
C. I, II, and III only
Which one of the following statements is correct? A. If the IRR exceeds the required return, the profitability index will be less than 1.0. B. The profitability index will be greater than 1.0 when the net present value is negative. C. When the internal rate of return is greater than the required return, the net present value is positive. D. Projects with conventional cash flows have multiple internal rates of return. E. If two projects are mutually exclusive, you should select the project with the shortest payback period.
C. When the internal rate of return is greater than the required return, the net present value is positive. *Based on the IRR rule, an investment is acceptable if the IRR exceeds the required return. (This means a positive NPV) It should be rejected otherwise*
An investment has an initial cost of $300,000 and a life of four years. This investment will be depreciated by $60,000 a year and will generate the net income shown below. Should this project be accepted based on the average accounting rate of return (AAR) if the required rate is 9.5 percent? Why or why not? A. Yes, because the AAR less than 9.5 percent B. Yes, because the AAR is 9.5 percent C. Yes, because the AAR is greater than 9.5 percent D. No, because the AAR is 9.5 percent E. No, because the AAR is greater than 9.5 percent
C. Yes, because the AAR is greater than 9.5 percent Average net income = ($14,500 + $16,900 + $19,600 + $23,700)/4 = $18,675 Average book value = ($300,000 + $240,000 + $180,000 + $120,000 + $60,000)/5 = $180,000 AAR = $18,675/$180,000 = 10.38 percent The project should be accepted because the AAR is greater than the required return
A proposed project will increase a firm's accounts payables. This increase is generally: A. treated as an erosion cost. B. a sunk cost and should be ignored. C. a cash inflow at time zero and a cash outflow at the end of the project. D. treated as an opportunity cost. E. a cash outflow at time zero and a cash inflow at the end of the project.
C. a cash inflow at time zero and a cash outflow at the end of the project
Firm A uses straight-line depreciation. Firm B uses MACRS depreciation. Both firms bought $60,000 worth of equipment last year. Both firms are in the 35 percent tax bracket. The operating cash flows for each firm are identical except for the depreciation effects. Given this, you know the: A. depreciation expense for Firm A will be greater than Firm B's expense every year. B. equipment has a higher value on Firm B's books than on Firm A's at the end of year 2. C. operating cash flow of Firm A is less than that of Firm B for year 2. D. market value of Firm A's equipment is greater than the market value of Firm B's equipment. E. market value of Firm B's equipment is greater than the market value of Firm A's equipment.
C. operating cash flow of Firm A is less than that of Firm B for year 2.
Bob's is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why? A. Accept, the project's NPV is $1.27 million. B. Accept, the NPV is $4.89 million. C. Reject, the NPV is $1.06 million. D. Reject, the NPV -$3.27 million. E. Reject, the NPV is -$5.71 million.
D. Reject, the NPV -$3.27 million
The reinvestment approach to the modified internal rate of return: A. individually discounts each separate cash flow back to the present. B. reinvests all the cash flows, including the initial cash flow, to the end of the project. C. discounts all negative cash flows to the present and compounds all positive cash flows to the end of the project. D. discounts all negative cash flows back to the present and combines them with the initial cost. E. compounds all of the cash flows, except for the initial cash flow, to the end of the project.
E. compounds all of the cash flows, except for the initial cash flow, to the end of the project. *Reinvestment Approach*: compound all cash flows, except for the initial cash flow, to the end of the project *Discounting Approach*: discount all negative cash flows back to the present at the required return and add them to the initial cost *Combination Approach*: negative cash flows are discounted back to the present, and positive cash flows are compounded to the end of the project. (Combines the first two approaches)
