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1. What is the present value (PV) of an investment that will pay $400 in one year's time, and $400 every year after that, when the interest rate is 5%?
2. A perpetuity has a PV of $32,000. If the interest rate is 10%, how much will the perpetuity pay every year?
3. A perpetuity will pay $1000 per year, starting five years after the perpetuity is purchased. What is the present value (PV) of this perpetuity on the date that it is purchased, given that the interest rate is 4%?
4. An annuity is set up that will pay $1500 per year for ten years. What is the present value (PV) of this annuity given that the discount rate is 6%?
PV = $11,040.13
5. Which of the following statements regarding annuities is FALSE?
The difference between an annuity and a perpetuity is that a perpetuity ends after some fixed number of payments.
6. An annuity pays $50 per year for 20 years. What is the future value (FV) of this annuity at the end of those 20 years, given that the discount rate is 7%?
FV20 = 2049.77
7. Clarissa wants to fund a growing perpetuity that will pay $5000 per year to a local museum, starting next year. She wants the annual amount paid to the museum to grow by 5% per year. Given that the interest rate is 8%, how much does she need to fund this growing perpetuity?
PV = 166,666.67
8. Martin wants to provide money in his will for an annual bequest to whichever of his living relatives is oldest. That bequest will provide $1000 in the first year, and will grow by 7% per year, forever. If the interest rate is 11%, how much must Martin provide to fund this bequest?
PV = $25000
9. You are thinking about investing in a mine that will produce $10,000 worth of ore in the first year. As the ore closest to the surface is removed it will become more difficult to extract the ore. Therefore, the value of the ore that you mine will decline at a rate of 8% per year forever. If the
10. What is the internal rate of return (IRR) of an investment that requires an initial investment of $10,000 today and pays $14,000 in one year's time?
IRR = 40%
11. You are interested in purchasing a new automobile that costs $35,000. The dealership offers you a special financing rate of 6% APR (0.5% per month) for 48 months. Assuming that you do not make a down payment on the auto and you take the dealer's financing deal, then your monthly car payments would be closest to:
PMT = $821.98
12. You are considering purchasing a new home. You will need to borrow $250,000 to purchase the home. A mortgage company offers you a 15-year fixed rate mortgage (180 months) at 9% APR (0.75% per month). If you borrow the money from this mortgage company, your monthly mortgage payment will be closest to:
PMT = $2,535.67
13. You are considering an investment that will pay $150 after 1 year, $500 after 2 years and $600 after 3 years. What is the present value of the cash flows if the appropriate discount rate is 10% per year?
PV = $1,000.38
14. You plan to deposit $1,000 today (t = 0), and then follow it by 10 equal payments of $500 each year for the next 10 years (from t = 1 to t = 10), into your savings account. What will your account balance be 10 years from today (at t = 10)? Assume your account pays 6% per year interest on all deposits.
FV = $8,381.20
15. A car dealer offers you a BMW Z4 for payments of $400 a month for 60 months. There is a grace period of the first 2 months where you do not make any payments Thus, you therefore make 60 equal installments from t = 2 to t = 61. If the rate of interest charged by the dealer is 1% per month, what amount are you borrowing?
PV = $17,803.98
16. You wish to buy a music system for $2000. Best Buy is offering to finance your purchase for 12 equal monthly installments at 2% per month for 12 months starting one month from today, and a final additional payment of $1000 after one year. What is your monthly payment if the first payment is due 1 month from today?
PMT = $114.5
17. Jason plans on purchasing a house for $120,000. If a local bank is willing to lend the entire amount for a 30 year term at an APR of 7.2%, what is the monthly payment on the loan?
PMT = $814.5
18. You are prepared to make monthly payments of $200, beginning the end of this month, into an account that pays an interest of 12% quoted as an APR with monthly compounding. How many payments will you have made when your account balance reaches $50,000?
N = 125.9
19. You will receive payments of $500 each year and forever where the payments start at t = 8. Compute the present value of these payments at t = 0 if the rate of interest is 10% per year?
20. Jason bought a house ten years ago. His payments are $700 per month and the APR on the loan is 6% and the original term was 30 years. With 20 years remaining now, what is the principal component of the next payment (121st payment)?
21. An annuity of $2000 with 10 payments starts today (10 payments from t = 0 to t = 9). If the rate of interest is 6% per year, what is the future value of this annuity at t = 10?
FV = 27,943
22. Dan buys a property for $250,000. He is offered a 20-year loan by the bank, at an interest rate of 6% per year. What is the annual loan payment Dan must make?
PMT = $21,796.139
23. Matthew wants to take out a loan to buy a car. He calculates that he can make repayments of $4,000 per year. If he can get a five-year loan with an interest rate of 7.5%, what is the maximum price he can pay for the car?
PV = $16,183.54
24. A businessman wants to buy a truck. The dealer offers to sell the truck for either $120,000 now, or six yearly payments of $25,000. What is the interest rate being offered by the dealer?
I/YR = 6.77%
25. Which of the following would be LEAST likely to lower the interest rate that a bank offers a borrower?
The investment will be for a long period of time.
26. What is the effective annual rate (EAR)?
The amount of interest that will be earned at the end of one year
27. A bank offers a loan that will requires you to pay 6% interest compounded monthly. What is the EAR charged by the bank?
EAR + 6.17%
Which of the following statements is FALSE?
The annual percentage rate indicates the amount of interest including the effect of compounding.
A house costs $138,000. It is to be paid off in exactly ten years, with monthly payments of $1,675. What is the APR of this loan?
30. A homeowner has five years of monthly payments of $1400 before she has paid off her house. If the interest rate is 7% APR, what is the remaining balance on her loan?
PV = $70,703
31. A Xerox DocuColor photocopier costing $42,000 is paid off in 60 monthly installments at 6.5% APR. After three years the company wishes to sell the photocopier. What is the minimum price for which they can sell the copier so that they can cover the cost of the balance remaining on the loan?
PV = $18,447.79
32. A truck costing $112,000 is paid off in monthly installments over four years with 8% APR. After three years the owner wishes to sell the truck. What is the closest amount from the following list that he needs to pay on his loan before he can sell the truck?
33. What is the real interest rate given a nominal rate of 8% and an inflation rate of 4.5%?
34. Given that the inflation rate in 2006 was about 3.24%, while a short term municipal bond offered a nominal rate of 2.9%, which of the following statement is correct?
Investors in these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.
35. In which of the following situations would the reserve bank in a certain country be most likely to lower interest rates?
The economy is growing slowly or not at all.
36. Term in years: 2 5 10 30
Rate: 2.25% 3.125% 3.5% 4.375% The table above shows the interest rates available from investing in risk-free U.S. Treasury securities with different investment terms. If an investment offers a risk-free cash flow of $100,000 in ten years' time, what is the present value (PV) of that cash flow?
37. Term in years: 1 2 3 4 5
Rate: 1.8% 2.25% 2.30% 2.66% 3.13% The table above shows the interest rates available from investing in risk-free U.S. Treasury securities with different investment terms. What is the present value (PV) of cash flows from an investment that yields $4000 at the end of each year for the next four years?
Sum of PV's = $15,093
38. In which of the following situations would it not be appropriate to use the following formula:
when short-term and long-term interest rates vary widely
39. Which of the following reasons for considering long-term loans inherently more risky than short-term loans most accurate?
Long-term loan values are much more sensitive to changes in market interest rates than short-term loan values.
Suppose the term structure of interest rates is shown below: Term 1 yr 2 yrs 3 yrs 5 yrs 10 yrs 20 yrs Rate
(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15% 40. What is the shape of the yield curve and what expectations are investors likely to have about future interest rates?
41. Given the term structure table above, the present value (PV) of receiving $1000 per year with certainty at the end of the next three years is closest to:
PV = $2737
42. What, typically, is used to calculate the opportunity cost of capital on a risk-free investment?
the interest rate on U.S. Treasury securities with the same term
43. Why, in general, do investment opportunities offer a rate greater than that offered by U.S. Treasury securities for the same horizon?
Most investment opportunities offer far greater risk than those offered by U.S. Treasury securities.
44. What is the effective annual rate when the APR equals 15% for monthly compounding?
45. A given rate is quoted as 12% APR and has an EAR of 12.68%. What is the compounding frequency during the year?
46. The monthly mortgage payment on your house is $960.34 starting one month from now. It is a 30 year mortgage at an APR of 6% compounded monthly. How much will still you owe the bank (loan outstanding) after making the required payments for 10 years?
47. You purchase a car for $15,000. The car loan is financed with a 5% per year, 5-year loan with annual payments starting at time 1 (1 year from today) through time 5. Each payment reduces the principal by a certain amount until the loan is completely paid off. What is the interest component of the first payment?
48. The term structure of interest rates generally refers to:
A graphical depiction of yield to maturity of government bonds vs. maturity.
49. An investor places $3000 in a bank account. The bank promises an interest rate of 8% in year 1, 9% in year 2 and 10% in year 3. What is the account balance at the end of 3 years?
50. Which of the following best illustrates why a bond is a type of loan?
When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance it will be repaid at a date in the future.
51. How much will be the coupon payments of a 20-year $500 bond with an 8% coupon rate and quarterly payments?
52. How much will the coupon payments be of a 30-year $10,000 bond with a 4.5% coupon rate and semiannual payments?
53. A corporate bond makes payments of $9.67 every month for ten years with a final payment of $2009.67. Which of the following best describes this bond?
a 10-year bond with a face value of $2000 and a coupon rate of 5.8% with monthly payments
54. Maturity (years) 1 2 3 4 5
Price $97.25 $94.53 $91.83 $89.23 $87.53 The above table shows the price per $100 face value of several risk-free, zero-coupon bonds. What is the yield to maturity of the three-year, zero-coupon, risk-free bond shown?
55. You are considering investing in a zero-coupon bond that will pay you its face value of $1000 in ten years. If the bond is currently selling for $485.20, then the internal rate of return (IRR) for investing in this bond is closest to:
56. A risk-free, zero-coupon bond with a face value of $1,000 has 15 years to maturity. If the YTM is 5.8%, what is the price this bond will trade at?
PV = $429.25
57. Which of the following statements is FALSE?
Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value.
58. Consider a zero-coupon bond with a $1,000 face value and ten years left until maturity. If the bond is currently trading for $459, then what is the yield to maturity on this bond?
Compute I/YR = 8.098 or 8.1%
193. The above information is for a corporate bond issued by the Markel Corporation. What sort of bond is this?
an investment grade bond
59. Why are the interest rates of U.S. Treasury notes less than the interest rates of equivalent corporate bonds?
U.S. Treasury securities are widely regarded to be risk-free.
60. A firm issues ten-year bonds with a coupon rate of 6.5%, paid semiannually. The credit spread for this firm's ten-year debt is 0.8%. New ten-year Treasury notes are being issued at par with a coupon rate of 5%. What should the price of the firm's outstanding ten-year bonds be per $100 of face value?
61. Security: AAA AA A BBB BB Yield (%): 5.6 5.7 5.9 6.4 7.0 A mining company needs to raise $100 million in order to begin open pit mining of a coal seam. The company will fund this by issuing 30-year bonds with a face value of $1000 and a coupon rate of 6%, paid annually. The above table shows the yield to maturity for similar 30-year corporate bonds of different ratings. If the mining company's bonds receive an A rating, what will be their selling price?
62. Security: AAA AA A BBB BB Yield (%): 5.7 5.8 6.0 6.6 6.9 Lloyd Industries raised $28 million in order to upgrade its roller kiln furnace for the production of ceramic tile. The company funded this by issuing 15-year bonds with a face value of $1000 and a coupon rate of 6.2%, paid annually. The above table shows the yield to maturity for similar 15-year corporate bonds of different ratings issued at the same time. 17 When Lloyd Industries issued their bonds, they received a price of $962.63. Which of the following is most likely to be the rating these bonds received?
63. A corporate bond which receives a BBB rating from Standard and Poor's is considered
an investment grade bond.
64. What is the yield to maturity of a ten-year, $1000 bond with a 5.2% coupon rate and semiannual coupons if this bond is currently trading for a price of $884?
65. What must be the price of a $10,000 bond with a 6.5% coupon rate, semiannual coupons, and two years to maturity if it has a yield to maturity of 8% APR?
PV = $9,727.75.
66. What must be the price of a $1,000 bond with a 5.8% coupon rate, annual coupons, and 30 years to maturity if YTM is 7.5% APR?
PV = 𝟕𝟗𝟗. 𝟐𝟐
67. What is the coupon rate of a two-year, $10,000 bond with semiannual coupons and a price of $9543.45, if it has a yield to maturity of 6.8%?
coupon rate = 4.32%
69. A bond is currently trading below par. Which of the following can be true about that bond?
B and C above
70. A treasury bond has an annual coupon rate of 4% that is paid semi-annually. The face Value of the bond is $1,000 and it has 10 years to maturity with a yield to maturity of 6% (expressed as an APR with semi-annual compounding). Compute the price of the bond.
71. As a zero coupon bond approaches maturity, the price gets closer to the:
68. Which of the following statements are true?
A rise in interest rates causes bond prices to fall.
72. If the yield to maturity on a coupon bond is equal to the coupon rate, it must be the case that ______________________. (If you cannot figure it out use some numbers to see what you get).
the bond sells for par value (face value).
73. Suppose you purchase a zero coupon bond with a face value of $1,000 and a maturity of 25 years, for $320. If the yield to maturity on the bond remains unchanged, what will the price of the bond be 5 years from now? Hint: compute the YTM first and then compute the bond price in 5 years.
74. What is the current market value of a bond that was issued 5 years ago if it had a maturity of 30 years on the issue date? The annual coupon rate is 18% with coupons paid semi-annually. Assume the bond has a $1,000 face value and a 14% per year yield to maturity (yield to maturity is expressed as an APR with semi-annual compounding).
75. In general a corporate bond with the same cash flows as a treasury bond, with the same maturity, and same face value as the treasury bond will sell at a price that is: A) Higher than the treasury bond because of credit risk.
Lower than the treasury bond because of credit risk.
76. Zoro Sword Company bonds have a coupon of 10% paid annually. The bonds have 10 years to remaining to maturity and a Face Value of $1,000. What is the price of the bonds today, if the investors' required rate of return is 10% per year? (Round your answer to the nearest $1.)
77. The bonds of Superman Comics Inc. pay a annual coupon. They have 15 years remaining to maturity and a Face Value of $1,000. What is the annual coupon rate on the bonds if investors require a rate of return of 10% per year and the current bond price is $1000?
78. Patar Inc. Bonds are zero coupon bonds with a maturity of 30 years. If the price of each bond is $41.19 per $100 face value, what is the annual yield to maturity of these bonds?
79. Which of the following will probably increase a bond price? (i) Increase in default risk. (ii) Decrease of expected inflation rates. 21 (iii) Increase of real rates of interest.
80. Big-Mart stock is expected to pay a dividend of $3.15 next year. The dividends are expected to grow at 5% per year thereafter, and the market discount rate for stocks of equivalent risk is 10%. What is the value of Big-Mart stock now?
81. Solaris Energy Inc. has a new issue of preferred stock. The stock will pay a constant dividend of $10 per year, but the first dividend payment will be made 3 years from now. If you require a 10% return on this preferred stock, how much would you pay at most today?
82. The stock price of Adama Industries is $80. Investors required a 9% of return on stocks with similar risk. If the company plans to pay a dividend of $4 next year, what is the expected annual growth rate of the company's dividends?
83. Suppose you invested $100 in the iShares High Yield Fund (HYG) a month ago. It paid a dividend of $1 today and then you sold it for $101. What was your dividend yield and capital gains yield on the investment?
84. Which of the following is NOT a way that a firm can increase its dividend per share?
by increasing its retention rate
85. OwenInc has a current stock price of $14.50 and is expected to pay a $0.85 dividend in one year. If OwenInc's equity cost of capital is 12%, what price would OwenInc's stock be expected to sell for immediately after it pays the dividend?
FV = 𝟏𝟓. 𝟑𝟗
86. Credenza Industries is expected to pay a dividend of $1.20 at the end of the coming year. It is expected to sell for $62.00 at the end of the year. If its equity cost of capital is 8%, what is the expected capital gain from the sale of this stock at the end of the coming year?
87. The Busby Corporation had a share price at the start of the year of $26.20, paid a dividend of $0.56 at the end of the year, and had a share price of $29.00 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period?
88. Valorous Corporation will pay a dividend of $1.80 per share at this year's end and a dividend of $2.40 per share at the end of next year. It is expected that the price of Valorous' stock will be $44 per share after two years. If Valorous has an equity cost of capital of 8%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today?
89. Which of the following statements is FALSE regarding profitable and unprofitable growth?
If a firm wants to increase its share price, it can always cut its dividend and invest more.
90. Which of the following statements is FALSE?
According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.
91. Which of the following statements is FALSE?
We cannot use the general dividend-discount model to value the stock of a firm with rapid or changing growth.
92. Which of the following statements is FALSE?
During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.
93. NoGrowth Industries presently pays an annual dividend of $1.50 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 12%, what is the value of a share of NoGrowth's stock?
94. Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 12%. Luther Industries' dividends are expected to grow at a constant rate indefinitely. The grow rate of Luther's dividends are closest to:
g = 0.075
95. The Sisyphean Company's common stock is currently trading for $25.00 per share. The stock is expected to pay a $2.50 dividend at the end of the year and the Sisyphean Company's equity cost of capital is 14%. If the dividend payout rate is expected to remain constant, then what is the expected growth rate in the Sisyphean Company's earnings?
g = 0.04
96. You expect KT industries (KTI) will have earnings per share of $3 at the end of this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%
b) What is the value of a share of KTI's stock?
g = 7.5%
97. You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Bean's equity cost of capital is 12%, then what is the price of a share of Bean's stock? Year Earnings Dividends g
1 $2.00 $0.00 20%
2 $2.40 $0.00 20%
3 $2.88 $0.00 20%
4 $3.46 $1.73 10%
5 $3.80 $1.90 10%
6 $4.18 $3.14 5%
98. Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport?
99. Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. The return on reinvested funds is expected to be 13%. If the reinvestment does not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this decision?
100. Suppose a stock X has a required return of 15% per period. The stock's price is expected to increase to $75 per share by t=1 and it will pay a dividend of $8 on t=1. Compute the price of this stock at t=0.
101. What is the price of a stock that just paid a dividend of $2 today (note this is D0) and has a required return of 10% per year? The dividends are expected to increase at an average rate of 4% per year from today. Hint: First compute dividend at t=1 before computing the price of the stock.
102. Find the required return for a stock whose dividends are expected to grow at a constant rate forever, given the following information: - Current stock price P0 = $15.00, expected dividend after one year D1 = $1.04 and the dividend growth rate is 4% per year forever. Hint: This is a constant dividend growth stock where rate is unknown.
103. Shares of Books Inc. expect to pay annual dividends of $1.5 at t = 1, $2.5 at t = 2 and $4 at t = 5 (there are no dividends at time 3 and 4). After this period Books Inc. dividends will grow at 5% per year. The required rate of return on the stock of Books Inc. is 12% per year. Calculate the price of Books Inc. today.
104. Systems Inc. stock is currently selling for $66.67. The dividend one year from today is expected to be $6.00 and is expected to grow forever at 3%. The required rate on Systems' stock is 12%. Calculate the price of the stock after 3 years (at time 3)? Hint: recall the example in class where the capital gains yield of a stock with constant growth was equal to the growth rate in dividends.
105. What is the value of a preferred stock that pays a constant and pre-determined dividend of $3.50 at the end of each year forever and has a required rate of return of 10% per year? (Round your answer to the nearest $1.)
106. With reference to question 105 above, what is the capital gains yield and dividend yield on the preferred stock?
107. Which of the following statements is FALSE?
By repurchasing shares, the firm increases its share count, which decreases its earnings and dividends on a per-share basis.
108. If you want to value the equity of a firm's equity that consistently pays out its earnings as dividends, the simplest model for you to use is the
109. If you want to value the equity of a firm that has consistent earnings growth, but varies how it pays out these earnings to shareholders between dividends and repurchases, the simplest model for you to use is the
total payout model.
110. Valence Electronics has 217 million shares outstanding. It expects earnings at the end of the year of $760 million. Valence pays out 40% of its earnings in total: 15% paid out as dividends and 25% used to repurchase shares. If Valence's earnings are expected to grow by 6% per year, these payout rates do not change, and Valence's equity cost of capital is 8%, what is Valence's share price?
111. What is the price of a stock that will pay a dividend of $3 in one year and has a required return of 9% per year? The dividends are expected to increase at an average rate of 4% per year from one year onwards.
112. Which of the following best describes the Net Present Value rule?
Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.
113. Which of the following investment decision measures is best defined as the amount of time it takes to pay back the initial investment?
114. Which of the following is NOT a limitation of the payback period rule?
It is difficult to calculate.
Year Cash Flow
If the appropriate discount rate (cost of capital) for this project is 15%, then what is its net present value (NPV)?
NPV = 1,419.91.
Year Cash Flow
116. What is the IRR of the project above? If the cost of capital is 15%, apply the IRR rule to accept or reject this project.
IRR = 21.86%
117. A florist is buying a number of motorcycles to expand its delivery service. These will cost $87,000, but are expected to increase profits by $3000 per month over the next four years. What is the payback period (in number of months) in this case?
118. The Sisyphean Company is planning on investing in a new project. This will involve the purchase of some new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as detailed below:
Year 1 Year 2 Year 3 Year 4 $200,000 $225,000 $275,000 $200,000
The appropriate discount rate for this project is 16%. What is the internal rate of return (IRR) for this project? Should the company invest in this project using the IRR rule?
IRR = 34.12%.
119. An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $580,000 per year. If the discount rate is 7.5%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?
120. Assume that projects Alpha and Beta are mutually exclusive. Which one would you choose to invest in and why?
Project Beta has a higher NPV than project Alpha. Therefore, invest in project Beta.
121. Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects above, which projects should you invest in and in what order?
By the rankings CBFG seem optimal, but this combination leaves $120,000 on the table not invested. By replacing G with H the full $600,000 is invested and the NPV of the combination of projects is increased by $11,000. Therefore you should invest in projects C, B, F, and H.
122. Which of the following best defines incremental earnings?
the amount by which a firm's earnings are expected to change as the result of an investment decision
123. Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense?
the redesign of the plant only
124. Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case?
125. CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over five years. It is expected that the range of candies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 35%, what are the incremental earnings in the second year of this project?
126. Which of the following costs would you consider when making a capital budgeting decision?
127. Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?
subtracting depreciation expenses
128. Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those 36 six years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 2?
129. Which of the following formulas will correctly calculate Net Working Capital?
Cash + Inventory + Receivables - Payables
130. CathFoods will release a new range of candies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 35%, what are the incremental free cash flows in the second year of this project?
131. A firm reports that in a certain year it had an unlevered net income of $4.5 million, depreciation expenses of $2.8 million, capital expenditures of $2.3 million, and Net Working Capital decreased by $1.5 million. What is the firm's free cash flow for that year?
132. Cromwell Industries is considering a new project which will have costs, revenues, etc. as shown by the data above. If the cost of capital is 8.5%, what is the net present value (NPV) of this project?
133. Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $100,000; however, a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land and would be willing to pay $650,000 for it. When calculating the net present value (NPV) of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is:
134. You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an increase in inventory of $8000, an increase in accounts payables of $2500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is:
135. The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's marginal corporate tax rate is 40%, then what is the value of the depreciation tax shield on the company's new project? Hint: Depreciation tax shield: the amount of tax savings due to the depreciation expense of the project
136. Caprica Company reported an unlevered net income of $300 million for the most recent fiscal year. The firm had depreciation expenses of $125 million and capital expenditures of $150 million. Although it had no interest expense, the firm did have an increase in net working capital of $20 million. What is Caprica's free cash flow?
FCF = 255
137. Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35%.
a) Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and only year of operation?
b) Assume that THSI's cost of capital for this project is 15%. What is the net present value (NPV) of this temporary housing project is closest to:
138. Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the incremental cash flow projections in the table above. After finding the free cash flows of the project for years 0 up to 3, find the NPV (at 12%) and the IRR of the project.
In year 0: FCF = -$90,000
In years 1 and 2: FCF = $13,000 + $30,000 - $0 - $5,000 = $38,000
In year 3: FCF = $13,000 + $30,000 - $0 - ( -$10,000) = $53,000
140. If you want to value the equity of a firm's equity that consistently pays out its earnings as dividends, the simplest model for you to use is the
141. If you want to value the equity of a firm that has consistent earnings growth, but varies how it pays out these earnings to shareholders between dividends and repurchases, the simplest model for you to use is the
total payout model.
153. The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what discount rate does her decision to renovate become untenable?
154. The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 6%, should she accept the project?
No, because the NPV is negative at that rate.
155. Which of the following situations can lead to IRR giving a different decision than NPV?
All of the above can lead to IRR giving a different decision than NPV
156. If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest?
157. If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or Project B) will rank highest?
158. Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which deal should she take given a discount rate of 8%?
PV = $203,810
PV2 = $200,000
159. A local government awards a landscaping company a contract worth $1.2 million per year for five years for maintaining public parks. The landscaping company will need to buy some new machinery before they can take on the contract. If the cost of capital is 7%, what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company?
160. If WiseGuy Inc is choosing one of the above mutually exclusive projects (Project A or Project B), given a discount rate of 8%, which should the company choose?
161. Time: 0 1 2 3
Investment A: -$1 million $300,000 $400,000 $500,000
Investment B: -$1 million $500,000 $400,000 $300,000 An investor is considering the two investments shown above. Her cost of capital is 8%. Which of the following statements about these investments is true?
The investor should take investment B since it has a greater net present value (NPV).
162. The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's marginal corporate tax rate is 40%, then what is the value of the depreciation tax shield on the company's new project?
163. A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,000,000. This in turn would cause inventory to increase by 47 $150,000, accounts receivable to increase by $100,000, and accounts payable to increase by $75,000. What is the firm's expected change in net working capital?
164. A firm is considering investing in a new machine that will cost $600,000 and will be depreciated straight-line over five years. If the firm's marginal tax rate is 39%, what is the annual depreciation tax shield of purchasing the machine?
165. A firm is considering a new project that will generate cash revenue of $1,000,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $200,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 35%?
166. Which of the following best explains why is it sensible for a firm to use an accelerated depreciation schedule such as MACRS rather than straight-line depreciation?
The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).
168. If the appropriate discount rate for the project is 10% per year, what is the NPV of the project?
169. What is the IRR of the project?
170. What is the payback period of the project?
171. Daily Enterprises purchases a $10 million machine to be depreciated on a straight line basis over 5 years. The machine generates incremental revenues of $4 million per year, 49 along with incremental costs of $1 million per year. If the marginal tax rate is 30%, compute the incremental free cash flows generated from the new machine. Assume any replaced machine is fully depreciated and has no salvage value.
172. Heinz markets a new test product where the marketing will cost $600,000. If the tax rate for Heinz is 40%, what is the actual cost of marketing assuming Heinz is a profitable company (that is, Heinz earns sufficient taxable income from operations against which it can offset this cost)?
173. Your income statement shows sales of $1,000,000, cost of goods sold as $500,000, depreciation expense of $100,000 and a tax rate of 40%. What are the free cash flows generated this period?
174. The current sales of a company are $500,000 and the current working capital is $50,000 (10% of sales). Sales are expected to increase by 20% next year. What is the change in net working capital from this increase in sales assuming that net working capital as a percent of sales remains unchanged?
175. Books Inc. purchases a new machine for $100,000 that is to be depreciated on a straight line basis over 10 years. After 5 years, Books Inc. sells the machine for $90,000. If the capital gains tax rate is 40%, what is the cash inflow from this sale?
181. When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.
182. The Sisyphean Company is planning on investing in a new project. This will involve an initial investment of $200,000. The Sisyphean Company expects cash inflows from this project as detailed below:
Year1 Year 2 Year 3 Year 4
$86,200 $86,200 $86,200 $86,200 The appropriate discount rate for this project is 20%. The internal rate of return (IRR) for this project is closest to:
183. A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%.
No, since net present value (NPV) is negative.
184. An investor has a budget of $50 million. He can invest in the projects shown below. If the cost of capital is 10%, what investment or investments should he make?
Projects C and D
185. You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?
186. Which of the following would you NOT consider when making a capital budgeting decision?
The cost of marketing study completed last year
187. Ford Motors Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $30 million next year. Without the new SUV, Ford expects to earn pretax income of $80 million from operations next year. Ford pays a 40% tax rate on its pretax income. The amount that Ford Motors Company owes in taxes next year with the launch of the new SUV is closest to:
188. To attract capital from outside investors, a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.
189. A firm has outstanding debt with a coupon rate of 9%, seven years maturity, and a price of $1,000 per $1,000 face value. What is the after-tax cost of debt if the marginal tax rate of the firm is 40%?
190. A firm is considering investing in a new project with an upfront cost of $500 million. The project will generate an incremental free cash flow of $50 million at the end of the first year and this cash flow is expected to grow at an annual rate of 4% forever. If the firm's WACC is 13%, what is the value of this project?
191. The cash flow from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.
A garage is installing a new "bubble-wash" car. It will promote the car wash as a fun activity for the family, and it is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 9%, the net present value (NPV) of this project is closest to____
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