Supplemental Instruction: Finance 301 Final Exam Review 12.11.08 **Tips for success** First off, I do not see the exam so I cannot say definitively what is on it. The EXAM COVERS EVERYTHING SINCE EXAM 3 THIS REVIEW ONLY COVERS 11-13!! See the SI Website for worksheets that cover the earlier chapters!! I would recommend working the problem sets for chapters 11, 12, and 13. o In the past, the exam has been more conceptual than people were expecting, so I recommend really reading the chapters and understanding the concepts. (especially for 12 and 13). This review is meant to touch on the main points of the chapters and to help refresh your memory and prepare you somewhat, however, taken alone I don t think that it is enough for you to ace the test. Make sure when you are working problems with the cash flow register that you do two things o Hit 2 nd clr work at the beginning/end of each problem to clear the CF register out. o Hit enter after every input to ensure that the calculator has stored what you put in Chapter 11: Capital Budgeting 1. What is capital budgeting? 2. What are the 5 steps to capital budgeting? 3. A project is if the cash flows of one can be adversely impacted by the other and therefore you have to choose only one. a. Independent b. Mutually exclusive c. Normal d. Non normal 4. A project is if the cash flows of one are unaffected by the acceptance of another, and therefore more than one can be accepted.
a. Independent b. Mutually Exclusive c. Normal d. Non normal 5. In deciding to start my own airline, I have an enormous initial cash outlay of $75,000,000. This outlay is followed by 5 years of inflows of $55,000 per year in ticket sales. At the end of year 5, I have another outlay of $50,000 as I have to update and repair my equipment. This is followed by another 5 years of inflows of $65,000 per year. This project represents a cash flow stream. a. Normal b. Non normal- the signs change more than once! c. Positive d. Negative 6. is the of the present values of all cash inflows and outflows of a project. a. Future value, product b. Net future value, dividend c. Present value, product d. Net Present Value, sum 7. What is the decision rule for NPV? a. If NPV > 0 accept if NPV < 0 reject. b. If NPV > WACC accept, if NPV < WACC reject c. If NPV < 0 accept, if NPV > 0 reject d. IDK! 8. The following two projects are being debated for acceptance by a firm. Based on NPV, which of the following should be accepted if the projects are independent? What if they are mutually exclusive? WACC=12% Year 0 CF Year 1 CF Year 2 CF Year 3 CF Project A $-500 $600 $400 $200 Project Z $-500 $200 $500 $700 a. If they are independent, accept them both. If they are mutually exclusive, accept project A. b. If they are independent, accept project Z. If they are mutually exclusive, accept project A. c. If they are independent, accept them both, if they are mutually exclusive accept Z. d. If they are independent, accept them both, if they are mutually exclusive accept, them both
9. The is the discount rate that forces the present value of inflows equal to cost, and the NPV equal to. a. WACC, 10% b. Payback, 0 c. Discounted payback, 10% d. Internal rate of return (IRR), 0. 10. What is the decision rule for IRR? a. If IRR > WACC then accept. If IRR < WACC then reject. b. If IRR > NPV then accept. If IRR < NPV then reject. c. If IRR < WACC then accept. If IRR > WACC then reject. d. If IRR > payback then accept. If IRR < payback then reject. 11. How is IRR similar to a bond s YTM? 12. The following two projects are being debated for acceptance by a firm. Assume they are mutually exclusive. Which project would you accept based on IRR? WACC=12% Year 0 CF Year 1 CF Year 2 CF Year 3 CF Project A $-1000 $600 $800 $850 Project Z $-1000 $850 $700 $650 13. What is an NPV profile? And what can you tell from the following NPV profile? $NPV 300 150 0 WACC % WACC=10 15%
14. What is the issue with crossover points on an NPV profile? 15. Why do we use NPV over IRR when there is a conflict? 16. What are two reasons that NPV profiles can cross? 17. Modified IRR (MIRR) assumes that cash flows are reinvested at the which makes it a better measure than the IRR. a. IRR b. NPV c. WACC 18. Project X costs $53,235, its expected net cash inflows are $20,000 per year for 4 years, and its WACC is 12%. What is the projects MIRR? 0 1 2 3 4-53,235 $20,000 $20,000 $20,000 $20,000
19. A project costs 20,000 and its expected net cash inflows are 2,000 for the first 3 years, and 8,000 for the next 4 years. Its WACC is 12%. What is the project s payback? Discounted payback? 0 1 2 3 4 5 6 7 CF s -20k 2k 2k 2k 8k 8k 8k 8k Cumulative Chapter 12: Cash Flow Estimation and Risk Analysis **Remember- read this chapter and work the problem set (#1-8) and know the concepts for a good understanding** 20. Should financing effects be included in cash flows? a. No dividends, and interest expense should not be included in the analysis b/c they have already been taken into account by discounting cash flows at the WACC. That would be double counting financing costs! b. Yes because you have to account for dividends and interest expense.
21. Should a cost that related to the project but was done before the start of the project be included in the analysis? a. Yes, if it is in any way related to the project then it should be considered, regardless of the time that it was completed. b. No because it is a sunk cost and analysis should only include incremental investment. 22. Should you include opportunity costs in the analysis of a project? a. Yes because they are relevant because this is money you could earn if you didn t do the project. (p.s. make them after tax) b. No because they are not cash flows generated from the project. 23. If the project were to cannibalize another area of the firm and therefore be an externality, would you include these costs in the analysis? a. Yes, the net cash flow loss per year on the other area of the firm are considered a cost to the project. (p.s. they can also be + if they are complements b. No because they are not cash flows generated from the project. 24. What are the three types of project risk? 25. Which type of risk is most relevant? a. Standalone b. Market c. Corporate d. They are all equally risky 26. Which is most easily measured? a. Standalone b. Corporate c. Market d. They are all easy to measure 27. Why isn t it detrimental to focus on standalone risk?
28. Sensitivity analysis measures the effect of changes in a variable on the projects. a. IRR b. WACC c. Risk d. NPV 29. What does inflation do to NPV? a. Makes up downwardly revised b. Makes it upwardly revised c. Has no effect 30. A company is considering an expansion. The necessary equipment would be purchased for $10 million, and it would also require an additional $5 million investment in working capital. The tax rate is 35%. a. What is the initial investment outlay? b. Last year the company spent $45,000 on research related to the project. Does this change your answer to part A? c. The building where the company wants to house the project could be sold for $500,000 (before tax) if they did not use it for the project. Does this affect your answer, and if yes, by how much? 31. A company is in the final year of a project. The equipment initially cost $30 million, of which 75% has been depreciated. It could be sold right now for $8,500,000, and the tax rate is 35%. What is the equipments after tax net salvage value?
Chapter 13: Real Options and other Topics in Capital Budgeting **Remember to read this chapter and work the problem set and know the concepts for a good understanding** 32. What is a real option analysis? 33. What are some examples of real options used in class/in the text? 34. Martin Development Co. is deciding whether to proceed with project X. The cost would be $9 million in year 0. There is a 50% chance that it would be very successful and generate annual after tax cash flows of $6million per year for 3 years. However, there is also a 50% chance that X would only generate $1million per year for 3 years. If X is very successful, it would open the door to project Y which would cost $10 million at the end of year 2. It would then be sold for $20 million at the end of year 3. The WACC is 11%. a. If they don t consider the options, what is the NPV of X? b. What is the NPV considering the growth option? c. So what is the value of the growth option?