Question 1

What is the difference in the value of a $5,000 annual perpetuity and an annuity of $5,000 for 100 years? Assume that the discount rate is 8% and that cash flows are received at the end of the year.

Accepted Answer

The present value of the perpetuity is 5,000/0.08 = $62,500.For the annuity:
The difference = 62,500 - 62,472 = $28
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Question 2

In a discounted cash flow analysis of Giant Corp.'s project described in the problem above,what would be the projected Year 1 free cash flow?

Accepted Answer

The answer of In a discounted cash flow analysis of...

Question 3

You plan to pay $50 for a share of preferred stock that pays a $2.40 dividend per year forever.What annual rate of return will you realize?

Accepted Answer

To calculate the annual rate of return, we divide the annual dividend by the price of the stock. $2.40/$50 = 0.048 or 4.8%. Therefore, the correct answer is C) 4.80%.

Question 4

In a discounted cash flow analysis of Giant Corp.'s project described in the problem above,what would be the projected Year 2 free cash flow?

Accepted Answer

The answer of In a discounted cash flow analysis of...

Question 5

Given the following information about a possible average-risk,new product investment,calculate the investment's net present value.

Accepted Answer

The answer of Given the following information about a possible...

Question 6

A company is considering two alternative methods of producing a new product.The relevant data concerning the alternatives are presented below.At the end of the useful life of whatever equipment is chosen the product will be discontinued.The company's tax rate is 50 percent and its cost of capital is 10 percent.a.Calculate the net present value of each alternative.b.Calculate the benefit-cost ratio for each alternative.c.Calculate the internal rate of return for each alternative.d.If the company is not under capital rationing,which alternative should be chosen? Why?

Accepted Answer

The answer of A company is considering two alternative methods...

Question 7

An investment costing $100,000 promises an after-tax cash flow of $36,000 per year for 6 years.a.Find the investment's accounting rate of return and its payback period.b.Find the investment's net present value at a 15 percent discount rate.c.Find the investment's benefit-cost ratio (profitability index)at a 15 percent discount rate.d.Find the investment's internal rate of return.e.Assuming the required rate of return on the investment is 15 percent,which of the above figures of merit indicate the investment is attractive? Which indicate it is unattractive?

Accepted Answer

The answer of An investment costing $100,000 promises an after-tax...

Question 8

You are to receive an annuity of $1,000 per year for 10 years.You will receive the first payment two years from today.At a discount rate of 10%,what is the present value of this annuity?

Accepted Answer

The PV = $6,144.57.But the first payment is received in two years,not one year,so discount the PV by one more year: 6,144.57/1.1 = $5,585.97
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Question 9

What is the benefit-cost ratio for an investment with the following cash flows at a 14.5 percent required return?
$\begin{array}{cc}
\hline \text { Year } & \text { Cash Flow } \
0 & \$(46,500) \
1 & \$ 12,200 \
2 & \$ 38,400 \
3 & \$ 11,300 \
\hline
\end{array}$

Accepted Answer

To calculate the benefit-cost ratio, we need to divide the present value of future cash inflows by the initial investment. Using a financial calculator, we can find the present value of these cash flows to be $1,232.09. Therefore, the benefit-cost ratio is $1,232.09/$1,209.20, which equals 1.02. Since the benefit-cost ratio is greater than 1, the investment is expected to generate a positive net present value, indicating that it is a profitable investment. Therefore, the best choice is C.

Question 10

Consider the following investment opportunity.Assume the annual figures are unchanged for the expected life of the investment.What is the rate of return on this investment? Assuming the investor wants to earn at least 12 percent,is this investment an attractive one?

Accepted Answer

The answer of Consider the following investment opportunity.Assume the annual...

Question 11

At $1,000 par value,10 percent coupon bond matures in 20 years.If the price of the bond is $1,196.80,what is the yield to maturity on the bond? Assume interest is paid annually.

Accepted Answer

The answer of At $1,000 par value,10 percent coupon bond...

Question 12

Ten years ago you invested $1,000 for 10 shares of Providien,Inc.common stock.You sold the shares recently for $2,000.While you owned the stock it paid $10.08 per share in annual dividends.What was your rate of return on Providien stock?

Accepted Answer

The answer of Ten years ago you invested $1,000 for...

Question 13

Which of the following statements related to the internal rate of return (IRR)are correct?
i.The IRR is the discount rate at which an investment's NPV equals zero.II.An investment should be undertaken if the discount rate exceeds the IRR.III.The IRR tends to be used more than net present value simply because its results are easier to comprehend.IV.The IRR is the best tool available for deciding between mutually exclusive investments.

Accepted Answer

i. Correct, as the IRR is indeed the rate at which the net present value (NPV) of all the cash flows (both positive and negative) from a project or investment equals zero.iii. Correct, because the IRR provides a single percentage figure that estimates the yield of an investment, which can be easier for decision-makers to interpret compared to NPV, especially for those without a financial background. However, it's important to note that while IRR might be more commonly used due to its simplicity, this doesn't inherently make it a better tool than NPV in all situations.

Question 14

Giant Corp.is considering a project that requires a $1,500 initial cost for a new machine that will be depreciated straight line to a salvage value of 0 on a 5-year schedule.The project will require a one-time increase in the level of net working capital of $300.The project will generate an additional $1,600 in revenues and $700 in operating expenses each year.The project will end at the end of year 2,at which time the machinery is expected to be sold for $800.Giant's tax rate is 50%.In a discounted cash flow analysis of this project,what would be the projected Year 0 free cash flow?

Accepted Answer

The projected Year 0 free cash flow is the initial cost of the new machine ($1,500) plus the one-time increase in net working capital ($300), totaling $1,800. This results in a cash outflow, hence -$1,800.

Question 15

Your brother,age 40,is the regional manager at an office supply company.He thinks he might want to leave his job to go back to school for an MBA.He expects that his current job,if he were to stay at it,would pay him a real income stream of $75,000 per year until retirement at age 65.If he goes back to school,he would forego two years of income,but his real income after graduation would be $115,000 per year until retirement at age 65.He has been accepted to an MBA program that costs a real $22,000 per year.If his real opportunity cost is 8 percent,would leaving his job to get an MBA be a smart financial decision?

Accepted Answer

The answer of Your brother,age 40,is the regional manager at...

Question 16

Sol's Sporting Goods is expanding,and as a result expects additional operating cash flows of $26,000 a year for 4 years.This expansion requires $39,000 in new fixed assets.These assets will be worthless at the end of the project.In addition,the project requires an additional $3,000 of net working capital throughout the life of the project;Sol expects to recover this amount at the end of the project.What is the net present value of this expansion project at a 16 percent required rate of return?

Accepted Answer

The answer of Sol's Sporting Goods is expanding,and as a...

Question 17

When making a capital budgeting decision,which of the following is/are NOT relevant?
i.The size of a cash flow.II.The risk of a cash flow.III.The accounting earnings from a cash flow.IV.The timing of a cash flow.

Accepted Answer

The accounting earnings from a cash flow are not relevant in making a capital budgeting decision because they do not represent actual cash inflows and outflows. The size, risk, and timing of cash flows are all important factors to consider in evaluating a potential investment.

Question 18

Given the spreadsheet below,what value would Excel return if you entered the following formula? =NPV(B2,B5:D5)

Accepted Answer

-250/1.09 + 500/1.09² + 500/1.09³ = $577.57

Question 19

A divisional manager submitted a project proposal to the chief financial officer,complete with a calculated NPV for the project.The chief financial officer studied the proposal and pointed out that the divisional manager had failed to account for a one-time increase in net working capital of $60,000 that will be required over the life of the seven-year project.Assuming the full value of net working capital will be recovered at the end of the project,how will the project's NPV change after making the chief financial officer's adjustment? Assume a discount rate of 9%.

Accepted Answer

The answer of A divisional manager submitted a project proposal...

Quiz 7: Discounted Cash Flow Techniques