Finance Exam Answers

Question 10.5 out of 0.5 points

The Fisher effect is defined as the relationship between which of the following variables?

Selected Answer:

b.

real rates, inflation rates, and nominal rates

Correct Answer:

b.

real rates, inflation rates, and nominal rates


Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?

Selected Answer:

a.

default risk

Correct Answer:

a.

default risk


The liquidity premium is compensation to investors for:

Selected Answer:

d.

the lack of an active market wherein a bond can be sold for its actual value.

Correct Answer:

d.

the lack of an active market wherein a bond can be sold for its actual value.


Which one of the following relationships is stated correctly?

Selected Answer:

d.

Decreasing the time to maturity increases the price of a discount bond, all else constant.

Correct Answer:

d.

Decreasing the time to maturity increases the price of a discount bond, all else constant.


Green Roof Inns is preparing a bond offering with a 6 percent, semiannual

coupon and a face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct?

Selected Answer:

e.

The bonds will sell at a premium if the market rate is 5.5 percent.

Correct Answer:

e.

The bonds will sell at a premium if the market rate is 5.5 percent.


Which one of the following bonds is the least sensitive to interest rate risk?

Selected Answer:

b.

3-year; 6 percent coupon

Correct Answer:

b.

3-year; 6 percent coupon


Bonds issued by the U.S. government:

Selected Answer:

c.

are considered to be free of default risk.

Correct Answer:

c.

are considered to be free of default risk.


The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as:

Selected Answer:

a.

0.05/(1 - t*) = 0.07.

Correct Answer:

a.

0.05/(1 - t*) = 0.07.


Al is retired and enjoys his daily life. His one concern is that his bonds provide a steady stream of income that will continue to allow him to have the money he desires to continue his active lifestyle without lowering his present standard of living. Although he has sufficient principal to live on, he only wants to spend the interest income provided by his holdings and thus is concerned about the purchasing power of that income. Which one of the following bonds should best ease Al's concerns?

Selected Answer:

e.

5- year TIPS

Correct Answer:

e.

5- year TIPS


Which of the following statements is correct concerning the term structure of interest rates?

I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates.

II. The term structure of interest rates includes both an inflation premium and an interest rate risk premium.

III. The real rate of return has minimal, if any, affect on the slope of the term structure of interest rates.

IV. The term structure of interest rates and the time to maturity are always directly related.

Selected Answer:

e.

I, II, and III only

Correct Answer:

e.

I, II, and III only


The bonds issued by Stainless Tubs bear a 6 percent coupon, payable semiannually. The bonds mature in 11 years and have a $1,000 face value. Currently, the bonds sell for $989. What is the yield to maturity?

Selected Answer:

b.

6.14 percent

Correct Answer:

b.

6.14 percent


Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 6.69 percent?

Selected Answer:

e.

$1,004.47

Correct Answer:

e.

$1,004.47


Grand Adventure Properties offers a 9.5 percent coupon bond with annual payments. The yield to maturity is 11.2 percent and the maturity date is 11 years from today. What is the market price of this bond if the face value is $1,000?

Selected Answer:

e.

$895.43

Correct Answer:

e.

$895.43


You are purchasing a 25-year, zero-coupon bond. The yield to maturity is 8.68 percent and the face value is $1,000. What is the current market price?

Selected Answer:

b.

$119.52

Correct Answer:

b.

$119.52

Question 150 out of 0.5 points

A 16-year, 4.5 percent coupon bond pays interest annually. The bond has a face value of $1,000. What is the percentage change in the price of this

bond if the market yield to maturity rises to 5.7 percent from the current rate of 5.5 percent?

Selected Answer:

d.

2.14 percent increase

Correct Answer:

a.

2.14 percent decrease


Blackwell bonds have a face value of $1,000 and are currently quoted at 98.4. The bonds have a 5 percent coupon rate. What is the current yield on these bonds?

Selected Answer:

e.

5.08 percent

Correct Answer:

e.

5.08 percent


A bond that pays interest annually yielded 7.47 percent last year. The inflation rate for the same period was 6.10 percent. What was the actual real rate of return on this bond for last year?

Selected Answer:

c.

1.29 percent

Correct Answer:

c.

1.29 percent


The yield to maturity on a bond is currently 8.46 percent. The real rate of return is 3.22 percent. What is the rate of inflation?

Selected Answer:

d.

5.08 percent

Correct Answer:

d.

5.08 percent

Question 19

0.5 out of 0.5 points

Kaiser Industries has bonds on the market making annual payments, with 14 years to maturity, and selling for $1,382.01. At this price, the bonds yield 7.5 percent. What is the coupon rate?

Selected Answer:

c.

12.00 percent

Correct Answer:

c.

12.00 percent


Suppose the real rate is 9.5 percent and the inflation rate is 1.8 percent. What rate would you expect to see on a Treasury bill?

Selected Answer:

e.

11.47 percent

Correct Answer:

e.

11.47 percent


A company has two open seats, Seat A and Seat B, on its board of directors. There are 6 candidates vying for these 2 positions. There will be a single election to determine the winner of both open seats. As the owner of 100 shares of stock, you will receive one vote per share for each open seat. You decide to cast all 200 of your votes for a single candidate. What is this type of voting called?

Selected Answer:

b.

cumulative

Correct Answer:

b.

cumulative


High Country Builders currently pays an annual dividend of $1.35 and plans on increasing that amount by 2.5 percent each year. Valley High Builders currently pays an annual dividend of $1.20 and plans on increasing its dividend by 3 percent annually. Given this information, you know for certain that the stock of High Country Builders' has a higher

______ than the stock of Valley High Builders.

Selected Answer:

a.

capital gains yield

Correct Answer:

a.

capital gains yield


Which one of the following is an underlying assumption of the dividend growth model?

Selected Answer:

b.

A stock's value is equal to the discounted present value of the future cash flows which it generates.

Correct Answer:

b.

A stock's value is equal to the discounted present value of the future cash flows which it generates.


The two-stage dividend growth model evaluates the current price of a stock based on the assumption a stock will:

Selected Answer:

c.

grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely.

Correct Answer:

c.

grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely.


The Blue Marlin is owned by a group of 5 shareholders who all vote independently and who all want personal control over the firm. What is the minimum percentage of the outstanding shares one of these shareholders must own if he or she is to gain personal control over this firm given that the firm uses straight voting?

Selected Answer:

b.

50 percent plus one vote

Correct Answer:

b.

50 percent plus one vote

Question 26


Chemical Mines has 5,000 shareholders and is preparing to elect two new board members. You do not own enough shares to personally control the elections but are determined to oust the current leadership. Likewise, no other single shareholder owns sufficient shares to personally control the outcome of the election. Which one of the following is the most likely outcome of this situation given that some shareholders are happy with the existing management?

Selected Answer:

d.

proxy fight for control of the board

Correct Answer:

d.

proxy fight for control of the board


Which of the following apply to a specialist who trades on the floor of the NYSE?

I. provides liquidity for an individual security.

II. partially being replaced by SuperDOT.

III. pays an annual fee for a trading license.

IV. acts as a dealer.

Selected Answer:

a.

I, III, and IV only

Correct Answer:

a.

I, III, and IV only


Which one of the following statements related to the NYSE is correct?

Selected Answer:

b.

Commission brokers work on behalf of brokerage firm clients.

Correct Answer:

b.

Commission brokers work on behalf of brokerage firm clients.


Which one of the following statements currently applies to a NYSE broker?

Selected Answer:

e.

matches customer buy and sell orders

Correct Answer:

e.

matches customer buy and sell orders


You own 600 shares of a NASDAQ listed stock that you wish to sell. Which of the following are options available to you for this purpose?

I. sell the shares to a dealer at the dealer's bid price.

II. sell directly to another individual via an ECN.

III. offer the shares yourself on NASDAQ via an ECN.

IV. have a broker offer the shares for sale on the NYSE.

Selected Answer:

e.

I, II, and III only

Correct Answer:

e.

I, II, and III only


Miller Brothers Hardware paid an annual dividend of $1.15 per share last month. Today, the company announced that future dividends will be increasing by 2.6 percent annually. If you require a 12 percent rate of return, how much are you willing to pay to purchase one share of this stock today?

Selected Answer:

a.

$12.55

Correct Answer:

a.

$12.55


Upper Crust Bakers just paid an annual dividend of $2.80 a share and is expected to increase that amount by 4 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of

security is 11.50 percent at the time of your purchase?

Selected Answer:

c.

$40.38

Correct Answer:

c.

$40.38


The common stock of Auto Deliveries sells for $28.16 a share. The stock is expected to pay $1.35 per share next year when the annual dividend is distributed. The firm has established a pattern of increasing its dividends by 3 percent annually and expects to continue doing so. What is the market rate of return on this stock?

Selected Answer:

b.

7.79 percent

Correct Answer:

b.

7.79 percent


Northern Gas recently paid a $2.80 annual dividend on its common stock. This dividend increases at an average rate of 3.8 percent per year. The stock is currently selling for $26.91 a share. What is the market rate of return?

Selected Answer:

b.

14.60 percent

Correct Answer:

b.

14.60 percent


Roy's Welding Supplies common stock sells for $38 a share and pays an annual dividend that increases by 3 percent annually. The market rate of return on this stock is 8.20 percent. What is the amount of the last dividend paid?

Selected Answer:

a.

$1.92

Correct Answer:

a.

$1.92


Douglass Gardens pays an annual dividend that is expected to increase by 4.1 percent per year. The stock commands a market rate of return of 12.6 percent and sells for $24.90 a share. What is the expected amount of the next dividend?

Selected Answer:

a.

$2.12

Correct Answer:

a.

$2.12


Home Canning Products common stock sells for $44.96 a share and has a market rate of return of 12.8 percent. The company just paid an annual dividend of $1.04 per share. What is the dividend growth rate?

Selected Answer:

e.

10.25 percent

Correct Answer:

e.

10.25 percent


Diets For You announced today that it will begin paying annual dividends next year. The first dividend will be $0.12 a share. The following dividends will be $0.15, $0.20, $0.50, and $0.60 a share annually for the following 4 years, respectively. After that, dividends are projected to increase by 4 percent per year. How much are you willing to pay to buy one share of this stock today if your desired rate of return is 8.5 percent?

Selected Answer:

b.

$10.38

Correct Answer:

b.

$10.38


Last year, Hansen Delivery paid an annual dividend of $3.20 per share. The company has been reducing the dividends by 10 percent annually. How much are you willing to pay to purchase stock in this company if your required rate of return is 11.5 percent?

Selected Answer:

a.

$13.40

Correct Answer:

a.

$13.40


Zylo, Inc. preferred stock pays a $7.50 annual dividend. What is the maximum price you are willing to pay for one share of this stock today if your required return is 9.75 percent?

Selected Answer:

e.

$76.92

Correct Answer:

e.

$76.92

Thursday, November 6, 2014 11:50:48 AM EST Question 1


A project has a net present value of zero. Which one of the following best describes this project?

Selected Answer:

d.

The project's cash inflows equal its cash outflows in current dollar terms.

Correct Answer:

d.

The project's cash inflows equal its cash outflows in current dollar terms.


Net present value:

Selected Answer:

a.

is the best method of analyzing mutually exclusive projects.

Correct Answer:

a.

is the best method of analyzing mutually exclusive projects.


Which one of the following statements related to payback and discounted payback is correct?

Selected Answer:

b.

Payback is used more frequently even though discounted payback is a better method.

Correct Answer:

b.

Payback is used more frequently even though discounted payback is a better method.


Which one of the following correctly applies to the average accounting rate of return?

Selected Answer:

e.

It can be compared to the return on assets ratio.

Correct Answer:

e.

It can be compared to the return on assets ratio.


Which one of the following statements related to the internal rate of return (IRR) is correct?

Selected Answer:

d.

The IRR is equal to the required return when the net present value is equal to zero.

Correct Answer:

d.

The IRR is equal to the required return when the net present value is equal to zero.


Which one of the following statements is correct in relation to independent projects?

Selected Answer:

a.

A project with investing type cash flows is acceptable if its internal rate of return exceeds the required return.

Correct Answer:

a.

A project with investing type cash flows is acceptable if its internal rate of return exceeds the required return.


When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:

Selected Answer:

a.

accepted because the profitability index is greater than 1.

Correct Answer:

a.

accepted because the profitability index is greater than 1.


Mutually exclusive projects are best defined as competing projects which:

Selected Answer:

e.

both require the total use of the same limited resource.

Correct Answer:

e.

both require the total use of the same limited resource.


The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following?

Selected Answer:

e.

required rate of return

Correct Answer:

e.

required rate of return


Kristi wants to start training her most junior assistant, Amy, in the art of project analysis. Amy has just started college and has no experience or background in business finance. To get her started, Kristi is going to assign the responsibility for all projects that have initial costs less than $1,000 to Amy to analyze. Which method is Kristi most apt to ask Amy to use in making her initial decisions?

Selected Answer:

d.

payback

Correct Answer:

d.

payback


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?

Year Cash Flow0 -$42,0001 $16,5002 $28,4003 $7,500

Selected Answer:

b.

Yes; The IRR exceeds the required return by about 0.06 percent.

Correct Answer:

b.

Yes; The IRR exceeds the required return by about 0.06 percent.


You are considering an investment with the following cash flows. If the required rate of return for this investment is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?

Year Cash Flow0 -$152,8001 $96,1002 $102,3003 -$4,900

Selected Answer:

b.

You cannot apply the IRR rule in this case.

Correct Answer:

b.

You cannot apply the IRR rule in this case.


Based on the profitability index rule, should a project with the following cash flows be accepted if the discount rate is 14 percent? Why or why not?

Year Cash Flow0 -$26,2001 $11,8002 $03 $24,900

Selected Answer:

a.

Yes; The PI is 1.04.

Correct Answer:

a.

Yes; The PI is 1.04.


J&J Enterprises is considering an investment that will cost $318,000. The investment produces no cash flows for the first year. In the second year, the cash inflow is $47,000. This inflow will increase to $198,000 and then $226,000 for the following two years, respectively, before ceasing permanently. The firm requires a 15.5 percent rate of return and has a required discounted payback period of three years. Should the project be accepted? Why or why not?

Selected Answer:

d.

reject; The project never pays back on a discounted basis.

Correct Answer:

d.

reject; The project never pays back on a discounted basis.


A project has an initial cost of $35,000 and a 3-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,200, $2,300, and $1,800 a year for the next 3 years, respectively. What is the average accounting return?

Selected Answer:

e.

10.10 percent

Correct Answer:

e.

10.10 percent


You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on IRR analysis?

Project A Project BYear Cash Flow Year Cash Flow

0 -$87,000 0 -$85,0001 $31,000 1 $15,0002 $37,000 2 $20,0003 $44,000 3 $90,000

Required rate of return 12% Required rate of return 14%Required payback period 2.5 years Required payback period 2.5 yearsRequired accounting return 10% Required accounting return 11%

Selected Answer:

e.

accept Project A and reject Project B

Correct Answer:

d.

You cannot make this decision based on internal rate of return analysis.


You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on net present value analysis?


0 -$87,000 0 -$85,0001 $31,000 1 $15,0002 $37,000 2 $20,0003 $44,000 3 $90,000


Selected Answer:

b.

accept both Projects A and B

Correct Answer:

d.

reject Project A and accept Project B


You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on payback analysis?


0 -$87,000 0 -$85,0001 $31,000 1 $15,0002 $37,000 2 $20,000

3 $44,000 3 $90,000Required rate of return 12% Required rate of return 14%Required payback period 2.5 years Required payback period 2.5 yearsRequired accounting return 10% Required accounting return 11%

Selected Answer:

c.

accept both Projects A and B

Correct Answer:

e.

accept Project A and reject Project B


You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on the profitability index?


0 -$87,000 0 -$85,0001 $31,000 1 $15,0002 $37,000 2 $20,0003 $44,000 3 $90,000


Selected Answer:

b.

You cannot make this decision based on the profitability index.

Correct Answer:

b.

You cannot make this decision based on the profitability index.


You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Should you accept or reject these projects based on the average accounting return?


0 -$87,000 0 -$85,0001 $31,000 1 $15,0002 $37,000 2 $20,0003 $44,000 3 $90,000

Required rate of return 12% Required rate of return 14%

Required payback period 2.5 years Required payback period 2.5 yearsRequired accounting return 10% Required accounting return 11%

Selected Answer:

b.

reject Project A and accept Project B

Correct Answer:

c.

You cannot make this decision based on the information provided.


Which one of the following best describes the concept of erosion?

Selected Answer:

e.

the cash flows of a new project that come at the expense of a firm's existing cash flows

Correct Answer:

e.

the cash flows of a new project that come at the expense of a firm's existing cash flows


Which one of the following best describes pro forma financial statements?

Selected Answer:

c.

financial statements showing projected values for future time periods

Correct Answer:

c.

financial statements showing projected values for future time periods


The depreciation tax shield is best defined as the:

Selected Answer:

b.

amount of tax that is saved because of the depreciation expense.

Correct Answer:

b.

amount of tax that is saved because of the depreciation expense.


Which one of the following is an example of a sunk cost?

Selected Answer:

c.

$1,200 paid to repair a machine last year

Correct Answer:

c.

$1,200 paid to repair a machine last year


Net working capital:

Selected Answer:

c.

can create either a cash inflow or a cash outflow at time zero of a project.

Correct Answer:

c.

can create either a cash inflow or a cash outflow at time zero of a project.


A company that utilizes the MACRS system of depreciation:

Selected Answer:

c.

will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.

Correct Answer:

c.

will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.


Kelly's Corner Bakery purchased a lot in Oil City 6 years ago at a cost of $280,000. Today, that lot has a market value of $340,000. At the time of the purchase, the company spent $15,000 to level the lot and another $20,000 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1.47 million. What amount should be used as the initial cash flow for this project?

Selected Answer:

b.

-$1,810,000

Correct Answer:

b.

-$1,810,000


Webster & Moore paid $139,000, in cash, for a piece of equipment 3 years

ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $89,000 from a firm that would like to purchase it. Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?

Selected Answer:

e.

$89,000

Correct Answer:

e.

$89,000


The Fluffy Feather sells customized handbags. Currently, it sells 18,000 handbags annually at an average price of $89 each. It is considering adding a lower-priced line of handbags that sell for $59 each. The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags?

Selected Answer:

e.

$146,000

Correct Answer:

e.

$146,000


You own some equipment that you purchased 4 years ago at a cost of $216,000. The equipment is 5-year property for MACRS. You are considering selling the equipment today for $75,500. Which one of the following statements is correct if your tax rate is 35 percent?

MACRS 5-year propertyYear Rate

1 20.00%2 32.00%3 19.20%4 11.52%5 11.52%6 5,76%

Selected Answer:

b.

The aftertax salvage value is $62,138.68.

Correct Answer:

b.

The aftertax salvage value is $62,138.68.


Bruno's Lunch Counter is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. 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 $3,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 16 percent?

Selected Answer:

c.

$32,409.57

Correct Answer:

c.

$32,409.57


Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, inventory will decrease by $16,000, accounts receivables will increase by $21,000, and accounts payable will increase by $15,000. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.5 percent?

Selected Answer:

e.

$84,049.74

Correct Answer:

e.

$84,049.74


The Buck Store is considering a project that will require additional

inventory of $216,000 and will increase accounts payable by $181,000. Accounts receivable are currently $525,000 and are expected to increase by 9 percent if this project is accepted. What is the project's initial cash flow for net working capital?

Selected Answer:

d.

-$82,250

Correct Answer:

d.

-$82,250


Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 with costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the project's cash flow at time zero?

Selected Answer:

a.

-$614,000

Correct Answer:

a.

-$614,000


Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual

sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the cash flow recovery from net working capital at the end of this project?

Selected Answer:

a.

$92,000

Correct Answer:

a.

$92,000


Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the value of the depreciation tax shield in year 4 of the project?

Selected Answer:

c.

$49,000

Correct Answer:

c.

$49,000


Winnebagel Corp. currently sells 28,200 motor homes per year at $42,300 each, and 11,280 luxury motor coaches per year at $79,900 each. The company wants to introduce a new portable camper to fill out its product line. It hopes to sell 19,740 of these campers per year at $11,280 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 4,700 units per year, and reduce the sales of its motor coaches by 1,222 units per year. What is the amount that should be used as the annual sales figure when evaluating this project?

Selected Answer:

c.

$323,839,400

Correct Answer:

c.

$323,839,

400


ABC, Inc. is considering a new 6-year expansion project that requires an initial fixed asset investment of $5.994 million. The fixed asset will be depreciated straight-line to zero over its 6-year tax life, after which time it will be worthless. The project is estimated to generate $5,328,000 in annual sales, with costs of $2,131,200. The tax rate is 31 percent. What is the operating cash flow for this project?

Selected Answer:

e.

$2,515,482

Correct Answer:

e.

$2,515,482


XYZ, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with costs of $883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project?

Selected Answer:

c.

$1,433,059

Correct Answer:

c.

$1,433,059


Your firm is contemplating the purchase of a new $1,628,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $158,400 at the end of that time. You will save $633,600 before taxes per year in order processing costs and you will be able to reduce working capital by $115,764 (this is a one-time reduction). The net working capital will return to its original level when the project ends. The tax rate is 35 percent. What is the internal rate of return for this project?

Selected Answer:

b.

21.65

percent

Correct Answer:

b.

21.65 percent


A firm's overall cost of capital:

Selected Answer:

c.

is the required return on the total assets of a firm.

Correct Answer:

c.

is the required return on the total assets of a firm.


Which one of the following represents the best estimate for a firm's pre-tax cost of debt?

Selected Answer:

a.

the current yield-to-maturity on the firm's existing debt

Correct Answer:

a.

the current yield-to-maturity on the firm's existing debt


An increase in the market value of a preferred stock will _____ the cost of preferred stock.

Selected Answer:

e.

decrease

Correct Answer:

e.

decrease


Capital structure weights are based on the:

Selected Answer:

e.

market values of a firm's debt and equity.

Correct e.

Answer: market values of a firm's debt and equity.


Which one of the following is a correct statement regarding a firm's weighted average cost of capital (WACC)?

Selected Answer:

b.

The WACC can be used as the required return for all new projects with similar risk to that of the existing firm.

Correct Answer:

b.

The WACC can be used as the required return for all new projects with similar risk to that of the existing firm.


The rate of return on its existing assets that a firm must earn to maintain the current value of the firm's stock is called the:

Selected Answer:

e.

weighted average cost of capital.

Correct Answer:

e.

weighted average cost of capital.


A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

I. automatically gives preferential treatment in the allocation of funds to its riskiest division.

II. encourages the division managers to only recommend their most conservative projects.

III. tends to change its overall risk structure over time.

IV. tends to allocate money equally among its divisions.

Selected Answer:

d.

I only

Correct Answer:

a.

I and III only


XYZ Company is trying to determine how to assign discount rates to the various projects proposed by its numerous international divisions. The company should put the greatest emphasis on which one of the following when assigning the discount rates?

Selected Answer:

a.

the tax structure to which the project will be subjected

Correct Answer:

e.

the various types of risk associated with the project


When using the pure play approach, a firm is seeking a rate of return which:

Selected Answer:

e.

is applicable to the risk level of the investment under consideration.

Correct Answer:

e.

is applicable to the risk level of the investment under consideration.


A firm which assigns every project to a risk class which determines the required rate of return for the project is using the _____ approach.

Selected Answer:

d.

subjective

Correct Answer:

d.

subjective


Hartford Enterprises just paid an annual dividend of $1.56 per share. This dividend is expected to increase by 3% annually. Currently, the firm has a beta of 1.13 and a stock price of $28 a share. The risk-free rate is 3% and the market rate of return is 10.5%. What is your best estimate of Hartford's cost of equity?

Selected Answer:

e.

10.11%

Correct e.

Answer: 10.11%


Grace Company has paid increasing dividends of $0.54, $0.58, $0.62, $0.67, and $0.72 a share over the past five years, respectively. The firm estimates that future increases in their dividends will be comparable to the arithmetic average growth rate over these past five years. The stock is currently selling for $38.60 a share. The risk-free rate is 4% and the market risk premium is 8%. What is your best estimate of Grace's cost of equity if their beta is 1.22?

Selected Answer:

c.

11.61%

Correct Answer:

c.

11.61%


Jessica's Boutique has 12,000 bonds outstanding at a quoted price of 98% of face value. The bonds mature in eleven years and carry a 9% annual coupon. What is Jessica's aftertax cost of debt if the applicable tax rate is 35%?

Selected Answer:

c.

6.33%

Correct Answer:

d.

6.04%


The preferred stock of CISO, Inc., pays an annual dividend of $6.50 a share and sells for $48 a share. What is CISO's cost of preferred stock?

Selected Answer:

d.

13.54%

Correct Answer:

d.

13.54%


Vandelay Industries has 125,000 shares of common stock outstanding at a

price of $43 a share. They also have 25,000 shares of preferred stock outstanding at a price of $55 a share. There are 10,000, 8% bonds outstanding that are priced at 99% of face value. The bonds mature in 16 years and pay interest semiannually. What is the capital structure weight of the preferred stock?

Selected Answer:

c.

8.26%

Correct Answer:

c.

8.26%


Wingslow Company has a cost of equity of 12%, a pre-tax cost of debt of 7%, and a tax rate of 35%. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.60?

Selected Answer:

d.

11.11%

Correct Answer:

c.

9.21%


Green and Red has a cost of equity of 11% and a pre-tax cost of debt of 8.5%. The firm's target weighted average cost of capital is 9% and its tax rate is 35%. What is the firm's target debt-equity ratio?

Selected Answer:

a.

57.55%

Correct Answer:

a.

57.55%


Silverstone and Moore has 10,000 shares of common stock outstanding at a price per share of $46 and a rate of return of 14%. The firm has 5,000 shares of preferred stock outstanding at a price of $58 a share and a rate of return of 12.07%. The outstanding debt has a total face value of $200,000 and a market price equal to 98% of face value. The yield-to-maturity on the debt is 8.03%. What is the firm's weighted average cost of capital if the tax rate is 34%?

Selected Answer:

c.

8.62%

Correct Answer:

b.

11.61%


ACS Industries is considering a project with an initial cost of $6.2 million. The project will produce cash inflows of $1.8 million a year for five years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +2%. The firm has a pre-tax cost of debt of 6.7% and a cost of equity of 9.4%. The debt-equity ratio is 0.6 and the tax rate is 35%. What is the net present value of the project?

Selected Answer:

c.

$710,053

Correct Answer:

c.

$710,053


ABC, Inc., has three divisions: A, B, and C. Division A has the least risk and division C has the most risk. ABC has an aftertax cost of debt of 4.6% and a cost of equity of 9.5%. The firm is financed with 50% debt and 50% equity. Management has told the divisional manager of division A that projects in that division are assigned a discount rate that is 1% less than the firm's weighted average cost of capital. What is the discount rate applicable to division A?

Selected Answer:

c.

6.65%

Correct Answer:

b.

6.05%

Thursday, November 6, 2014 11:52:57 AM EST

PA 4 ANSWERS

Problem Assignment 4

1. RMC is considering an investment on a machine. The machine costs $200,000 today, will have a five-year life and will be depreciated over a 5-year life on a straight-line basis toward a zero salvage value. The company paid a consulting company $4,000 last year to help them decide whether there is a sufficient demand for the machine’s products. In addition to the investment on the machine, RMC also invests $10,000 in net working capital but decides NOT to recoup the net working capital at the end of the investment project. RMC has estimated the performance of the new machine and believes the following are good estimates of the new asset:

Sales per year $120,000Cost of goods sold (35% of sales) per yearAdministrative expenses per year $15,000

RMC has a 10% cost of capital and a 30% tax rate. Answer the following questions:

a. Should we consider consulting fee, $4,000, in estimating project’s cash flows?b. What is the cost of investment and annual cash flows?

Pro Forma Income StatementSalesCOGSGross marginAdministrative expenseDepreciationEBITTaxesNet income

0 1 2 3 4 5Project OCFChange in NWCCapital spending

c. Calculate payback period, NPV, IRR, and PI.d. Should RMC accept the project?e. What is the maximum price that RMC has to pay if the target profitability index is 1.2?f. What is the minimum annual cash flow that project has to generate in order to accept the

project?

Cash Flow x PVIFA(10%, 5) – 210,000 = 0, Cash Flow = 55,397.472. Given the following information, compute the weighted average cost of capital (WACC) for XYZ Company.

a. Bonds issued by XYZ pays 8.8% annual interest, have a par value of $1,000 and 25 years to maturity. The bonds are currently selling for $890.78. XYZ has a 25% tax rate. What is the after-tax cost of debt?

b. Preferred stocks issued by XYZ pay an annual dividend of $6. The preferred stock price is $54. What is the cost of preferred stock?

c. Common stocks issued by XYZ will pay a dividend of $2.5 next year. The stock has an estimated growth rate of 8% and is currently selling for $50. The beta coefficient for XYZ is 1.25. The risk-free rate is 5% and the expected return on the market is 13%. What is the best estimate for the cost of equity?

d. If XYZ’s capital structure is 35% in debt, 25% in preferred stock, and 40% in equity, what is the weighted average cost of capital?

The point distribution for PA 4 is shown in the following table:

Question Point1a 11b 21c 41d 11e 11f 12a 2.52b 2.52c 2.52d 2.5

Please check the answers below. If you have any questions, please let me know.

1.

a. No because it is a sunk cost.b.

Pro Forma Income StatementSales 120000COGS 42000Gross margin 78000Administrative expense 15000Depreciation 40000EBIT 23000Taxes 6900Net income 16100

OCF = NI + Depreciation = 16,100 + 40,000 = 56,100

0 1 2 3 4 5Project OCF 56100 56100 56100 56100 56100Change in NWC 10000Capital spending 200000Projec Cash Flow

-210000 56100 56100 56100 56100 56100

c.PB = 210,000 / 56,100 = 3.74 yearsNPV = 56,100 x PVIFA(10%, 5) – 210,000 = 2,663.1456,100 x PVIFA(IRR, 5) – 210,000 = 0, IRR = 10.50%PI = 56,100 x PVIFA(10%, 5) / 210,000 = 1.01d. Yes because NPV > 0 and IRR > 10%e.56,100 x PVIFA(10%, 5) / Price = 1.2; Price = 177,219.28f.Cash Flow x PVIFA(10%, 5) – 210,000 = 0, Cash Flow = 55,397.47

2.

a.The yield to maturity is the estimate for before-tax cost of debt. Bond valuation formula is used to get yield to maturity.890.78 = 88 x PVIFA(YTM, 25) + 1,000 x PVIF(YTM, 25)890.78 < 1,000, so, YTM > 8.8%If YTM = 9%B0 = 88 x PVIFA(9%, 25) + 1,000 x PVIF(9%, 25) = $980.42If YTM = 10%B0 = 88 x PVIFA(10%, 25) + 1,000 x PVIF(10%, 25) = $890.78So, YTM = 10%After tax cost of debt = 10% x (1 – 25%) = 7.5%

b. Rp = 6/54 = 11.11%c.Re (DGM) = next dividend / current stock price + growth rate = 2.5 / 50 + 8% = 13%Re (CAPM) = risk free rate + beta x (marke porfolio return - risk free rate) = 5% + 1.25 x (13% – 5%) = 15%The average of the two cost of equity estimates is the best estimate. (13% + 15%) / 2 = 14%d.Weighted average cost of capital = 35% x 7.5% + 25% x 11.11% + 40% x 14% = 11%

There are five questions in CA 2. The point distribution is 4 points for Q.1, 8 points for Q.2, 6 points each for the others. The following answers refer to the questions you did incorrectly. If you have any questions, please post them here.

1.

Total Reported Earnings increases for each projects:

Project A Project B Project C Project D

Year 1: $(13,250) $ 29,313 $(60,000) $ 192,206

Year 2: $ (450) $ 87,938 $(16,000) $ 129,846

Year 3: $ 25,494

$146,563 $ 61,640

$ (43,350)

Year 4: $101,003

$234,500 $162,140

$ (62,475)

Year 5: $ 63,315

$322,438 $262,640

$ (94,350)

Total: $176,112

$820,752 $410,420

$ 121,877

She will be attracted to Project B

2.

Payback Period, IRR, and NPV of each alternative:

Project A Project B Project C Project D

Payback Period:

3.70 years

4.39 Years

4.05 Years

2 Years

IRR: 14.08% 7.18% 11.95% 12.48%

NPV at 10%: $39,971.97

-$63,846.7

8

$52,192.41

$20,608.74

PI: 1.13 0.91 1.07 1.04

4.

c. If the size of Aerocomp’s capital budget were not limited, the IRR method would accept projects A, C, and D. Project B, with an IRR of 7.18%, nearly three percentage points less than the cost of capital, would be rejected.

5.

a. According to the NPV method, Project C, with an NPV of over $52,000, will be chosen.

c. The likely selection is Project C because of its high net present value.

PA 3Problem Assignment 3

1. Bonds issued by VIX Industries have a par value of $1,000. The bonds are currently selling for $885.50. They have 10 years remaining to maturity. The coupon rate is 10% and the coupon payment is paid semiannually. What is the bonds’ yield to maturity?

2. WMT Enterprise has bonds with face value of $1,000 on the market making annual payments, with 10 years to maturity, and selling for $1,146.80. At this price, the bonds yield 6%. What must the coupon rate be on WMT’s bonds?

2.1,223.47 = Coupon x 7.3601+ 1,000 x .5584Coupon = 80Coupon rate = 80 / 1,000 = 8%

3. A MU Industries bond has a 10% coupon rate and a $1,000 face value. Interest is paid semiannually, and the bond has 15 years to maturity. If investors require a 8% yield, what is the bond’s value?This is a semi-annual coupon bond. The formula should contain semi-annual coupons, semi-annual rate, and number of semi-annual periods.B0 = 10% x 1,000 / 2 x PVIFA(8% / 2, 15 x 2) + 1,000 x PVIF(8% / 2, 15 x 2) = $1172.924. ABC Co. has just paid a cash dividend of $2.1 per share. Investors require a 16% return from investments such as this. If the dividend is expected to grow at a steady 9% per year, what is the current value of the stock? What will the stock be worth in five years?4.$2.1 has paid, which implies $2.1 is D0.P0 = D1 / (r – g) = 2.1 × FVIF(9%, 1) / (0.16 – 0.09) = $32.7P5 = D6 / (r – g) = 2.1 × FVIF(9%, 6) / (0.16 – 0.09) = $50.31The Hugh Co. expects to pay a cash dividend of $2.5 per share next year. Investors require a 14% return from investments such as this. If the dividend is expected to grow at a steady 5% per year, what will the stock be worth in five years?

2.5xFVIF(5% ,1/.14-.05)=

5. XYZ Corporation will pay a $4.5 per share dividend next year. The company pledges to increase its dividend by 4% per year, indefinitely. If you require a 10% return on your investment, how much will you pay for the company stock today?

6. Suppose we observe a stock selling for $40 per share. The next dividend will be $1 per share, and you think the dividend will grow at 12% per year forever. What is the dividend yield in this case? The capital gains yield? The total required return?

7. TXN, Inc., has an issue of preferred stock outstanding that pays a $6.3 dividend every year, in perpetuity. If this issue currently sells for $78.86 per share, what is the required return?

8. BGN, Inc. just paid a dividend of $4. The dividend is expected to grow at a 30% rate for the next 3 years and at a 10% rate thereafter. What is the value of the stock if the required rate of return is 20%?8.D0 = 4D1 = 4 × (1 + 30%) = 5.2D2 = 5.2 × (1 + 30%) = 6.76D3 = 6.76 × (1 + 30%) = 8.788D4 = 8.788 × (1 + 10%) = 9.6668P3 = 9.6668 / (0.2 – 0.1) = 96.668

P0 = 5.2 × PVIF(20%, 1) + 6.76 × PVIF(20%, 2) + 8.788 × PVIF(20%, 3) + 96.668 × PVIF(20%, 3) = $70.06D=2.2

D=2.2 x (1+25%)=2.75

D2=2.75x

The point distribution for PA 3 is 4 points each for Q.4 and Q.6, and 2 points for other questions. Please check the answers below. If you have any questions, please post them here.

1.B12% = 50 x PVIFA(6%, 20) + 1,000 x PVIF(6%, 20) = 50 x 11.470 + 1000 x 0.312 = 885.5YTM = 12%

2.1,146.80 = Coupon x PVIFA(6%, 10) + 1,000 x PVIF(6%, 10)Coupon = 80Coupon rate = 80 / 1,000 = 8%3.This is a semi-annual coupon bond. The formula should contain semi-annual coupons, semi-annual rate, and number of semi-annual periods.B0 = 10% x 1,000 / 2 x PVIFA(8% / 2, 15 x 2) + 1,000 x PVIF(8% / 2, 15 x 2) = $1172.924.$2.1 has paid, which implies $2.1 is D0.P0 = D1 / (r – g) = 2.1 × FVIF(9%, 1) / (0.16 – 0.09) = $32.7P5 = D6 / (r – g) = 2.1 × FVIF(9%, 6) / (0.16 – 0.09) = $50.31 5.$4.5 will be paid next year, which implies $4.5 is D1.P0 = D1 / (r – g) = 4.5 / (0.10 – 0.04) = $75 6.

Dividend yield = 2.5%Capital gains yield = growth rate = 12%Required rate of return = 14.5% 7.6.3 / 78.86 = 7.99% 8.D0 = 4D1 = 4 × (1 + 30%) = 5.2D2 = 5.2 × (1 + 30%) = 6.76D3 = 6.76 × (1 + 30%) = 8.788D4 = 8.788 × (1 + 10%) = 9.6668P3 = 9.6668 / (0.2 – 0.1) = 96.668P0 = 5.2 × PVIF(20%, 1) + 6.76 × PVIF(20%, 2) + 8.788 × PVIF(20%, 3) + 96.668 × PVIF(20%, 3) = $70.06

Exam 2 will take place on November 9, 2014. In order to accommodate students in different time zones, I will make the exam available from 0:00:00 EST to 23:59:59 EST on November 9; however, you will need to choose a two-hour period and only have two hours to work on the exam. The exam has thirty-three multiple choice questions. MCAs 3, 4 and PAs 3, 4 are the study guide for the exam. You can check the answers to PAs at Discussion Board and the answers to MCAs via My Grades under Student Tools. The answers to MCAs and PAs will not be available after 0:00:00 EST on November 9.In your chosen two-hour period, you can make three attempts at most on the exam. For example, if you start the exam at 2:00 PM, you need to finish the exam at 4:00 PM and can make three attempts at most in the 2:00-4:00 period. Only the score on the latest attempt counts. The exam will be presented all questions at once and show answers in random order for every attempt. Instead of finding the answers for exam questions from the materials during the test, you should study the materials very carefully and thoroughly as if you were to take a closed-book exam in a classroom. The purpose of the exam is to test whether you understand and remember the materials not to test how fast you can find the answers from the materials.To avoid any network problems while you take the exam, you should find a computer with stable internet connection (e.g., MSU lab, public library, etc.). Unless MSU system fails or shuts down, you will not gain any time extension or extra attempt for the exam. Once you access the exam, you should submit your exam in two hours. The Blackboard will record the time you start the exam and the time you submit the exam. You will need to prepare a timer or use a clock to time the exam yourself. If you do not have a timer or a clock, you may consider use the timer at http://www.online-stopwatch.com/. If you work on the exam more than two hours, your score for the exam will be deducted by the number of minutes you go over the limit (one point per minute). If you have any questions, please let me know.The format for Exam 2 is the same as that for Exam 1. Exam 2 has 22 problem-solving questions and 11 conceptual questions. To prepare for problem-solving questions, you need

to focus on problem assignments, capital budgeting example, market value of capital structure, payback period for unequal cash flows, and accounting rate of return.When working on capital budgeting questions, please be mindful to the following:1. Consulting fee which is a sunk cost cannot be included in project cash flow estimation. Interest expense, dividends, and other financing costs cannot be included in project cash flow estimation.2. The net working capital will be assumed not to be recouped at the end of project life; therefore, the annual project cash flow after project implementation will be the same.3. When using bond valuation formula to compute the cost of debt, you need to know the difference between the annual coupon bonds and the semiannual coupon bonds.4. When using dividend growth model to compute the cost of equity, you need to know the difference between D0 and D1.5. When using capital asset pricing model to compute the cost of equity, you need to know the difference between expected rate of return on the market portfolio and market risk premium.6. The best estimate of cost of equity is the average of numbers from dividend growth model and capital asset pricing model.7. The weighted average cost of capital should be used to compute the net present value and the profitability index. In the exam, make sure that you round your WACC up to the hundredth decimal place. For example, if you have WACC 0.0578, you should use 0.06 for calculating NPV and PI.

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