Indicate the best answer for each question in the space provided. 1 Which of the following is not a capital budgeting decision? a Whether to acquire a subsidiary company. b Whether to expand a product line. c Whether to fill a special order. d Whether to purchase a fleet of trucks. 2 Which of the following is an example of a nonfinancial consideration in capital budgeting? a Will an investment generate adequate cash flows to promptly recover its cost? b Will an investment generate an acceptable rate of return? c Will an investment have a positive net present value? d Will an investment have an adverse effect on the environment? 3 Which of the following is not considered when using the payback period to evaluate an investment? a The profitability of the investment over its entire life. b The annual net cash flow of the investment. c The cost of the investment. d The expected life of the investment. Use the following data for questions 4 and 5. Stone Mfg. is considering expanding operations by investing $300,000 in equipment. The equipment has a useful life of eight years, with no salvage value. Straightline depreciation is used. Stone predicts that net income will increase $37,500 per year as a result of this strategy. 4 Refer to the above data. The payback period for this investment is: a 8 years. b 4 years. c Over 13 years. d 2.5 years. 5 Refer to the above data. Return on average investment for this investment is: a 25%. b 20%. c 12 1/2%. d 15%.
CHAPTER 26 10MINUTE QUIZ B
NAME SECTION
#
Physician’s Pharmacy is considering the purchase of a copying machine which it will make available to customers at a percopy charge. The copying machine has an initial cost of $7,500, an estimated useful life of five years, and an estimated salvage value of $500. The estimated annual revenue and expenses relating to operation of the machine are as follows: $8,000 Expenses $5,500 Revenue other...
...(D)
2.
$158.80
$253.06
Bill plans to fund his individual retirement account with the maximum
contribution of $2,000 at the end of each year for the next 20 years. If Bill can
earn an effective return of 12 per cent per annum on his contributions, how much
will he have accumulated at the end of twenty years, rounded to the nearest
dollar?
(A)
(B)
$19,292
(C)
$144,105
(D)
3.
$14,938
$40,000
A firm’s profit before tax is $150 000 and depreciation expense is $30,000.
Assuming a company tax rate of 30%, the firm’s cashflow from operations is:
(A)
$840,000
(B)
$180,000
(C)
$135,000
(D)
$75,000
4.
Given an effective annual interest rate of 14 per cent, the presentvalue of a
perpetuity consisting of yearly payments of $25,000 starting immediately is,
rounded to the nearest dollar
(A)
(B)
$203,571
(C)
$178,571
(D)
5.
$232,071
$156,641
If the presentvalue of a perpetual income stream is increasing, the discount rate
must be
(A)
(B)
decreasing
(C)
increasing proportionally
(D)
6.
increasing
changing unpredictably
Janice would like to send her parents on a cruise for their 25th wedding
anniversary. She has priced the cruise at $15,000 and she has 5 years to
accumulate this money. To the nearest dollar, how much must Janice deposit
annually in an account paying interest of 10 per...
...Bonds pay semiannual coupons unless otherwise stated;
7) Bonds have a par value (or face value) of $1,000; and
8) You may use the back of the exam paper as your scrap paper.
Good Luck.
32 Calculation Questions (4 marks each)
1. The common stock of Robin's Tools sells for $24.50. The firm's beta is 1.2, the riskfree rate is 4%, and the return on the market portfolio is 12%. Next year's dividend is
expected to be $1.50. Assuming that dividend growth is expected to remain constant
for Robin’s Tools over the foreseeable future, what is the firm's anticipated dividend
growth rate?
A)
B)
C)
D)
E)
6.65%
7.48%
9.15%
13.6%
15.0%
Solution: B
r = 4% + 1.2 x (12%  4%) = 13.6% and
$24.50 = $1.50 / (13.6%  g)
Leads to g = 7.48%
2. What is the yield to maturity on a 10year zerocoupon bond with a $1,000 face value
selling at $742?
A)
B)
C)
D)
E)
3.03%
7.42%
13.48%
34.78
42.37%
Solution: A
YTM = (1000/742) 1/10 1 = .03029 or 3.03%
3. Consider the following monthly cashflows (see the diagram below):
X
Today
Z
X
Z
X
Z
1
2
3
4
19
20
Cashflows of an amount X are made for months 1, 3, 5, …, 17 and 19 (the ten oddnumbered months) and cashflows of an amount Z are made for months 2, 4, 6, …, 18
and 20 (the ten evennumbered months). The APR is 6% and is compounded on a...
...(qualitatively) to value AirThread. Should Ms. Zhang use WACC, APV or some combination thereof? Explain. (2 points)
* From the statement of AirThread case, we know that American Cable Communication want to raise capital by Leveraged Buyout (LBO) approach. This means ACC will finance money though equity and debt to buy AirThread and pay the debt by the cashflows or assets of AirThread.
* In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact.
* If we want to use WACC method, one assumption must be met: this program will not change the debtequity ratio of AirThread. Under LBO approach, it’s impossible.
* So we decide to use APV method to value AirThread. WACC method is not appropriate here, but we still need to calculate the weight average cost of capital (WACC) of AirThread.
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered free cashflow for AirThread.
* Discount AirThread’s unlevered free cashflows at unlevered WACC.
2. Determine the PV of interest tax shield:
* Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend...
...to 1. Which of the following could help explain the divergence of the ratios from the beginning to the end of the year?
a. An increase in inventory levels during the current year.
b. An increase in credit sales in relationship to cash sales.
c. An increase in the use of trade payables during the current year.
d. An increase in the collection rate of accounts receivable.
2. Which of the following will cause a decrease in a company’s accounts receivable turnover ratio?
a. Tighten credit standards.
b. Enforce credit terms more aggressively.
c. Ease enforcement of credit terms.
d. Factor all accounts receivable.
3. If, just prior to a period of rising prices, a company changed its inventory measurement method from FIFO to LIFO, the effect in the next period would be to
a. increase both the current ration and inventory turnover.
b. decrease both the current ratio and inventory turnover.
c. increase the current ratio and decrease inventory turnover.
d. decrease the current ratio and increase inventory turnover.
4. A firm that has substantial leased assets that need not be capitalized would tend to
a. Overstate its debt ratio.
b. Overstate its earnings per share.
c. Overstate its return on assets.
d. Overstate its debt to tangible net worth.
5. A measure of profitability and not shortterm liquidity is the
a. Accounts receivable turnover ratio.
b. Sales to working capital ratio.
c. Total asset turnover ratio.
d....
...Examples Of NetPresentValue (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
NetPresentValue  Method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
Discount Rate  Also known as the hurdle rate or required rate of return, is the rate that a project must achieve in order to be accepted rather than rejected.
Return on Investment – Expected income divided by the amount originally invested
Payback Analysis – The number of years needed to recover the initial cash outlay.
Formulas
NetPresentValue = (t=1..n A * (1+r)t OR (t=1..n A/ (1+r)t
Where A = Cashflow
r = Required rate of return
t = year of cashflow
n = the nth year
Return On Investment = (Discounted Benefits – Discounted Costs) / Discounted Costs
Payback Period = Years taken to repay initial outlay .
Eg. Project Z Outlay =...
...recommendation to Mr. Burton and the executive staff at Tesca Works, Inc. Using the information provided by the Tesca team we were able to create a comprehensive capital budget and cashflow analysis for the proposed refrigerator project.
Through our analysis we found that the cost of capital of the project to be 13.487% and a Weighted Average Cost of Capital (WACC) to be at a value of 9.70%. Factoring in the WACC into our projections we found that if the demand maintains at an average rate the project will be at a positive NetPresentValue of $5,997,505.31 with an IRR of 13.21%, a profitability index of 8.84, and an approximate payback period of 6.84 years. Please see Exhibits below for a snapshot of the capital budget and NPV values.
This information seemed to be very promising for the project in general. However, our continued analysis showed the project to be very sensitive to the sales price per unit of the refrigerator. We used the average demand scenario to produce a sensitivity analysis and found that with just a 5% decrease in the sales price of the refrigerator the NPV quickly dipped into a negative value thus showing the project to be extremely sensitive to the sales price of the refrigerator.
Our scenario analysis also exposed a strong probability of the project giving a negative NetPresent...
...Netpresentvalue
In finance, the netpresentvalue (NPV) or netpresent worth (NPW) of a time series of cashflows, both incoming and outgoing, is defined as the sum of the presentvalues (PVs) of the individual cashflows. In case when all future cashflows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cashflows minus the purchase price (which is its own PV). NPV is a central tool in discounted cashflow (DCF) analysis, and is a standard method for using the time value of money to appraise longterm projects. Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cashflows, in presentvalue terms, once financing charges are met.
The NPV of a sequence of cashflows takes as input the cashflows and a discount rate or discount curve and outputting a price; the converse process in DCF analysis, taking as input a sequence of cashflows and a price and inferring as...
...
FINC5001 Capital Market and Corporate Finance

Workshop 5 – Capital Budgeting II
1. Basic Concepts Review
a) In applying NetPresentValue, what factors do we include, and what factors do we ignore?
Use cashflows not accounting income
Ignore
* sunk costs
* financing costs
Include
* opportunity costs
* side effects
* working capital
* taxation
* inflation
2. Practice Questions
a) After spending $3 million on research, Better Mousetraps has developed a new trap. The project requires an initial investment in plant and equipment of $6 million. This investment will be depreciated straightline over five years to a value of zero, but, when the project comes to an end in five years, the equipment can in fact be sold for $500,000. The firm believes that working capital at each date must be maintained at 10% of next year's forecasted sales. Production costs are estimated at $1.50 per trap and the traps will be sold for $4 each. (There are no marketing expenses.) Sales forecasts are given in the following table. The firm pays tax at 35% and the required return on the project is 12%. What is the NPV?

Figures in 000's  
Year  0  1  2  3  4  5 
Unit Sales   500  600  1,000  1,000  600 
Revenues   2,000  2,400...
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