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Unformatted text preview: MONASH UNIVERSITY
DEPARTMENT OF ACCOUNTING AND FINANCE AF02140 BUSINESS FINANCE 0W UNWERSITY LIBRARY IIIIIIIIIIIIIIIII I III _ 004111112 M
MlDSEM ESTER TEST — SOLUTIONS FIRST SEMESTER 2004 URNAME (FAMILY NAME) IVEN NAME(S) FACULTY AND YEAR
ID NUMBER
UTOFI'S NAME UTORIAL DAY AND TIME INSTRUCTIONS: TIME ALLOWED: 60 MINUTES WRITING TIME (NIL READING TIME) CALCULATOR WITH NONALPHABETIC KEYBOARD ONLY MAY BE USED
CLOSED BOOK TEST ANSWER ALL 3 QUESTIONS (AND IN THE SPACES PROVIDED) A FORMULA SHEET IS INCLUDED AT THE BACK (WHICH CAN BE DETACHED) OFFICE USE ONLY QUESTION E
1 I TOTAL (OUT 0F 50) Page1 of 14‘— Question 1 This question consists of 15 multiplechoice questions. For each multiple
choice question, choose the 933 correct answer from the four alternatives
given by placing a tick next to the correct letter A, B, C, or D. Each multiple
choice question counts as 2 marks, giving a total of 30 marks for Question 1. The following abbreviations are used in the multiplechoice questions:
NPV net present value HRH required rate of return lFlFl internal rate of return 1. Which of the following is the correct method of calculating the NPV of a project? A: The future incremental cash flows are added and subtracted from the
initial outlay to determine the NPV. .
VB: The sum of the discounted cash flows is added to the outlay to
determine the NPV.
C: The sum of the discounted cash flows is subtracted from the initial
outlay to determine the NPV.
D: The initial outlay of the project is subtracted from the sum of the discounted cash inflows to determine the project NPV. 2. A project under consideration has an NPV of $4,000. Which of the following best
applies? A: The project should be rejected.
B: The project NPV is positive, but does not generate a competitive return
for shareholders, so the project should be rejected.
V0: The project NPV of $4,000 indicates an increased value for
shareholders of $4,000, so the project should be accepted.
D: The project’s positive NPV indicates that the project will increase
reported profits in the future. 3. Your business is evaluating the decision to market a new product to replace your
current product (a computer modem). Which of the following would not be
relevant to your decision making process? A: A loss in revenue of $30,000 from terminating the old modem line.
B: Equipment with a market value of $40,000 that you already own, and
that can be used to build the new modems.
u/C: $50,000 spent on research and development costs over time on the
older modem.
D: $25,000 disposal value you will receive for scrapping the old modem’s obsolete production equipment. Page 2 of Aﬁ 4. Which of the following cash flows should be excluded from a NPV evaluation of
an investment project? A: The cost of marketing and sales promotion undertaken during the first
year of the project. .
B: The purchase cost of materials that can be used in the project but that
the company uses regularly in other operations.
VC: Interest charges on a loan taken out to finance the project.
D: An increase in fixed costs due to renting a new building for the project. 5. In a beforetax analysis of a project, which of the following would not affect the
NPV? A: A change in the expected life of the project.
B: A change in the BBB for the project.
C: A change in estimated scrap value.
VD: A change in the depreciation rate for the project. 6. Suppose you are considering two mutually exclusive projects, A and B, both of
which have a BBB of 10%. A) =+$+, s00 1L !
Period ProjectA Project B WA 4— "" 5' "4‘19: “00 0 $10,000 $10,000 0 "L0 {1+ 0 ’ A.)
; 2:22:33 3 means
2 3.1333 3 NPV5'=+$13I“° as...
5 +$4,000 +$13,000 (1% o , .95"
Using discounted cash flow techniques, what is your decision? :2 4— 1! 1% 53 VA: Accept Project A only.
B: Accept Project B only.
C: Accept both projects.
D: Reject both projects. Page 3 ofﬁqr . ="$q'/ “'0
0.ﬁ_ digest:
gala: g' o..gj_ E‘ 7. Consider the following two machines.
___{L (A. 4—0 “$200 ’m
ﬁg— $165M ‘= EACIﬁ —$1’1.’L,4_3‘°\ 113‘— ——.$2.2_2, 4.261 . r23}— ~$11if+410 ‘1—5 i: Machine Initial Cost 0 erational Costs Life I $200,000 $7,000/year 4years $E_ ﬁ— 3  $205,000 $5,000/year 6 years 0' 4 .4.4.41 219‘"
= 4710,1111 . ii, Which machine should be chosen based on equivalent annual cost (EAC), if the appropriate BBB is 10%? A:
B:
C:
VD: 8. —$‘2.1Ja, muss E 919:1: ‘2‘
Machine I, EAC = $70,094.16 1 i _1_
Machine I, EAC = $222,189.27 0.,_,_ " (.
Machine ll, EAC = $226,766.45 ' (1 ” ° ’5') Machine , EAC = $52,069.51 An alternative to the equivalent annual cost (or value) method to evaluate projects with different lives is the replacement cycle approach s/A:
B: C:
D. under which projects are assumed to be replicated repeatedly over
time until they have common equal total lives. under which we assume that projects terminate at a point in time equal
to the average of the lives of the projects. requiring alternative RRRs for longerlived projects.
all of the above. A company has used probability analysis to analyse an investment project. They estimate that there is a 50% possibility the project will result in a NPV of a
negative $1 million, a 30% possibility of a NPV of a positive $2 million, and a
20% possibility of a NPV of a positive $5 million. The company should probably A:
s/B:
C:
D reject the project.
accept the project. never invest in a project with a 50% chance of a negative NPV.
hire a team of high priced consultants to analyse the data. >< ~$1Lm ~1— 0»’5><+$1m 4 0.7.)<+$5,,,= +$ioim 10. Suppose we have two mutually exclusive land development projects. The first is
an office building which can be constructed for an initial outlay of $20 million and
sold a year later for $24 million. The other use for the land is for a parking lot
where an initial outlay of $10,000 will produce a cash inflow of $10,000 per year
forever. The lFiFi of the building project is given by iFiFlB and the IRR of the
perpetuity producing parking project is given by iFiRp. Which is the correct pair of lFlFis for the two projects? A:
B:
C:
D: J $iolm s $‘10m__7.= . 131% = 10% and “RR: = 100% 4_
ram, = 10% and IRRP = 50% (i + mes)
11:11:13 = 5% and IRRP = 50%
rang = 20% and ii=1i=1P = 100% 33323 5" ° 7 '10 m __ Page 4 of 1‘}— Iggy 11. An investment project has multiple IBRs. What must be true about this project? A: The project has a negative IRFi. B: The project has negative cash flows in the first few years, followed by
positive cash flows.
C: The project must be mutually exclusive.
VD: The project cash flows must change signs at least twice. 12. Consider a project with an initial investment and positive future cash flows. As
the BBB is decreased the VA: lFfFi remains constant while the NPV increases.
13: iFtFi remains constant while the NPV decreases.
0: [RB increases while the NPV remains constant.
D: iFtB decreases while the NPV decreases. 13. Given two mutually exclusive projects, X and Y, and the following information,
what is the correct wealth maximisation decision? item Project X Project Y
NPV @ 5% $1,000 $1,200
IRB 1 2% 1 1 %
BBB 5% " 5% A: Accept both projects. B: Accept Project X.
V 0: Accept Project Y. D: Cannot determine based upon this information. 14. Which of the following are problems with the payback method that are over come
by the NPV method? A: The payback period is in years versus a percentage return number
used in the NPV and the payback does not consider the time value of
money. VB: The cash ﬂows beyond the payback period and the time value of
money are not considered. C: Annual accounting profits are considered, not cash flows, and the time
value of money is ignored. D: Cash flows beyond the payback period are not considered, nor are taxes on the incremental added revenue from the project. Page 5 of $3 15. A project has a FlFtFt of 12% and a 6~year life. Which of the following is
inconsistent with this information?  VA: The payback period is 6 years. B: IRFt = 12%.
C: The present value of the future cash flows equals the initial outlay.
D: None of the above is inconsistent. Page 6 of 6 Question 2 [10 marks in total] A company has identified a new market for its products. To increase the output
level, the company is considering the purchase of some new machinery at a cost of
$400,000. Estimated net operating cash flows (before tax) for the coming 3 years
are: $260,000 in the first year, $240,000 in the second year, and $200,000 in the
third year. The machinery will be sold at the end of the third year and its market
value at that time is estimated to be $50,000. The company tax rate is 30% and
reducing balance depreciation at 40% per year is allowed. The operating cash flows
should be considered to occur at yearend. The beforetax required rate of return is
14% per year. Required:
(a) Prepare a cash flow analysis for the useful economic life of the machinery to the company, and use the cash flow analysis to estimate the machinery’s net present
value. Show all ofyourworkings. [8 marks] 3 b) ’m" 0") “Meme cask} Film; = E C
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MNM TEE 35w :MQU Question 2 continued (b) State ONE assumption that you found it necessary to make in (a). [2 marks]
Any ONE afﬁne/ﬂuctuang Itmwdedeprmwwamd/lowowmwabrmtmlﬂe/
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13¢me artheye/nd/ofthaoperat’mg/yw towI’uZOh/LtVe/Latexéa Page 9 of {LC}, Question 3 [10 marks in total]
A business consultant has determined that the success or failure of a company’s
proposed new venture over the next 3 years will be dependent upon sales revenue and total costs. The consultant has estimated worst case, best case, and expected
annual sales and cost figures for the new venture over the next 3 years as follows: Cash Flow Item Worst Case Expected Best Case Sales Revenue $2 million/year $3 million/year $4 million/year
Total Costs $2.25 million/year $2 million/year $1.75 million/year initial start up costs in relation to the new venture will be $1.5 million.
Required: (3) Conduct a sensitivity analysis of the proposed project, assuming a required rate
of return of 12% per year. Show all of your workings. [6 marks] (i) woesr Cage: SALQ’ lax/ac.er 63513 W = —" “em '= a. \i? 3697’“ erases: feces" EXPECTED c.0373” AW 1" ' .r A“ $1 r.
04.7. E (4"‘L0'4‘q3 = + $3 '3) m
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K3») exitsma Sec—EE/ 661' We: C0375 I [QR/= +$3m“$i'wm 4_——— "L zeta} (1+0va.1,_ ':+$ I PagetOof 1‘"— Extra space for Question 3(a) Hoffm CﬂSQ Q9»! 66'7" WE: va (ﬂags 0? “WV Page 11 of AA Question 3 continued (b) Provide a brief, but comprehensive, interpretation of the results of your analysis
in (a). [4 marks] T’heNPV ofﬁbeprq’ect by WWwetecWMthe
form/stmﬁgoww; MWWWWWN?V range/form
which/WW4 tan/Lee greater thawtheoowegpcmdmg/
differenoemNPi/yfor cost}. Foremtmeyﬁgwrey howeﬂLe "4031‘ Impact cam/the NPV ofthe project, (Mr De @1490“ evidenced/ by the negative NPV for the worst
caee Mic: The equiwalent NPV for com epmee Page 12 of AA— Space for rough workings Page 13 of 51%— FORMULA SHEET va=i+ C2 +....+ C" C 1+k (1+k)2 (1%)"— 0 py=f_,[1_(l+li)n] Page14of 14 ...
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 Finance, Net Present Value

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