Final Exam_ reference _1_answer

1.The internal rate of return is defined as the:A.maximum rate of return a firm expects to earn on a project.B.rate of return a project will generate if the project in financed solely with internal funds.C.discount rate that equates the net cash inflows of a project to zero.D.discount rate which causes the net present value of a project to equal zero.

2.Net present value:A.is the best method of analyzing mutually exclusive projects.B.is less useful than the internal rate of return when comparing different sized projects.C.is the easiest method of evaluation for non-financial managers to use.D.is less useful than the payback period method when comparing mutually exclusive projects.

3.Samuelson Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule?A.Project A onlyB.Project B onlyC.Both A and BD.Neither A nor B

4.Which one of the following statements is correct in relation to independent projects?A.The internal rate of return cannot be used to determine the acceptability of a project that has financing type cash flows.B.A project with investing type cash flows is acceptable if its internal rate of return exceeds the required return.C.A project with financing type cash flows is acceptable if its internal rate of return exceeds the required return.D.The net present value profile is upsloping for projects with both investing and financing type cash flows.

5.Mutually exclusive projects are best defined as competing projects which:A.would commence on the same day.B.have the same initial start-up costs.C.both require the total use of the same limited resource.D.both have negative cash outflows at time zero.

6.Isaac has analyzed two mutually exclusive projects of similar size and has compiled the following information based on his analysis. Both projects have 3- year lives.

Isaac has been asked for his best recommendation given this information. His recommendation should be to accept:A.both projects.B.project B because it has the shortest payback period.C.project B and reject project A based on their net present values.D.project A and reject project B based on their payback period.

7.What is the net present value of a project with the following cash flows if the required rate of return is 12 percent? A.-$1,574.41B.-$1,208.19C.-$842.12D.$729.09

8.A project will produce cash inflows of $3,200 a year for 4 years with a final cash inflow of $5,700 in year 5. The project's initial cost is $9,500. What is the net present value of this project if the required rate of return is 16 percent?A.-$311.02B.$2,168.02C.$4,650.11D.$9,188.98

9.You are considering the following two mutually exclusive projects. The required rate of return is 14.6 percent for project A and 13.8 percent for project B. Which project should you accept and why?

A.project A; because it has the higher required rate of returnB.project A; because its NPV is about $4,900 more than the NPV of project BC.project B; because it has the largest total cash inflowD.project B; because it has the largest cash inflow in year oneE.project B; because it has the lower required return

10.Day Interiors is considering a project with the following cash flows. What is the IRR of this project?A.6.42 percentB.7.03 percentC.7.48 percentD.8.22 percentE.8.56 percent

11.An investment has the following cash flows and a required return of 13 percent. Based on IRR, should this project be accepted? Why or why not?A.No; The IRR exceeds the required return by about 0.06 percent.B.No; The IRR is less than the required return by about 0.94 percent.C.Yes; The IRR exceeds the required return by about 0.06 percent.D.Yes; The IRR exceeds the required return by about 0.94 percent.

12.You are considering two independent projects with the following cash flows. The required return for both projects is 16 percent. Given this information, which one of the following statements is correct?A.You should accept Project A and reject Project B based on their respective NPVs.B.You should accept Project B and reject Project A based on their respective NPVs.C.You should accept Project A and reject Project B based on their respective IRRs.D.You should accept both projects based on both the NPV and IRR decision rules.13.A project has an initial cost of $6,500. The cash inflows are $900, $2,200, $3,600, and $4,100 over the next four years, respectively. What is the payback period?A.1.73 yearsB.2.51 yearsC.2.94 yearsD.3.51 yearsE.3.94 years14.Motor City Productions sells original automotive art on a prepaid basis as each piece is uniquely designed to the customer's specifications. For one project, the cash flows are estimated as follows. Based on the internal rate of return (IRR), should this project be accepted if the required return is 9 percent?A.Accept the project.B.Reject the project.C.The IRR cannot be used to evaluate this type of project.D.The firm should be indifferent to either accepting or rejecting this project.15.Consider the following two mutually exclusive projects:

The required return is 15 percent for both projects. Which one of the following statements related to these projects is correct?A.Because the IRR imply accepting Project B, that project should be accepted.C.The IRR decision rule should be used as the basis for selecting the project in this situation.C.Only NPV implies accepting Project A.D.NPV, IRR both imply accepting Project A.

Final Exam_ reference _2_answer

Consider the following two projects: -------------------------------

ProjectYear 0Cash FlowYear 1Cash FlowYear 2Cash FlowYear 3Cash FlowYear 4Cash FlowDiscount Rate

A-100404040400.15

B-73303030300.15

1. How much is the NPV of project A?A) 12.00B) 14.20C) 14.45D) 8.67Answer: NPV=npv(15%, 40, 40, 40, 40)-100

2. How much is the NPV of project B?A) 12.65B) 23.31C) 12.08D) 15.01Answer: NPV=npv(15%, 30, 30, 30, 30)-73

3.How much is IRR of project A?A) 17.11%B) 14.39%C) 15%D) 21.86%Answer: IRR= IRR(year 0s CF in the table : year 4s cash flow in the table)

4. How much is the payback period project A?A) 1.5 yearsB) 2 yearsC) 2.5 yearsD) 3 yearsAnswer: -100+40+40 = -20, so by the end of year 2, still owe 20, so 2+20/40=2.5 years

5. If the two projects are mutually exclusive (choose one but one, so choose the one with higher NPV), which project shall you accept?A) Project A.B) Project B.Answer: compare by NPV_a with NPV-b, and choose the higher one, which is NPV_a. 6. Which one of the following methods determines the dollar amount of the change a proposed project will have on the value of a firm?A)net present valueB)paybackC)internal rate of returnAnswer: NPV dominates all other approaches

7. A firm evaluates all of its projects by applying the IRR rule. The required return for the following project is 21 percent. The IRR is _____ percent and the firm should ______ the project.A.23.67 percent; rejectB.24.26 percent; acceptC.24.26 percent; rejectD.26.30 percent; acceptAnswer: use the IRR in excel and you get 26.3%. Rule: accept project when rate 0, then IRR > WACC (discount rate, or required rate of return) c.NPV >0, then IRR < 0 [endnoteRef:2].Calculate NPV. [2: .]

WACC (required rate of return, or discount rate): 9%Yearyear0year1year2year3Cash flows-$1000.00 $500.00$500.00$500.00a.$265.65b.$268.93c.$262.88d.$277.52

WACC: 9.00%Year0123Cash flows-$1,000$500$500$500

NPV = $265.65

[endnoteRef:3].Find IRR [3: .]

Yearyear0year1year2year3Cash flows-$1000.00 $425.00 $425.00$425.00

a.13.85%b.13.21%c.12.87%d.13.56%

Year0123Cash flows-$1,000$425$425$425

IRR = 13.21%

[endnoteRef:4].Find payback period [4: .]

Yearyear0year1year2year3CF-$1150$500$500$500

a.1.86 yearsb.2.17 yearsc.2.10 yearsd.2.30 years

Year0123Cash flows-$1,150$500$500$500 Cumulative CF-$1,150-$650-$150$350 Payback = 2.30---2.30

Payback = last year before cum CF turns positive + abs. val. last neg. cum CF/CF in payback year.

[endnoteRef:5].Find the changes in NPV due to increase in WACC [5: .]

Old WACC: 10.00%New WACC: 11.25%Year0123Cash flows-$1,000$410$410$410

a.-21.89 dollarsb.-22.88 dollarsc.-21.93 dollarsd.-22.03 dollars Old WACC: 10.00%New WACC: 11.25%Year0123Cash flows-$1,000$410$410$410

Old NPV = $19.61New NPV = -$2.42Change = -$22.03

[endnoteRef:6].Find the crossover rate with the following information [6: .]

WACC: 10.25%Yearyear0year1year2year3year4CFS-$2,050$750$760$770$780CFL-$4,300$1,500$1,518$1,536$1,554

a.14.79%b.14.18%c.13.27%d.16.29%

[endnoteRef:7].The after-tax cost of debt, which is lower than before-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC. [7: .]

a.Trueb.False

8.Firm AAAs beta is 2. What is the firm's cost of equity, given risk free rate of 5% and market return of 10%? A.13%B.14%C.15%D.16%

9.Firm AAAs debt has 10 years to maturity and is selling for $$900. Coupon rate is 3% and flotation cost is $50. Tax rate is 30%. How much is after tax cost of debt? A.4.31%B.3.89%C.4.22%D.3.46%

10.Firm AAA's debt-equity ratio is 1 (weight of debt is 50% and weight of equity is 50%) and tax rate is 30%. The cost of equity is 14.5% and the after tax cost of debt is 4.8%. WACC?A.9.65%B.8.17%C.10.01%D.9.44%

11.The average of a firm's cost of equity and after tax cost of debt that is weighted based on the firm's capital structure is used as the discount rate when calculating NPV.A.TrueB.False.

12.Firm AAA just issued 80000 bonds selling at par value. The yield to maturity is 8.5%. This firm also has $4,000,000 of common stock. This firms beta is 1.1 and the price of the stock is $40 per share. The risk free rate is 4% and the market risk premium is 8%. Tax rate is 35%. What is this firms WACC? (hard)A.10.38 percent B.9.17 percent C.11.65 percentD.9.65 percent

Re = .04 + (1.1 .08) = .128Debt: 80,000 $1,000 = $80mCommon: 4m $40 = $160mTotal = $80m + $160m = $240m

13.Firm AAAs stock price is $36 per share and there are 210,000 shares of common stock outstanding. Last month, this firm paid $1.593 per share dividend. Its growth rate is 4%. This firm has 6,000 bonds outstanding with a face value of $1,000 per bond and the market value of $990. Coupon rate is 7% and the maturity is 4.89 years. Tax rate is 34% and no flotation costs. What is WACC? (hard) A.6.3%B.6.8%C.7.3%D.6.9% 14.Net present value is defined as the present value of an investment minus its cost.A.TrueB.False

15. There are two mutually exclusive projects. Their cash flows are the following. The crossover rate is _____ and if the required rate is higher than the crossover rate then project _____ should be accepted.A.15.44%; AB.15.44%; BC.13.94%; AD.13.94%; B

16.Internal rate of return is defined as the discount rate that makes the net present value of an investment exactly equal to zero.A.TrueB.False

17.Firm AAA is choosing one project from two mutually exclusive projects of similar size. Both projects will last for five years. Which one is better?

A.B is better its payback period is shorterB.both should be chosen because both NPV > 0C.Choose A because NPV of A > NPV of BD.Choose B based on payback period and required return

18.What is the net present value of a project with the following cash flows and a required return of 12%?A.-$187.22B.-$177.62C.$177.62D.$204.36

19.The project cash flow is follows. If the required rate of return is 9.5%. Shall you accept this project? Why or why not?A.yes; because IRR > required returnB.yes; because IRR < required return C.yes; because IRR > 0 20.Yancy is considering a project which will produce cash inflows of $1000 a year for 4 years. The project has a 9% required rate of return and an initial cost of $3,000. What is the payback period?A.3.00 yearsB.4.50 yearsC.3.50 yearsD.4.00 years 21. You are considering two mutually exclusive projects with the following cash flows. Will your choice between the two projects differ if the required rate of return is 8% rather than 11%? If so, what should you do?A.yes; Select A when rate = 8% and B when rate = 11%.B.yes; Select B when rate = 8% and A when rate = 11%.C.no; choose A always since NPV of A always > NPV of BD.no; choose B always since NPV of B always > NPV of A

22. Which of the following statements is CORRECT?

a.A change target capital structure (percentage finance via equity and debt) of a firm cannot affect WACC.b.WACC should be calculated by the before-tax costs of capitalc.Flotation costs normally reduce the WACC.d.When tax rate increases, then WACC decline.

23.The AAA firm use CAPM to calculate cost of equity. The firm has common stock and debt. Which of the following can REDUCE its WACC?

a.The market risk premium declines.b.The flotation costs from issuing new common stock increase.c.The companys beta increases.d.Expected inflation increases.

24. Pick correct one

a.If a projects IRR > 0, then its NPV > 0.b.If a projects IRR < WACC, then its NPV > 0. c.A projects IRR = the rate that causes the PV of the inflows to be equivalent to the cost of the project

25.Firm AAA has two projects with the given cash flows as shown below. The CEO wants to use the IRR to pick one project, while the CFO likes NPV method. If IRR is used to evaluate project and is used as WACC, the firm might lose how much value?

WACC: 6.00%Year01234CFS-$1,025$380$380$380$380CFL-$2,150$765$765$765$765

a.$218.61b.$189.13c.$209.07d.$214.25

WACC: 6.000%Year01234CFS-$1,025$380$380$380$380CFL-$2,150$765$765$765$765

IRR, L15.781%IRR, S17.861%

NPV, L$500.81$209.07NPV, S$291.74$209.07= Value lost if use the IRR criterion

SL291.7500.80%495.0910.02%421.9762.94%354.4626.96%291.7500.88%233.6383.810%179.5274.912%129.2173.613.860%85.485.414%82.279.016%38.3-9.418%-2.8-92.120%-41.3-169.622%-77.4-242.424%-111.4-310.7

Note that the WACC is constrained to be less than the crossover point, so there is a conflict between NPV and IRR, hence following the IRR rule results in a loss of value. In the next problem the constraint is relaxed. Graphs such as this one could be created for the following problems, but we do not show them.

26.A project shall not be accepted if its acceptance would increase firm's cost of capital (WACC).

a.Trueb.False

27.A basic rule in capital budgeting is that if a project's NPV exceeds zero, then the project should be accepted.

a.Trueb.False

28.All else holding constant, an increase in WACC will lead to a decrease in a project's IRR.

a.Trueb.false

Final Exam_ reference _4_answer

1.The internal rate of return is defined as the:A.maximum rate of return a firm expects to earn on a project.B.rate of return a project will generate if the project in financed solely with internal funds.C.discount rate that equates the net cash inflows of a project to zero.D.discount rate which causes the net present value of a project to equal zero.2.Net present value:A.is the best method of analyzing mutually exclusive projects.B.is less useful than the internal rate of return when comparing different sized projects.C.is the easiest method of evaluation for non-financial managers to use.D.is less useful than the payback period method when comparing mutually exclusive projects.3.Samuelson Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule?A.Project A onlyB.Project B onlyC.Both A and BD.Neither A nor B4.Which one of the following statements is correct in relation to independent projects?A.The internal rate of return cannot be used to determine the acceptability of a project that has financing type cash flows.B.A project with investing type cash flows is acceptable if its internal rate of return exceeds the required return.C.A project with financing type cash flows is acceptable if its internal rate of return exceeds the required return.D.The net present value profile is upsloping for projects with both investing and financing type cash flows.

5.Mutually exclusive projects are best defined as competing projects which:A.would commence on the same day.B.have the same initial start-up costs.C.both require the total use of the same limited resource.D.both have negative cash outflows at time zero.

6. Isaac has analyzed two mutually exclusive projects of similar size and has compiled the following information based on his analysis. Both projects have 3- year lives.

Isaac has been asked for his best recommendation given this information. His recommendation should be to accept:A.both projects.B.project B because it has the shortest payback period.C.project B and reject project A based on their net present values.D.project A and reject project B based on their payback period.7.What is the net present value of a project with the following cash flows if the required rate of return is 12 percent? A.-$1,574.41B.-$1,208.19C.-$842.12D.$729.09

8.A project will produce cash inflows of $3,200 a year for 4 years with a final cash inflow of $5,700 in year 5. The project's initial cost is $9,500. What is the net present value of this project if the required rate of return is 16 percent?A.-$311.02B.$2,168.02C.$4,650.11D.$9,188.98

9.You are considering the following two mutually exclusive projects. The required rate of return is 14.6 percent for project A and 13.8 percent for project B. Which project should you accept and why?

A.project A; because it has the higher required rate of returnB.project A; because its NPV is about $4,900 more than the NPV of project BC.project B; because it has the largest total cash inflowD.project B; because it has the largest cash inflow in year oneE.project B; because it has the lower required return10.Day Interiors is considering a project with the following cash flows. What is the IRR of this project?A.6.42 percentB.7.03 percentC.7.48 percentD.8.22 percentE.8.56 percent11.An investment has the following cash flows and a required return of 13 percent. Based on IRR, should this project be accepted? Why or why not?

A.No; The IRR exceeds the required return by about 0.06 percent.B.No; The IRR is less than the required return by about 0.94 percent.C.Yes; The IRR exceeds the required return by about 0.06 percent.D.Yes; The IRR exceeds the required return by about 0.94 percent.

12.You are considering two independent projects with the following cash flows. The required return for both projects is 16 percent. Given this information, which one of the following statements is correct?A.You should accept Project A and reject Project B based on their respective NPVs.B.You should accept Project B and reject Project A based on their respective NPVs.C.You should accept Project A and reject Project B based on their respective IRRs.D.You should accept both projects based on both the NPV and IRR decision rules.13.A project has an initial cost of $6,500. The cash inflows are $900, $2,200, $3,600, and $4,100 over the next four years, respectively. What is the payback period?A.1.73 yearsB.2.51 yearsC.2.94 yearsD.3.51 yearsE.3.94 years

14. Motor City Productions sells original automotive art on a prepaid basis as each piece is uniquely designed to the customer's specifications. For one project, the cash flows are estimated as follows. Based on the internal rate of return (IRR), should this project be accepted if the required return is 9 percent?A.Accept the project.B.Reject the project.C.The IRR cannot be used to evaluate this type of project.D.The firm should be indifferent to either accepting or rejecting this project.

15.Consider the following two mutually exclusive projects:

The required return is 15 percent for both projects. Which one of the following statements related to these projects is correct?A.Because the IRR imply accepting Project B, that project should be accepted.C.The IRR decision rule should be used as the basis for selecting the project in this situation.C.Only NPV implies accepting Project A.D.NPV, IRR both imply accepting Project A.16. Which of the following statements is CORRECT?

a.If a project has normal cash flows, then its IRR must be positive.b.If a project has normal cash flows, then its MIRR must be positive.c.If a project has normal cash flows, then it will have exactly two real IRRs.d.The definition of normal cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the projects life. e.If a project has normal cash flows, then it can have only one real IRR, whereas a project with nonnormal cash flows might have more than one real IRR.

17. You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the projects risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

a.You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.b.You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.c.You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that that the firms value will increase if the project is accepted.d.You should recommend that the project be rejected because (1) its NPV is positive and (2) it has two IRRs, one of which is less than the WACC, which indicates that the firms value will decline if the project is accepted.e.You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firms value will decline if it is accepted.