Question 1

The accounting rate of return is deficient as a figure of merit because it is insensitive to the timing of cash flows.

Accepted Answer

The accounting rate of return only considers the average annual profit and does not take into account the timing of the cash flows. This means that it may not accurately reflect the actual profitability of an investment.

Question 2

Your brother will borrow $17,800 to buy a car.The terms of the loan call for monthly payments for 5 years at an 8.6 percent annual interest rate,compounded monthly.What is the amount of each payment?

Accepted Answer

The monthly payment can be calculated using the formula for an amortizing loan: $ M = \frac{P \times r \times (1 + r)^n}{(1 + r)^n - 1} $, where $ P $ is the principal amount ($17,800), $ r $ is the monthly interest rate (8.6% annual rate divided by 12 months), and $ n $ is the total number of payments (5 years times 12 months). Plugging in these values gives a monthly payment of approximately $366.05.

Question 3

When conducting a discounted cash flow analysis of a project,it is important to always include a careful estimate of financing costs in the project's cash flows.

Accepted Answer

In discounted cash flow (DCF) analysis, financing costs are typically not included in the project's cash flows because the analysis discounts future cash flows using a rate that reflects the project's risk, including the cost of capital. Financing costs are accounted for in the discount rate (e.g., WACC) rather than in the cash flows themselves to avoid double counting.

Question 4

Which of the following should be included in the cash flow projections for a new product?
I.Money already spent for research and development of the new product
II.Capital expenditures for equipment to produce the new product
III.Increase in working capital needed to finance sales of the new product
IV.Interest expense on the loan used to finance the new product launch

Accepted Answer

II and III are correct because capital expenditures for equipment and the increase in working capital needed are future cash flows directly associated with the production and sale of the new product. Money already spent on research and development is a sunk cost and not included in future cash flow projections. Interest expense is part of financing cash flows and not typically included in cash flow projections for a product.

Question 5

The IRR is the discount rate at which an investment's NPV equals its initial cost.

Accepted Answer

The IRR is the discount rate at which an investment's Net Present Value (NPV) equals zero, not its initial cost.

Question 6

Naomi plans on saving $3,000 a year and expects to earn an annual rate of 10.25 percent.How much will she have in her account at the end of 45 years?

Accepted Answer

The answer of Naomi plans on saving $3,000 a year...

Question 7

Pro forma free cash flows for a proposed project should:
i.exclude the cost of employing existing assets that could be sold anyway.II.exclude interest expense.III.include the depreciation tax shield related to the project.IV.exclude any required increase in operating current assets.

Accepted Answer

II and III onlyPro forma free cash flows should exclude interest expense because free cash flow aims to measure the cash a company generates from its operations, independent of its capital structure. It should include the depreciation tax shield because this represents a cash flow benefit to the project by reducing taxable income. Costs of employing existing assets and changes in operating current assets are relevant cash flows and should not be excluded.

Question 8

Which of the following figures of merit might not use all possible cash flows in its calculations?
I.Payback period
II.Internal rate of return
III.Net present value (NPV)
IV.Benefit-cost ratio

Accepted Answer

The payback period only considers the cash flows up to the point when the initial investment is recovered, so it may not use all possible cash flows in its calculations. The other figures of merit (Internal rate of return, Net present value and Benefit-cost ratio) consider all the cash flows associated with a project.

Question 9

When evaluating investments under capital rationing that are independent and can be acquired fractionally,ranking by the BCR is the appropriate technique.

Accepted Answer

When evaluating independent investments that can be acquired fractionally under capital rationing, the appropriate technique is to rank them according to their Benefit-to-Cost Ratio (BCR). This allows the investor to make the most efficient use of their limited resources and maximize their returns.

Question 10

You are the beneficiary of a life insurance policy.The insurance company informs you that you have two options for receiving the insurance proceeds.You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years.You can earn a 6 percent annual rate on your money,compounded monthly.Which option should you take and why?

Accepted Answer

The present value of the monthly payments, calculated using a 6% annual interest rate compounded monthly, is approximately $195,413, which is less than the $200,000 lump sum.

Question 11

You plan to buy a new Mercedes four years from now.Today,a comparable car costs $82,500.You expect the price of the car to increase by an average of 4.8 percent per year over the next four years.How much will your dream car cost by the time you are ready to buy it?

Accepted Answer

To calculate the future value of the car, we can use the formula:

FV = PV x (1 + r)^n

where FV is the future value, PV is the present value, r is the annual interest rate, and n is the number of years.

Plugging in the given values, we get:

FV = 82,500 x (1 + 0.048)^4
FV = 82,500 x 1.2155
FV = 99,517.41

Therefore, the answer is C: $99,517.41.

Question 12

Which of the following is NOT an important step in the financial evaluation of an investment opportunity?

Accepted Answer

While estimating the accounting rate of return can be helpful in evaluating an investment, it is not considered as essential as estimating relevant cash flows, calculating a figure of merit, and comparing that figure to an acceptance criterion. Therefore, option B is not an important step in the financial evaluation of an investment opportunity.

Question 13

Which of the following is NOT a reason why a dollar today is worth more than a dollar in the future?

Accepted Answer

This statement is actually the opposite of the truth- the value of a dollar in the future will be LESS than the value of a dollar today due to inflation and other factors, not more. A) is true because inflation reduces the purchasing power of future dollars. C) is true because there is greater uncertainty looking further into the future. D) is true because a dollar today can be invested and earn interest, increasing its value over time.

Question 14

Which of the following figures of merit does not directly take into consideration the time value of money?
I.Payback period
II.Internal rate of return
III.Net present value (NPV)
IV.Accounting rate of return

Accepted Answer

The Payback Period and Accounting Rate of Return do not directly consider the time value of money. The Payback Period focuses on the time it takes to recover the initial investment, and the Accounting Rate of Return looks at the average annual profit compared to the initial investment, without discounting future cash flows.

Question 15

Ian is going to receive $20,000 six years from now.Sunny is going to receive $20,000 nine years from now.Which one of the following statements is correct if both Ian and Sunny apply a 7 percent discount rate to these amounts?

Accepted Answer

The present value of Ian's money can be calculated by using the formula PV = FV / (1 + r)^n, where PV is the present value, FV is the future value, r is the discount rate, and n is the number of years. Plugging in the values, we get PV = 20,000 / (1 + 0.07)^6 = $13,426.04. Similarly, the present value of Sunny's money can be calculated as PV = 20,000 / (1 + 0.07)^9 = $12,039.17. Therefore, Ian's money is worth more than Sunny's money in today's dollars. Hence, the correct option is C.

Question 16

The IRR and NPV always yield the same investment recommendations.

Accepted Answer

The IRR and NPV can sometimes give conflicting investment recommendations, especially in cases where there are mutually exclusive projects or where the cash flows of projects differ significantly in timing or magnitude. Therefore, it is important to use both metrics in conjunction with other investment evaluation methods to make a well-informed decision.

Question 17

As a noncash expense,depreciation is irrelevant in the determination of a project's cash flows.

Accepted Answer

Depreciation is an important factor in determining a project's cash flows as it affects the project's taxable income, which in turn affects the amount of taxes paid by the project. Depreciation reduces the amount of taxes paid, which results in an increase in cash flows. Therefore, depreciation is relevant in the determination of a project's cash flows.

Question 18

EAC Nutrition offers a 9.5 percent coupon bond with annual payments,maturing 11 years from today.Your required return is 11.2 percent.What price are you willing to pay for this bond if the face (or par)value is $1,000?

Accepted Answer

The bond price is calculated using the present value of its future cash flows, which include annual coupon payments and the face value at maturity. Given the coupon rate, required return, and time to maturity, the bond price is $895.43.

Question 19

A project will produce after-tax operating cash inflows of $3,200 a year for 5 years.The after-tax salvage value of the project is expected to be $2,500 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?

Accepted Answer

The NPV is calculated by discounting the cash inflows and salvage value at the required rate of return and subtracting the initial cost. The NPV is $2,168.02.

Question 20

Your grandmother invested a lump sum 26 years ago at 4.25 percent interest.Today,she gave you the proceeds of that investment which totaled $51,480.79.How much did she originally invest?

Accepted Answer

To find the original investment amount, we use the formula for compound interest: A = P(1 + r/n)^(nt), where A is the amount of money accumulated after n years, including interest, P is the principal amount (the initial amount of money), r is the annual interest rate (decimal), n is the number of times that interest is compounded per year, and t is the time the money is invested for in years. In this case, we are given A = $51,480.79, r = 4.25% or 0.0425, n = 1 (assuming the interest is compounded annually for simplicity), and t = 26 years. We need to solve for P.Rearranging the formula to solve for P gives us P = A / (1 + r/n)^(nt).Plugging in the given values: P = $51,480.79 / (1 + 0.0425)^(26) = $51,480.79 / (1.0425)^(26).Calculating this gives us P ≈ $17,444.86, which matches option C.

Quiz 7: Discounted Cash Flow Techniques