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Principles Of Fianance: Exam Chapter 8 Homework 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 | Exam 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 | Final Exam 1 2 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? The firm should increase in value each time it accepts a new project The net present value of each new project is zero. The firm is most likely steadily losing value. The internal rate of return on each new project is zero. The price of the firm's stock should remain constant. The modified internal rate of return is specifically designed to address the problems associated with: crossover points. long-term projects. mutually exclusive projects. negative net present values. unconventional cash flows Baker's Supply imposes a payback cutoff of 3.5 years for its international investment projects. If the company has the following two projects available, which project(s), if either, should it accept? Both the projects have payback less than 3.5 , hence it should accept both the projects B(3.09) has better payback than A (3.36)  Accept both Projects A and B Reject both Projects A and B Accept Project B but not Project A Both Project A and B are acceptable but you can select only one project Accept Project A but not Project B Molly is considering a project with cash inflows of $811, $924, $638, and $510 over the next four years, respectively. The relevant discount rate is 11.2 percent. What is the net present value of this project if it the start-up cost is $2,700?  $131.83 $229.50 $383.01 $10.45 $425.91 What is the payback period for a project with the following cash flows?  2.56 years 3.24 years 3.08 years Never 2.89 years Expert Answer
Payback period=A+(B/C) where A is last year with negative cumulative cash flow B is absolute value of cumulative cash flow after A C is total cash flow during period after A Hence payback period = 3 + (2000 / 25000) = 3.08 years (C) Woodcrafters requires an average accounting return (AAR) of at least 17.5 percent on all fixed asset purchases. Currently, it is considering some new equipment costing $169,700. This equipment will have a four-year life over which time it will be depreciated on a straight-line basis to a zero book value. The annual net income from this equipment is estimated at $7,100, $13,300, $18,600, and $19,200 for the four years. Should this purchase occur based on the accounting rate of return? Why or why not? No, because the AAR is less than 17.5 percent No, because the AAR is greater than 17.5 percent Yes,because the AAR is greater than 17.5 percent Yes, because the AAR is equal to 17.5 percent Yes, because the AAR is less than 17.5 percent ARR = average accounting income/average investment = (7,100+13,300+18,600+19,200)/4*(169,700/2) = 17.15% Quattro, Inc. has the following mutually exclusive projects available. The company has historically used a four-year 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? 3.92 years; 3.64 years; $780.85; $1,211.48; accept both Projects 3.96 years; 3.42 years; -$19,764.06; -$10,566.02; reject both projects 4.06 years; 3.79 years; $211.60; -$7,945.93; accept Project A only 3.92 years; 3.79 years; -$17,108.60; $1,211.48; accept Project B only 3.96 years; 3.42 years; $17,780.85; -$1,211.48; accept Project A only project A: Cumulative cash flow for year 0 = -75,000 Cumulative cash flow for year 1 = -75,000 + 6,200 = -68,800 Cumulative cash flow for year 2 = -68,800 + 9,400 = -59,400 Cumulative cash flow for year 3 = -59,400 + 28,100 = -31,300 Cumulative cash flow for year 4 = -31,300 + 32,600 = 1,300 31,300 / 32,600 = 0.96 Payback for project A = 3 + 0.96 = 3.96 years Project B: Cumulative cash flow for year 0 = -85,000 Cumulative cash flow for year 1 = -85,000 + 27,700 = -57,300 Cumulative cash flow for year 2 = -57,300 + 26,500 = -30,800 Cumulative cash flow for year 3 = -30,800 + 24,200 = -6,600 Cumulative cash flow for year 4 = -6,600 + 15,600 = 9,000 6,600 / 15,600 = 0.42 Payback for project B = 3 + 0.42 = 3.42 years NPV = present value of cash inflows - present value of cash outflows project A: NPV = -75,000 + 6200 / ( 1 + 0.11)1 + 9400 / ( 1 + 0.11)2 + 28100 / ( 1 + 0.11)3 + 32600 / ( 1 + 0.11)4 NPV = -19,764.05 Project B: NPV = -85,000 + 27700 / ( 1 + 0.11)1 + 26500 / ( 1 + 0.11)2 + 24200 / ( 1 + 0.11)3 + 15600 / ( 1 + 0.11)4 NPV = -10,566 Company should reject both as both projects have negative NPV. Soft and Cuddly is considering a new toy that will produce the following cash flows. Should the company produce this toy based on IRR if the firm requires a rate of return of 17.5 percent?  No, because the project's rate of return is 11.47 percent No, because the internal rate of return is zero percent No, because the project's rate of return is 16.45 percent Yes, because the project's rate of return is 11.47 percent Yes, because the project's rate of return is 16.45 percent NPV = 0 = -$132,000 + $97,000 / (1 + IRR) + $42,000 / (1 + IRR)2 + $28,000 / (1 + IRR)3 IRR = 16.45 percent  Which one of the following methods of analysis has the greatest bias toward short-term projects? Payback Average accounting return Net present value Profitability index Internal rate of return Textiles Unlimited has gathered projected cash flows for two projects. At what interest rate would the company be indifferent between the two projects? Which project is better if the required return is 12 percent?  12.49 percent; A -4.44 percent; B -4.44 percent; A 12.49 percent; B 11.76 percent; A Expert Answer In order to determine, which project is better, we calculate the NPV of both at 12%:
At -4.44% both projects nearly have the same NPV and hence at an interest rate of -4.44% would the company be indifferent between the two projects. This is shown in the table below:
Which one of the following indicates that a project is expected to create value for its owners? A) Profitability index less than 1.0 B) Payback period greater than the requirement C) Positive net present value D) Positive average accounting rate of return E) Internal rate of return that is less than the requirement 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. The Black Horse is currently considering a project that will produce cash inflows of $11,000 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 9 percent? A) .85 B) .93 C) 1.04 D) 1.09 E) 1.12 PI = ($11,000 / 1.09 + $11,000 / 1.092 + $11,000 / 1.093 + $6,500 / 1.094) / $38,000 PI = .85 Which one of the following indicates that a project should be rejected? Assume the cash flows are normal, i.e., the initial cash flow is negative. A) Average accounting return that exceeds the requirement B) Payback period that is shorter than the requirement period C) Positive net present value D) Profitability index less than 1.0 E) Internal rate of return that exceeds the required return What is the net present value of a project with the following cash flows if the discount rate is 15 percent? Year 0: CF = -48,100 Year 1: CF = 15,600 Year 2: CF = 28,900 Year 3: CF = 15,200 A) -$2,687.98 B) -$1,618.48 C) $1,044.16 D) $1,035.24 E) $9,593.19 A) -$2,687.98 NPV = - $48,100 + $15,600 / 1.15 + $28,900 / 1.152 + $15,200 / 1.153 NPV = -$2,687.98 Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? A) Mutually exclusive B) Conventional C) Multiple choice D) Dual return E) Crosswise Services United is considering a new project that requires an initial cash investment of $26,000. The project will generate cash inflows of $2,500, $11,700, $13,500, and $10,000 over each of the next four years, respectively. How long will it take to recover the initial investment? A) 2.74 years B) 2.87 years C) 2.99 years D) 3.27 years E) 3.68 years Payback = 2 + ($26,000 -2,500 -11,700)/$13,500 = 2.87 years Which one of the following is specifically designed to compute the rate of return on a project that has a multiple negative cash flows that are interrupted by one or more positive cash flows? A) Average accounting return B) Profitability index C) Internal rate of return D) Indexed rate of return E) Modified internal rate of return An investment has an initial cost of $2.7 million and net income of $189,400, $178,600, and $172,500 for Years 1 to 3. This investment will be depreciated by $900,000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 12.5 percent? Why or why not? A) Yes, because the AAR is 12.5 percent B) Yes, because the AAR is less than 12.5 percent C) Yes, because the AAR is greater than 12.5 percent D) No, because the AAR is greater than 12.5 percent E) No, because the AAR is less than 12.5 percent C) Yes, because the AAR is greater than 12.5 percent AAR = [($189,400 + 178,600 + 172,500) / 3] / [($2,700,000 + 0) / 2] = .1335, or 13.35 percent. The AAR is greater than the requirement, so the investment should be accepted. Which of the following present problems when using the IRR method. Non-conventional cash flows Mutually exclusive projects The NPV is_____ if the required return is less that the IRR Positive The NPV IS ____ if the required return is greater than the IRR Negative Based on the payback rule, an investment is acceptable if its calculated payback period is ___________ than some prespecified numbers of years less What is the NPV of A project with an initial investment of $95, a cash flow in once year of $107, and a discount rate of 6 percent? $5.94 NVP = - $95 + (107 / 1.06) = 5.94 Based on the average accounting return rule, a project is _________________________ if its average accounting return exceeds a target average accounting return. acceptable The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate True The profitability index is calculated by dividing the PV of the ____ cash inflows by the initial investment Future Based on the IRR rule, an investment is ____________________ if the IRR exceeds the required return. It should be ________________ otherwise. acceptable; rejected Which of the following are weaknesses of the payback method Time value of money principles are ignored. Cash flows received after the payback period are ignored. The cutoff date is arbitrary The net present value of an investment represents the difference between the investment's: Cost and its market value A project with non-conventional cash flows will produce two or more IRR True Capital budgeting is: the decision-making process for accepting and rejecting projects The basic NPV investment rule is: Accept a project if the NPV is greater than zero Reject a project if it is less than zero If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference An investment should be accepted if the net present value is _________________ and rejected if it is _______________________. positive; negative Net present value involves discounting an investment's: A) future profits. B) future cash flows. C) assets. D) liabilities. E) costs. Discounted cash flow valuation is the process of discounting an investment's: Future cash flows The Steel Factory is considering a project that will produce annual cash flows of $36,800, $45,500, $56,200, and $21,800 over the next four years, respectively. What is the internal rate of return if the initial cost of the project is $135,000? 7.56% The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: Recoup its initial cost Diamond Enterprises is considering a project that will produce cash inflows of $238,000 a year for three years followed by $149,000 in year 4. What is the internal rate of return if the initial cost of the project is $749,000? 6.32% The reinvestment approach to the modified internal rate of return: Compounds all of the cash flows, except the initial cash flow, to the end of the project Which one of the following methods of analysis ignores cash flows? A) Profitability index B) Modified internal rate of return C) Payback D) Average accounting return E) Internal rate of return The average net income of a project divided by the project's average book value is referred to as the project's: Average accounting return Miller Brothers is considering a project that will produce cash inflows of $61,500, $72,800, $84,600, and $68,000 a year for the next four years, respectively. What is the internal rate of return if the initial cost of the project is $225,000? 10.22% The net present value profile illustrates how the net present value of an investment is affected by which one of the following? Discount rate Which one of the following statements is correct? A) The payback period considers the timing and amount of all of a project's cash flows. B) The payback rule states that you should accept a project if the payback period is less than one year. C) The payback rule is biased in favor of long-term projects. D) The payback period ignores the time value of money. E) A longer payback period is preferred over a shorter payback period. Which one of the following defines the internal rate of return for a project? Discount rate that results in a zero net present value for the project Which one of the following can be defined as a benefit-cost ratio? Profitability index What is the market called that facilitates the sale of shares between individual investors? A) Inside B) Secondary C) Initial D) Primary E) Proxy The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as: Multiple rates of return Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? Mutually exclusive ` Miller Brothers is considering a project that will produce cash inflows of $61,500, $72,800, $84,600, and $68,000 a year for the next four years, respectively. What is the internal rate of return if the initial cost of the project is $225,000? 10.22% Which of the following indicates that a project is expected to create value for its owners? Positive net present value The Tool Box needs to purchase a new machine costing $1.46 million. Management is estimating the machine will generate cash inflows of $223,000 the first year and $600,000 for the following three years. If management requires a minimum 12 percent rate of return, should the firm purchase this particular machine? Why or why not? Yes, because the IRR is 12.74% Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? Net present value You were recently hired by a firm as a project analyst. The owner of the firm is unfamiliar with financial analysis and wants to know only what the expected dollar return is per dollar spent on a given project. Which financial method of analysis will provide the information that the owner requests? A) Modified internal rate of return B) Payback C) Profitability index D) Internal rate of return E) Net present value Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting? A) Aggregate B) Condensed C) Straight D) Cumulative E) Proxy The net present value: Decreases as the required rate of return increases Jensen Shipping has four open seats on its board of directors. How many shares will a shareholder need to control to ensure that his or her candidate is elected to the board given the fact that the firm uses straight voting? Assume each share receives one vote. A) One-third of the shares plus one share B) Twenty percent of the shares plus one share C) Twenty-five percent of the shares plus one share D) Fifty percent of the shares plus one share E) Fifty-one percent of the shares plus one share A preferred stock sells for $54.20 a share and has a market return of 9.68 percent. What is the dividend amount? A) $5.42 B) $5.09 C) $5.25 D) $5.14 E) $4.75 .0968 × 54.20 = 5.25 Based on the most recent survey information presented in your textbook, CFOs tend to use which two methods of investment analysis the most frequently? A) Payback and internal rate of return B) Payback and net present value C) Internal rate of return and net present value D) Profitability index and internal rate of return E) Net present value and profitability index 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 net present value is greater than 1.0. B) The average accounting return is 1.0. C) The net present value is equal to zero. D) The investment never pays back. E) The internal rate of return exceeds the required rate of return. Homework 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 | Exam 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 | Final Exam 1 2
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