Unit Exam 3 - BAM 313 - Financial Management

Unit Exam 3 - BAM 313 - Financial Management - Introduction...

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Unformatted text preview: Introduction to Financial Management Unit 3 Examination Multiple Choice Questions (Enter your answers on the enclosed answer sheet) 1) Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs $75,000 and is expected to generate $48,000 in year one and $45,000 in year two. Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000 in year two, $26,000 in year three, and $25,000 in year four. Zetlars, lnc.’s required rate of return for these projects is 10%. The net present value for Project A is: a. $5,826 b. $6,347 C. $18,000 d. $9,458 2) Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs $75,000 and is expected to generate $48,000 in year one and $45,000 in year two. Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000 in year two, $26,000 in year three, and $25,000 in year four. Zellars, Inc.'s required rate of return for these projects is 10%. The net present value for Project B is: a. $18,097 b. $42,000 c. $34,238 d. $21,378 3) Zellars, inc. is considering two mutually exclusive projects, A and 8. Project A costs $75,000 and is expected to generate $48,000 in year one and $45,000 in year two. Project B costs $80,000 and is expected to generate $34,000 in year one, $37,000 in year two, $26,000 in year three, and $25,000 in year tour. Zellars, |nc.’s required rate of return for these projects is 10%. The internal rate of return for Project B is: a. 18.64% b. 16.77% C. 20.79% d. 26.74% 4) All of the foilowing are criticisms of the payback period criterion except: a. Time vaiue of money is not accounted for. b. it deals with accounting profits as opposed to cash flows. c. Cash flows occurring after the payback are ignored. d. None of the above; they are all criticisms of the payback period criteria. 5) A significant disadvantage of the payback period is that it: a. Does not property consider the time value of money. b. is complicated to explain. c. Increases firm risk. d. Provides a measure of liquidity. 137 Introduction to Financial Management Unit 3 Examination 6) A significant advantage of the internal rate of return is that it: a. Provides a means to choose between mutually exclusive projects. b. Considers all of a project‘s cash flows and their timing. c. Provides the most realistic reinvestment assumption. d. Avoids the size disparity problem. 7) A significant disadvantage of the internal rate of return is that it: a. it does not give propezr weight to all cash 1flows. b. It is expressed as a percentage. c Does not fully consider the time vatue of money. d Can result in multiple rates of return (more than one lRR). 8) Your firm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash flows of $1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and it is not subject to capital rationing. Assum- ing both projects can be replaced with a similar investment at the end of their respec— tive lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B. $2,865 and $94 5,000 and $1,500 . $3,528 and $136 d. $2,232 and $85 OCT?) 9) Determine the five—year equivalent annuat annuity of the following project if the ap— propriate discount rate is 16%: Initial Outflow = $150,000 Cash Flow Year 1 2 $40,000 Cash Ftow Year 2 = $90,000 Cash Flow Yea:r 3 = $60,000 Cash Flow Year 4 = $0 Cash Flow Year 5 = $80,000 a. $9,872 b. $8,520 c. $7,058 d. $9,454 138 Introduction to Financial Management Unit 3 Examination 10) A project would be acceptable if: a. The net present value is positive. b. The payback is greater than the discounted equivalent annual annuity. c. The equivalent annual annuity is greate;r than or equal to the firm’s discount rate. d. The profitability index is greater than the net present value. 11) Which of the foltowing methods of evaluating investment projects can properly evalu- ate projects of unequal Eives? a. The equivaient annual annuity. b. The internal rate of return. c. The payback. d. The net present value. 12) Taste Good Chocolates develops a new candy bar and plans to sell each bar for $1. Taste Good predicts that 1 million candy bars will be sold in the first year if the new candy bar is produced and sold, and includes $1 million of incremental revenues in its capital budgeting analysis. A senior executive in the company believes that 1 mil- lion candy bars will be sold, but lowers the estimate of incremental revenue to $700,000. What would explain this change? a. excessive marketing costs to sell the 1 million candy bars b. a lower discount rate c. cannibalization of 300,000 of Taste Good Chocolates' other candy bars d. a higher selling price for the new candy bars 13) JW Enterprises is considering a new marketing campaign that will require the addition of a new computer programmer and new software. The programmer will occupy an office in JW’s current building and will be paid $8,000 per month. The software license costs $1,000 per month. The rent for the building is $4,000 per month. JW’s computer system is always on, so running the new software will not change the current monthly electric bill of $900. The incremental expenses for the new market— ing campaign are: a. $8,000 per month. b. $13,000 per month. c. $13,900 pear month. d. $9,000 per month. 14) lrcreased depreciation expenses affect tax—related cash flows by a. increasing taxable income, thus increasing taxes. b. decreasing taxable income, thus reducing taxes. c. pushing a corporation into a higher tax bracket. d. decreasing taxable income, with no effect on cash flow since depreciation is a non- cash expense. 139 introduction to Financial Management Unit 3 Examination 15) When terminating a project for capital budgeting purposes, the working capital outlay required at the initiation of the project will not affect the cash flow. decrease the cash flow because it is an outlay. increase the cash flow because it is recaptured. decrease the cash flow because it is a historical cost. up 0-9: 16) J.B. Enterprises purchased a new molding machine for $75,000. The company paid $6,000 for shipping and another $4,000 to get the machine integrated with the company’s existing assets. J.B. must maintain a supply of speciai lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $2,000. The machine is to be depreciated on a straight-tine basis over its expected useful life of 10 years. Which of the following statements concerning the change in working capital is most accurate? a. The $2,000 paid for oil is added to the initial outlay, offset by the tax savings $800. b. Even if the $2,000 is fully recovered at the end of the project, the project's NPV and IRR will be lower if the change in working capital is included in the analysis. c. The $2,000 may be expensed each year over the life of the project as part of the incremental free cash flows. d. The $2,000 is added to the initial outlay and recaptured during the terminai year, hence having no impact on the projects NPV or lRR. 17) Brooke Burke Corporation is considering a new product line. The company currently manufactures several lines of snow skiing apparel. The new products, insulated ski bikinis, are expected to generate sales of $1 million per year for the next five years. They expect that during this five-year period, they will lose about $250,000 in sales on their existing lines of longer ski pants. The new line will require no additional equipment or space in the plant and can be produced in the same manner as the apparel products. The new project will, however, require that the company spend an additional $80,000 per year on insurance in case customers sue for frostbite. Also, a new marketing director would be hired to oversee the line at $45,000 per year in salary and benefits. Because of the different construction of the bikinis, an increase in inventory of $3,800 would be required initially. If the marginal tax rate is 30%, compute the incremental after tax cash flows for years 1—5. a $437,500 per year b. $625,000 per year c. $187,500 per year d $434,500 per year 140 Introduction to Financial Management Unit 3 Examination 18) If bankruptcy costs and/or shareholder under diversification are an issue, what mea— sure of risk is relevant when evaluating project risk in capital budgeting? a. Total project risk to. Systematic risk c. Capital rationing risk d. Contribution-towfirm risk 19) The pure play method a. calculates beta using only project returns. b. selects a firm similar to the project being analyzed and uses its returns as the market return in estimating a project beta. c. uses the beta of a firm that is similar to the project being analyzed to determine the required rate of return for the project. d. selects one of the firm’s existing projects that is similar to the project being analyzed and uses that project’s required rate of return. 20) in general, which of the following rankings, from highest to lowest cost. is most ac- curate? a. cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt b. cost of preferred stock, cost of new common stock, cost of retained earnings, cost of debt c. cost of new common stock, cost of preferred stock, cost of debt, cost of retained earn— 1th d. cost of debt, cost of preferred stock, cost of new common stock, cost of retained earn~ irgs 21) Kinslow Manufacturing Company paid a dividend yesterday of $2.50 per share. The dividend is expected to grow at a constant rate of 5% per year. The price of Kinslow's common stock today is $25 per share. it Kinslow decides to issue new common stock, flotation costs will equal $2.00 per share. Keys’ marginal tax rate is 34%. Based on the above information, the cost of new common stock is: a. 15.00% b. 16.41% c. 10.55% d. 15.50% 22) Royal Mediterranean Cruise Line's common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Royal’s retained earnings? 141 introduction to Financial Management Unit 3 Examination a. b. 11.45% C. 11.78% d. 5.73% 23) Cost of capital is a. the average cost of the firm's assets. b. a hurdle rate set by the board of directors. c. the coupon rate of debt. d. the rate of return that must be earned on additionai investment if firm value is to remain unchanged. 24) Acme Conglomerate Corporation operates three divisions. One division involves sig- nificant research and development, and thus has a high-risk cost of capital of 15%. The second division operates in business segments related to Acme's core business, and this division has a cost of capital of 10% based upon its risk. Acme’s core busi- ness is the least risky segment, with a cost of capital of 8%. The firm's overall weight ed average cost of capital of 11% has been used to evaluate capital budgeting proj- acts for all three divisions. This approach will a. favor projects in the core business division because that division is the least risky. b. favor projects in the research and development division because the higher risk proj- ects look more favorable if a lower cost of capital is used to evaiuate them. c. not favor any division over the other because they all use the same company-wide weighted average cost of capital. d. favor projects in the related businesses division because the cost of capital for this division is the closest to the firm’s weighted average cost of capital. 25) Market value added is aqua; to a. the current stock price per share minus the par value per share of stock. b. the total market value of the company minus total invested capital. c. the total market value of the company less retained earnings. d. the total market value of the company minus the debt owed by the company. 142 ...
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Unit Exam 3 - BAM 313 - Financial Management - Introduction...

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