Practice Questions Exam 2
Multiple Choice
1. Limousine Conversion Company purchases ordinary Cadillacs, cuts them in half, and then
adds a middle section to the vehicles to create stretch limousines. With respect to the number
of cars converted, the cost
Accounting 242 Exam #3 Practice Questions Solutions
1. Which of the following would be included in net income, but not in annual cash flows?
a. Sales revenue
b. Depreciation
c. Initial investment
d. Direct labor
2. The payback method measures:
a. How quic
values. In general, the present value of an ordinary annuity may be calculated by
using Equation (12.20): (12.20) Consider, again, the situation depicted in Figure
12.5, where an investor deposits $500 at the end of each of the next 5 years and
earns 5% p
and deposit the initial $1,000 at the end of the year, or should he open the
certificate of deposit immediately? Solution. If Tom decides to deposit $1,000 into
a certificate of deposit immediately, the future value of an annuity due is On the
other hand,
you agree with this statement? If not, then why not? 11.5 What is the difference
between block pricing and commodity bundling? 11.6 Sales of frankfurter rolls in
packages of eight or beer in six-packs are examples of what pricing practice? What
is the obj
Budgeting Procedures under Inflation, Financial Management,Winter 1975, pp.
1827; and P.L. Cooley, R.L. Rosenfeldt, and I.K. Chew,Capital Budgeting
Procedures under Inflation: Cooley, Rosenfeldt and Chew vs. Findlay and Frankle,
Financial Management, Autu
reflects the understanding that a dollar received today is worth more than a dollar
received tomorrow. In capital budgeting, future cash inflows and outflows of
different capital investment projects are expressed as a single value at a common
point in tim
Littlechild, S. C. Peak-Load Pricing of Telephone Calls. The Bell Journal of
Economics and Management Science, Autumn (1970), pp. 191210. Oi, W. Y. A
Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse Monopoly. Quarterly
Journal of Economics, 85 (Feb
12.3. Suppose that Sergeant Garcia deposits $100,000 in a time deposit that pays
10% interest per year compounded annually. How much will Sergeant Garcia
receive when the deposit matures after 5 years? How would your answer have
been different for interes
cash flow in period t, k is the cost of capital, and n is the life of the project. Net
cash flows are defined as the difference between cash inflows (revenues), Rt, and
cash outflows, Ot. Equation (12.25) may thus be rewritten as (12.26) NPV R k O k R
O k
provided in Figure 12.7 into Equation (12.21), we find that the present value of an
annuity due is The cash flow diagram for this problem is illustrated in Figure 12.11.
Problem 12.9. Suppose that an individual invests $2,500 at the beginning of each
of t
The reader should verify that the largest interest component of the amortization
schedule is paid in at the end of the first year; thereafter, as the amount of the
principal outstanding declines, the payments are correspondingly less. Problem
12.10. Suppo
rate of return.Thus, an essential element of any investment decision is the proper
evaluation of alternative investment opportunities involving alternative initial
outlays, expected net returns, and time horizons. In this chapter we evaluate
alternative i
0 150 000 1 50 000 50 000 1 150 000 1 3 1 1 05646 0 05647 20 20 20 = ( ) + - ( ) + =
( ) + = + = = , , , , . . k k k k k 516 Capital Budgeting Solution. Since the projects have
different lives, they must be compared over the least common multiple of years
The par value of a bond is the face value of the bond. It is the amount originally
borrowed by the issuer. Why would an investor consider purchasing a bond for an
amount in excess of its par value? The reason is simple. In the present example,
when the bo
which the fixed payments are made at the end of each period. Definition: The
future value of an ordinary annuity (FVOA) is the future value of an annuity in
which the fixed payments are made at the end of each period. For the situation
depicted in Figure
value is positive, Illuvatar should build the new processing plant. Problem 12.13.
Senior management of Bayside Biotechtronics is considering two mutually
exclusive investment projects. The projected net cash flows for projects A and B
are summarized in T
present value is positive, we can conclude that the investment opportunity is
profitable. c. The investor will be indifferent to the investment if the net present
value is zero. Substituting NPV = 0 into the expression and solving for the discount
rate yi
The discounted payback is the number of periods required to recover the original
investment where the projects cash flows are discounted using the cost of capital.
Suppose that the initial cost of a project is $25,000 and that cost of capital (k) is
10%.T
Problem 12.4. Suppose that Adam borrows $10,000 from National Security Bank
and agrees to repay the loan in 3 years at an interest rate of 6% per year,
compounded continuously. How much must Adam repay the bank at the end of 3
years? Solution. Substitutin
these investments at the end of the fifth year? This situation, which is illustrated
in Figure 12.5, is referred to as an ordinary (deferred) annuity. In the case of an
ordinary annuity, note carefully that the fixed payments are made at the end of
each p
bias when one is evaluating projects with different lives, it is necessary to modify
the net present value calculations to make the projects comparable. A fair
comparison of alternative capital projects requires that net present values be
calculated over
in which Adam borrows $10,000 from National Security Bank to buy a new car.
Suppose that Adam agrees to repay the loan in 3 years at an interest rate of 6%
per year, compounded annually. Adam further agrees to repay the loan in equal
annual installments,
continuously ($7,788.01). Clearly, the more frequent the compounding, the
smaller is the required initial investment. Problem 12.7. If the prevailing interest
rate on a time deposit is 8% per year, how much would Sergeant Garcia have to
deposit today to r
amount of consumer surplus. Full-cost pricing Another term for cost-plus pricing.
Fully allocated per-unit cost The sum of the estimated average variable cost of
producing a good or service and a per-unit allocation for fixed cost. It is an
approximation
investments, that will grow to some future specified amount at a designated rate
of interest. To calculate the present value of a lump-sum investment for n periods
at an interest rate of i, consider again Equation (12.7). (12.7) Solving Equation
(12.7) fo