ch1 Introduction to Corporate Finance

Transcription

1 ch1 Introduction to Corporate Finance 1. Which one of the following terms is defined as the management of a firm's long-term investments? A. agency cost analysis B. capital budgeting C. financial allocation D. working capital management E. capital structure 2. Which one of the following terms is defined as the mixture of a firm's debt and equity financing? A. cost analysis B. capital budgeting C. working capital management D. cash management E. capital structure 3. Which one of the following is defined as a firm's short-term assets and its short-term liabilities? A. net capital B. investment capital C. capital structure D. debt E. working capital 4. A business owned by a solitary individual who has unlimited liability for its debt is called a: A. general partnership. B. limited liability company. C. sole proprietorship. D. corporation. E. limited partnership. 5. A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a: A. generally partner. B. zero partner. C. sole proprietor. D. corporate shareholder. E. limited partner. 6. Which of the following accounts are included in working capital management? I. accounts payable II. accounts receivable III. fixed assets IV. inventory A. II, III, and IV only B. II and IV only C. I, II, and IV only D. I and III only E. I and II only 7. Which of the following are advantages of the corporate form of business ownership? I. limited liability for firm debt II. double taxation III. ability to raise capital IV. unlimited firm life A. I, III, and IV only 1

2 B. I, II, III, and IV C. I and II only D. III and IV only E. II, III, and IV only 8. Corporate bylaws: A. describe the intended life and purpose of the organization. B. determine how a corporation regulates itself. C. cannot be amended once adopted. D. must be amended should a firm decide to increase the number of shares authorized. E. define the name by which the firm will operate. 9. Which type of business organization has all the respective rights and privileges of a legal person? A. general partnership B. corporation C. sole proprietorship D. limited partnership E. limited liability company 10. Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management? A. increase in the market value per share B. increase in the number of shares outstanding C. increase in the amount of the quarterly dividend D. decrease in the per unit production costs E. decrease in the net working capital 2

3 ch1 Answers B E E C E C A B b A 3

4 ch2 Financial Statements, Taxes, and Cash Flow 1. The cash flow of a firm which is available for distribution to the firm's creditors and stockholders is called the: A. operating cash flow. B. net capital spending. C. net working capital. D. cash flow from assets. E. cash flow to stockholders. 2. Cash flow to stockholders is defined as: A. the total amount of interest and dividends paid during the past year. B. the change in total equity over the past year. C. cash flow from assets plus the cash flow to creditors. D. operating cash flow minus the cash flow to creditors. E. dividend payments less net new equity raised. 3. Which of the following are current assets? I. patent II. Inventory III. accounts payable IV. cash A. I and III only B. II and IV only C. I, II, and IV only D. I, II and III only E. II, III, and IV only 4. Which of the following are included in current liabilities? I. note payable to a supplier in eight months II. amount due from a customer next month III. account payable to a supplier that is due next week IV. loan payable to the bank in fourteen months A. I and III only B. II and III only C. I, II, and III only D. I, III, and IV only E. I, II, III, and IV 5. A firm has $520 in inventory, $1,860 in fixed assets, $190 in accounts receivables, $210 in accounts payable, and $70 in cash. What is the amount of the current assets? A. $710 B. $780 C. $990 D. $2,430 E. $2, Your firm has total assets of $4,900, fixed assets of $3,200, long-term debt of $2,900, and short-term debt of $1,400. What is the amount of net working capital? A. -$100 1

5 B. $300 C. $600 D. $1,700 E. $1, Kaylor Equipment Rental paid $75 in dividends and $511 in interest expense. The addition to retained earnings is $418 and net new equity is $500. The tax rate is 35 percent. Sales are $15,900 and depreciation is $680. What are the earnings before interest and taxes? A. $ B. $1, C. $1, D. $1, E. $1, Given the tax rates as shown, what is the average tax rate for a firm with taxable income of $311,360? A percent B percent C percent D percent E percent 9. Crandall Oil has total sales of $1,349,800 and costs of $903,500. Depreciation is $42,700 and the tax rate is 34 percent. The firm does not have any interest expense. What is the operating cash flow? A. $129,152 B. $171,852 C. $179,924 D. $281,417 E. $309, At the beginning of the year, the long-term debt of a firm was $72,918 and total debt was $138,407. At the end of the year, long-term debt was $68,219 and total debt was $145,838. The interest paid was $6,430. What is the amount of the cash flow to creditors? A. -$18,348 B. -$1,001 C. $11,129 D. $13,861 E. $19,172 2

6 Ch2 Answers D E B A B B B C E C 5. Current assets = $520 + $190 + $70 = $ Net working capital = $4,900 - $3,200 - $1,400 = $ Net income = $75 + $418 = $493 Taxable income = $493/(1 -.35) = $ Earnings before interest and taxes = $ $511 = $1, Tax =.15($50,000) +.25($25,000) +.34($25,000) +.39($211,360) = $104, Average tax rate = $104,680.40/$311,360 = percent 9. Earnings before interest and taxes = $1,349,800 - $903,500 - $42,700 = $403,600 Tax = $403, = $137,224 Operating cash flow = $403,600 + $42,700 - $137,224 = $309, Cash flow to creditors = $6,430 - ($68,219 - $72,918) = $11,129 3

7 ch3 Working with Financial Statements 1. Which one of the following standardizes items on the income statement and balance sheet relative to their values as of a common point in time? A. statement of standardization B. statement of cash flows C. common-base year statement D. common-size statement E. base reconciliation statement 2. The formula which breaks down the return on equity into three component parts is referred to as which one of the following? A. equity equation B. profitability determinant C. SIC formula D. Du Pont identity E. equity performance formula 3. On a common-base year financial statement, accounts receivables will be expressed relative to which one of the following? A. current year sales B. current year total assets C. base-year sales D. base-year total assets E. base-year accounts receivables 4. Which of the following ratios are measures of a firm's liquidity? I. cash coverage ratio II. interval measure III. debt-equity ratio IV. quick ratio A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and III only E. I, II, III, and IV 5. The Corner Hardware has succeeded in increasing the amount of goods it sells while holding the amount of inventory on hand at a constant level. Assume that both the cost per unit and the selling price per unit also remained constant. This accomplishment will be reflected in the firm's financial ratios in which one of the following ways? A. decrease in the inventory turnover rate B. decrease in the net working capital turnover rate C. no change in the fixed asset turnover rate D. decrease in the day's sales in inventory E. no change in the total asset turnover rate 6. Wise's Corner Grocer had the following current account values. What effect did the change in net working capital have on the firm's cash flows for 2009? 4

8 A. net use of cash of $37 B. net use of cash of $83 C. net source of cash of $83 D. net source of cash of $111 E. net source of cash of $ A firm has sales of $2,190, net income of $174, net fixed assets of $1,600, and current assets of $720. The firm has $310 in inventory. What is the common-size statement value of inventory? A percent B percent C percent D percent E percent 8. A firm has total assets of $311,770 and net fixed assets of $167,532. The average daily operating costs are $2,980. What is the value of the interval measure? A days B days C days D days E days 9. Al's Sport Store has sales of $897,400, costs of goods sold of $628,300, inventory of $208,400, and accounts receivable of $74,100. How many days, on average, does it take the firm to sell its inventory assuming that all sales are on credit? A days B days C days D days E days 10. Reliable Cars has sales of $807,200, total assets of $1,105,100, and a profit margin of 9.68 percent. The firm has a total debt ratio of 78 percent. What is the return on equity? A percent B percent C percent D percent E percent 5

9 Ch3 Answers C D E B D D A B C E Common-size inventory = $310/($1,600 + $720) = percent 8. Interval measure = ($311,770 - $167,532)/$2,980 = days 9. Inventory turnover = $628,300/$208,400 = Days in inventory = 365/ = days 10. Return on equity = (.0968 $807,200)/[$1,105,100 (1 -.78)] = percent 6

10 ch4 Long-Term Financial Planning and Growth 1. Which one of the following correctly defines the retention ratio? A. one plus the dividend payout ratio B. addition to retained earnings divided by net income C. addition to retained earnings divided by dividends paid D. net income minus additions to retained earnings E. net income minus cash dividends 2. Financial planning accomplishes which of the following for a firm? I. determination of asset requirements II. development of plans to contend with unexpected events III. establishment of priorities IV. analysis of funding options A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and III only E. I, II, III, and IV 3. Which one of the following statements is correct? A. Pro forma statements must assume that no new equity is issued. B. Pro forma statements are projections, not guarantees. C. Pro forma statements are limited to a balance sheet and income statement. D. Pro forma financial statements must assume that no dividends will be paid. E. Net working capital needs are excluded from pro forma computations. 4. Which one of the following capital intensity ratios indicates the largest need for fixed assets per dollar of sales? A B C D E The plowback ratio is: A. equal to net income divided by the change in total equity. B. the percentage of net income available to the firm to fund future growth. C. equal to one minus the retention ratio. D. the change in retained earnings divided by the dividends paid. E. the dollar increase in net income divided by the dollar increase in sales. 6. Which of the following can affect a firm's sustainable rate of growth? I. capital intensity ratio II. profit margin III. dividend policy IV. debt-equity ratio A. III only B. I and III only 7

11 C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV 7. Wagner Industrial Motors, which is currently operating at full capacity, has sales of $29,000, current assets of $1,600, current liabilities of $1,200, net fixed assets of $27,500, and a 5 percent profit margin. The firm has no long-term debt and does not plan on acquiring any. The firm does not pay any dividends. Sales are expected to increase by 4.5 percent next year. If all assets, short-term liabilities, and costs vary directly with sales, how much additional equity financing is required for next year? A. -$ B. -$ C. $ D. $1, E. $1, Gladsden Refinishers currently has $21,900 in sales and is operating at 45 percent of the firm's capacity. What is the full capacity level of sales? A. $31,755 B. $36,250 C. $48,667 D. $51,333 E. $54, Stop and Go has a 4.5 percent profit margin and a 15 percent dividend payout ratio. The total asset turnover is 1.6 and the debt-equity ratio is What is the sustainable rate of growth? A percent B percent C percent D percent E percent 10. A firm has a retention ratio of 45 percent and a sustainable growth rate of 6.2 percent. The capital intensity ratio is 1.2 and the debt-equity ratio is What is the profit margin? A percent B percent C percent D percent E percent 8

12 Ch4 Answers B E B E B E A C E E 7. Projected assets = ($1,600 + $27,500) = $30, Projected liabilities = $1, = $1,254 Current equity = $1,600 + $27,500 - $1,200 = $27,900 Projected increase in retained earnings = $29, = $1, Equity funding need = $30, $1,254 - $27,900 - $1, = -$ Full-capacity sales = $21,900/0.45 = $48, Return on equity = ( ) = Sustainable growth = [ (1-0.15)]/{1 - [.1152 (1-0.15)]} = percent = [ROE 0.45]/[1 - (ROE 0.45)]; ROE = = PM (1/1.2) ( ); PM = percent 9

13 ch5 Introduction to Valuation: The Time Value of Money 1. You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now? A. future value B. present value C. principal amounts D. discounted value E. invested principal 2. Interest earned on both the initial principal and the interest reinvested from prior periods is called: A. free interest. B. dual interest. C. simple interest. D. interest on interest. E. compound interest. 3. Gerold invested $6,200 in an account that pays 5 percent simple interest. How much money will he have at the end of ten years? A. $8,710 B. $9,000 C. $9,300 D. $9,678 E. $10, Alex invested $10,500 in an account that pays 6 percent simple interest. How much money will he have at the end of four years? A. $12,650 B. $12,967 C. $13,020 D. $13,256 E. $13, You invested $1,650 in an account that pays 5 percent simple interest. How much more could you have earned over a 20-year period if the interest had compounded annually? A. $ B. $ C. $ D. $1, E. $1, Today, you earn a salary of $36,000. What will be your annual salary twelve years from now if you earn annual raises of 3.6 percent? A. $55, B. $57, C. $58, D. $59, E. $59,

14 7. You are depositing $1,500 in a retirement account today and expect to earn an average return of 7.5 percent on this money. How much additional income will you earn if you leave the money invested for 45 years instead of just 40 years? A. $10, B. $11, C. $12, D. $12, E. $13, You would like to give your daughter $75,000 towards her college education 17 years from now. How much money must you set aside today for this purpose if you can earn 8 percent on your investments? A. $18, B. $20, C. $28, D. $29, E. $32, Your older sister deposited $5,000 today at 8.5 percent interest for 5 years. You would like to have just as much money at the end of the next 5 years as your sister will have. However, you can only earn 7 percent interest. How much more money must you deposit today than your sister did if you are to have the same amount at the end of the 5 years? A. $ B. $ C. $ D. $ E. $ One year ago, you invested $1,800. Today it is worth $1, What rate of interest did you earn? A percent B percent C percent D percent E percent 11

15 Ch5 Answers A E C C E A B B B D 3. Ending value = $6,200 + ($6, ) = $9, Ending value = $10,500 + ($10, ) = $13, Simple interest = $1,650 + ($1, ) = $3,300 Annual compounding = $1,650 (1.05) 20 = $4, Difference = $4, $3,300 = $1, Future value = $36,000 ( ) 12 = $55, Future value = $1,500 ( ) 45 = $38, Future value = $1,500 ( ) 40 = $27, Difference = $38, $27, = $11, Present value = $75,000 [1/(1 +.08) 17 ] = $20, Future value = $5,000 ( ) 5 = $7, Present value = $7, [1/(1 +.07) 5 ] = $5, Difference = $5, $5,000 = $ $1, = $1,800 (1 + r)1; r = 6.92 percent 12

16 ch6 Discounted Cash Flow Valuation 1. An ordinary annuity is best defined by which one of the following? A. increasing payments paid for a definitive period of time B. increasing payments paid forever C. equal payments paid at regular intervals over a stated time period D. equal payments paid at regular intervals of time on an ongoing basis E. unequal payments that occur at set intervals for a limited period of time 2. Which one of the following accurately defines a perpetuity? A. a limited number of equal payments paid in even time increments B. payments of equal amounts that are paid irregularly but indefinitely C. varying amounts that are paid at even intervals forever D. unending equal payments paid at equal time intervals E. unending equal payments paid at either equal or unequal time intervals 3. The interest rate that is quoted by a lender is referred to as which one of the following? A. stated interest rate B. compound rate C. effective annual rate D. simple rate E. common rate 4. Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment? A. amortized loan B. modified loan C. balloon loan D. pure discount loan E. interest-only loan 5. A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) loan. A. amortized B. continuous C. balloon D. pure discount E. interest-only 6. Which of the following statements related to interest rates are correct? I. Annual interest rates consider the effect of interest earned on reinvested interest payments. II. When comparing loans, you should compare the effective annual rates. III. Lenders are required by law to disclose the effective annual rate of a loan to prospective borrowers. IV. Annual and effective interest rates are equal when interest is compounded annually. A. I and II only B. II and III only C. II and IV only D. I, II, and III only E. II, III, and IV only 13

17 7. You are comparing two annuities which offer quarterly payments of $2,500 for five years and pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while annuity B will pay you on the last day of each month. Which one of the following statements is correct concerning these two annuities? A. These two annuities have equal present values but unequal futures values at the end of year five. B. These two annuities have equal present values as of today and equal future values at the end of year five. C. Annuity B is an annuity due. D. Annuity A has a smaller future value than annuity B. E. Annuity B has a smaller present value than annuity A. 8. You are comparing two annuities with equal present values. The applicable discount rate is 8.75 percent. One annuity pays $5,000 on the first day of each year for 20 years. How much does the second annuity pay each year for 20 years if it pays at the end of each year? A. $5,211 B. $5,267 C. $5,309 D. $5,390 E. $5, You are scheduled to receive annual payments of $4,800 for each of the next 7 years. The discount rate is 8 percent. What is the difference in the present value if you receive these payments at the beginning of each year rather than at the end of each year? A. $1,999 B. $2,013 C. $2,221 D. $2,227 E. $2, Alexa plans on saving $3,000 a year and expects to earn an annual rate of percent. How much will she have in her account at the end of 45 years? A. $1,806,429 B. $1,838,369 C. $2,211,407 D. $2,333,572 E. $2,508,316 14

18 Ch6 Answers C D A E D C E E A D 8. Because each payment is received one year later, then the cash flow has to equal: $5,000 ( ) = $5, Difference = $26,990 - $24,991 = $1,999 Note: The difference = 0.08 $24,991 = $1,

19 ch7 Interest Rates and Bond Valuation 1. A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years. The bond was originally issued 3 years ago at par. Which one of the following statements is accurate in respect to this bond today? A. The face value of the bond today is greater than it was when the bond was issued. B. The bond is worth less today than when it was issued. C. The yield-to-maturity is less than the coupon rate. D. The coupon rate is greater than the current yield. E. The yield-to-maturity equals the current yield. 2. Phil has researched TLM Technologies and believes the firm is poised to vastly increase in value. He wants to invest in this company. Phil has decided to purchase TLM Technologies bonds so that he can have a steady stream of interest income. However, he still wishes that he could share in the firm's success along with TLM's shareholders. Which one of the following bond features will help Phil fulfill his wish? A. put provision B. positive covenant C. warrant D. crossover rating E. call provision 3. A sinking fund is managed by a trustee for which one of the following purposes? A. paying interest payments B. early bond redemption C. converting bonds into equity securities D. paying preferred dividends E. reducing coupon rates 4. The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond? A. increase the coupon rate B. decrease the coupon rate C. increase the market price D. decrease the market price E. increase the time period 5. Oil Well Supply offers 7.5 percent coupon bonds with semiannual payments and a yield to maturity of 7.68 percent. The bonds mature in 6 years. What is the market price per bond if the face value is $1,000? A. $ B. $ C. $ D. $1, E. $1, The semiannual, 8-year bonds of Alto Music are selling at par and have an effective annual yield of percent. What is the amount of each interest payment if the face value of the bonds is $1,000? A. $41.50 B. $42.25 C. $

20 D. $85.00 E. $ The current yield is defined as the annual interest on a bond divided by which one of the following? A. coupon B. face value C. market price D. call price E. dirty price 8. Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond? A. real rate risk B. interest rate risk C. default risk D. liquidity risk E. taxability risk 9. Last year, you purchased a "TIPS" at par. Since that time, both market interest rates and the inflation rate have increased by 0.25 percent. Your bond has most likely done which one of the following since last year? A. decreased in value due to the change in inflation rates B. experienced an increase in its bond rating C. maintained a fixed real rate of return D. increased in value in response to the change in market rates E. increased in value due to a decrease in time to maturity 10. Bryceton, Inc. has bonds on the market with 13 years to maturity, a yield-to-maturity of 9.2 percent, and a current price of $ The bonds make semiannual payments. What is the coupon rate? A percent B percent C percent D percent E percent 17

21 Ch7 Answers C C B D B B C B C A Coupon rate = ($39 2)/$1,000 = 7.80 percent 18

22 ch8 Stock Valuation 1. What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate? A. zero growth B. dividend growth C. capital pricing D. earnings capitalization E. discounted dividend 2. Big Falls Tours just paid a dividend of $1.55 per share. The dividends are expected to grow at 30 percent for the next 8 years and then level off to a 7 percent growth rate indefinitely. What is the price of this stock today given a required return of 15 percent? A. $67.54 B. $69.90 C. $72.47 D. $77.67 E. $ Bonnie's Ice Cream is expecting its ice cream sales to decline due to the increased interest in healthy eating. Thus, the company has announced that it will be reducing its annual dividend by 2 percent a year for the next five years. After that, it will maintain a constant dividend of $2 a share. Last year, the company paid $2.20 per share. What is this stock worth to you if you require a 9.5 percent rate of return? A. $16.21 B. $17.48 C. $18.64 D. $19.09 E. $ National Warehousing just announced it is increasing its annual dividend to $1.18 next year and establishing a policy whereby the dividend will increase by 3.25 percent annually thereafter. How much will one share of this stock be worth 8 years from now if the required rate of return is 9.5 percent? A. $24.38 B. $25.68 C. $26.51 D. $27.02 E. $ The next dividend payment by Hillside Markets will be $2.35 per share. The dividends are anticipated to maintain a 4.5 percent growth rate forever. The stock currently sells for $70 per share. What is the dividend yield? A percent B percent C percent D percent E percent 6. Which one of these statements related to preferred stock is correct? A. Preferred shareholders normally receive one vote per share of stock owned. 19

23 B. Preferred shareholders determine the outcome of any election that involves a proxy fight. C. Preferred shareholders are considered to be the residual owners of a corporation. D. Preferred stock normally has a stated liquidating value of $1,000 per share. E. Cumulative preferred shares are more valuable than comparable non-cumulative shares. 7. Great Lakes Health Care common stock offers an expected total return of 9.2 percent. The last annual dividend was $2.10 a share. Dividends increase at a constant 2.6 percent per year. What is the dividend yield? A percent B percent C percent D percent E percent 8. The Stiller Corporation will pay a $3.80 per share dividend next year. The company pledges to increase its dividend by 2.4 percent indefinitely. How much are you willing to pay to purchase this company's stock today if you require a 6.9 percent return on your investment? A. $55.07 B. $63.09 C. $72.22 D. $78.47 E. $ You want to be on the board of directors of Wisely Foods. Since you are the only shareholder that will vote for you, you will need to own more than half of the outstanding shares of stock if you are to be elected to the board. What is the type of voting called that requires this level of stock ownership to be successfully elected under these conditions? A. democratic B. cumulative C. straight D. deferred E. proxy 10. Springboro Tech is a young start-up company. No dividends will be paid on the stock over the next 15 years, because the firm needs to plow back its earnings to fuel growth. The company will pay a $12 per share dividend in 16 years and will increase the dividend by 3 percent per year thereafter. What is the current share price if the required return on this stock is 8 percent? A. $75.66 B. $88.19 C. $ D. $ E. $

24 Ch8 Answers B D E A B E E E C A Dividend yield = = 6.6 percent

25 ch9 Net Present Value and Other Investment Criteria 1. If a project has a net present value equal to zero, then: A. the total of the cash inflows must equal the initial cost of the project. B. the project earns a return exactly equal to the discount rate. C. a decrease in the project's initial cost will cause the project to have a negative NPV. D. any delay in receiving the projected cash inflows will cause the project to have a positive NPV. E. the project's PI must be also be equal to zero. 2. Which one of the following is the best example of two mutually exclusive projects? A. building a retail store that is attached to a wholesale outlet B. producing both plastic forks and spoons on the same assembly line at the same time C. using an empty warehouse to store both raw materials and finished goods D. promoting two products during the same television commercial E. waiting until a machine finishes molding Product A before being able to mold Product B 3. You are analyzing a project and have gathered the following data: Based on the net present value of, you should the project. A. -$15,030.75; reject B. -$12,995.84; reject C. -$9,283.60; accept D. $9,283.60; accept E. $12,995.84; accept 4. Which one of the following correctly applies to the average accounting rate of return? A. It considers the time value of money. B. It measures net income as a percentage of the sales generated by a project. C. It is the best method of analyzing mutually exclusive projects from a financial point of view. D. It is the primary methodology used in analyzing independent projects. E. It can be compared to the return on assets ratio. 5. Which one of the following methods determines the amount of the change a proposed project will have on the value of a firm? A. net present value B. discounted payback C. internal rate of return D. profitability index E. payback 22

26 6. The Chandler Group wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up". As a result, the cemetery project will provide a net cash inflow of $57,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 7 percent per year forever. The project requires an initial investment of $759,000. The firm requires a 14 percent return on such undertakings. The company is somewhat unsure about the assumption of a 7 percent growth rate in its cash flows. At what constant rate of growth would the company just break even? A percent B percent C percent D percent E percent 7. The Green Fiddle is considering a project that will produce sales of $87,000 a year for the next 4 years. The profit margin is estimated at 6 percent. The project will cost $90,000 and will be depreciated straight-line to a book value of zero over the life of the project. The firm has a required accounting return of 11 percent. This project should be because the AAR is percent. A. rejected; B. rejected; C. rejected; D. accepted; E. accepted; You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on payback analysis? A. accept Project A and reject Project B B. reject Project A and accept Project B C. accept both Projects A and B D. reject both Projects A and B E. You cannot make this decision based on payback analysis. 9. Boston Chicken is considering two mutually exclusive projects with the following cash flows. What is the crossover rate? If the required rate of return is lower than the crossover rate, which project should be accepted? 23

27 A percent; A B percent; B C percent; A D percent; B E percent; B 10. A project with financing type cash flows is typified by a project that has which one of the following characteristics? A. conventional cash flows B. cash flows that extend beyond the acceptable payback period C. a year or more in the middle of a project where the cash flows are equal to zero D. a cash inflow at time zero E. cash inflows which are equal in amount 24

28 Ch9 Answers B E E E A D E A C D 3. You should accept the project because the NPV is positive. 6. The minimum growth rate is the IRR as that is the rate that produces a zero NPV. This problem is solved using the growing perpetuity formula. 0 = -$759,000 + $57,000/( g); g = 6.49 percent Accept Project A is it pays back within the required 2.5 years. Reject B as it does not. 9. The crossover rate is percent. At a rate lower than the crossover rate, such as 15 percent, Project A will have the higher NPV and should be accepted. 25

29 ch10 Making Capital Investment Decisions 1. Bi-Lo Traders is considering a project that will produce sales of $28,000 and increase cash expenses by $17,500. If the project is implemented, taxes will increase by $3,000. The additional depreciation expense will be $1,600. An initial cash outlay of $1,400 is required for net working capital. What is the amount of the operating cash flow using the top-down approach? A. $4,500 B. $5,900 C. $6,100 D. $7,500 E. $8, Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the value of the depreciation tax shield in year 4 of the project? A. $49,000 B. $52,200 C. $68,600 D. $71,400 E. $76, Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow? A. erosion effects B. taxes C. fixed expenses D. salaries E. depreciation expense 4. Dog Up! Franks is looking at a new sausage system with an installed cost of $397,800. This cost will be depreciated straight-line to zero over the project's 7-year life, at the end of which the sausage system can be scrapped for $61,200. The sausage system will save the firm $122,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $28,560. All of the net working capital will be recovered at the end of the project. The tax rate is 33 percent and the discount rate is 9 percent. What is the net present value of this project? A. -$41,311 B. -$7,820 C. $81,507 D. $98,441 E. $118, The bid price is: A. an aftertax price. B. the aftertax contribution margin. C. the highest price you should charge if you want the project. D. the only price you can bid if the project is to be profitable. 26

30 E. the minimum price you should charge if you want to financially breakeven. 6. Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the aftertax cash flow from the sale of the fixed assets at the end of this project? A. $35,496 B. $68,904 C. $104,400 D. $287,615 E. $344, Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the amount of the aftertax salvage value of the equipment? A. $17,150 B. $31,850 C. $118,800 D. $237,600 E. $343, Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision? A. internal rate of return B. operating cash flow C. equivalent annual cost D. depreciation tax shield E. bottom-up operating cash flow 9. Webster & Moore paid $139,000, in cash, for a piece of equipment 3 years ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $89,000 from a firm that would like to purchase it. Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project? A. $0 B. $21,000 C. $89,000 D. $110,000 E. $160, Net working capital: 27

31 A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project. 28

32 Ch10 Answers D A E E E B B C C D 1. OCF = $28,000 - $17,500 - $3,000 = $7, Depreciation tax shield = $980,000/ = $49, OCF = $122,400(1-0.33) + ($397,800/7)(0.33) = $100, Aftertax salvage value = $522, (1-0.34) = $68, Aftertax salvage value = $980, (1-0.35) = $31, Relevant value = $89,000 29

33 ch11 Project Analysis and Evaluation 1. A company is considering a project with a cash break-even point of 22,600 units. The selling price is $28 a unit, the variable cost per unit is $13, and depreciation is $14,000. What is the projected amount of fixed costs? A. $325,000 B. $339,000 C. $342,000 D. $348,000 E. $353, The accounting manager of Gateway Inns has noted that every time the inn's average occupancy rate increases by 2 percent, the operating cash flow increases by 5.3 percent. What is the degree of operating leverage if the contribution margin per unit is $47? A B C D E Mountain Gear can manufacture mountain climbing shoes for $14.95 per pair in variable raw material costs and $18.46 per paid in variable labor costs. The shoes sell for $127 per pair. Last year, production was 170,000 pairs and fixed costs were $830,000. What is the minimum acceptable total revenue the company should accept for a one-time order for an extra 10,000 pairs? A. $149,500 B. $287,600 C. $334,100 D. $380,211 E. $1,164, PC Enterprises wants to commence a new project but is unable to obtain the financing under any circumstances. This firm is facing: A. financial deferral. B. financial allocation. C. capital allocation. D. marginal rationing. E. hard rationing. 5. Your company is reviewing a project with estimated labor costs of $21.20 per unit, estimated raw material costs of $37.18 a unit, and estimated fixed costs of $20,000 a month. Sales are projected at 42,000 units over the one-year life of the project. All estimates are accurate within a range of plus or minus 5 percent. What are the total variable costs for the worst-case scenario? A. $890,400 B. $1,561,560 C. $2,445,830 D. $2,451,960 E. $2,691, Steve, the sales manager for TL Products, wants to sponsor a one-week "Customer Appreciation Sale" where the firm offers to sell additional units of a product at the lowest price possible without negatively affecting the 30

34 firm's profits. Which one of the following represents the price that should be charged for the additional units during this sale? A. average variable cost B. average total cost C. average total revenue D. marginal revenue E. marginal cost 7. The CFO of Edward's Food Distributors is continually receiving capital funding requests from its division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is: A. operating at the accounting break-even point. B. operating at the financial break-even point. C. facing hard rationing. D. operating with zero leverage. E. operating at maximum capacity. 8. Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million, respectively. For the firm as a whole, Uptown Promotions is limited to spending $10 million for new projects next year. This is an example of: A. scenario analysis. B. sensitivity analysis. C. determining operating leverage. D. soft rationing. E. hard rationing. 9. We are evaluating a project that costs $854,000, has a 15-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 154,000 units per year. Price per unit is $41, variable cost per unit is $20, and fixed costs are $865,102 per year. The tax rate is 33 percent, and we require a 14 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within 14 percent. What is the worst-case NPV? A. $984,613 B. $1,267,008 C. $1,489,511 D. $1,782,409 E. $1,993, Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as: A. scenario analysis. B. sensitivity analysis. C. leveraging. D. hard rationing. E. soft rationing. 31

35 Ch11 Answers B E C E C E C D E E 1. FCcash break-even = 22,600 ($28 - $13) = $339, DOL = 0.053/0.02 = Marginal total revenue = 10,000 ($ $18.46) = $334, Total variable costs = [($ $37.18) 1.05][42, ] = $2,445, OCFWorst = {[($ ) - ($ )][154, ] - ($865, )}{1-0.33) + ($854,000/15)(0.33) = $463,