Question 1 Multiple Choice

Problem 1

Big Bucks Mines is considering a project with start-up costs of $16 million,

expected after tax cash flows of $2 million per year for 30 years, and a shut

down cost of $45 million to be paid to a contractor at the start of year 31.

BBM has a cost of capital (discount rate) of 9.5% (EAR).

For what range of IRR does the project have positive NPV?

Answer

a. 0.000% to 10.333%

b. 0.211% to 10.300%

c. 0.255% to 10.318%

d. 0.000% to 15.427%

e. 0.000% to 3.574%

f. 3.574% to 10.456%

g. All RRR greater than 0%

h. All RRR greater than 1%

Question 2 Multiple Choice

Problem 1 Continued...

Is the project worthwhile for BBM?

Answer

a. Yes

b. No

c. Insufficient Information 2

Question 3 Multiple Choice

Problem 1 Continued...

The government, annoyed by several mining companies going broke before paying the

clean-up costs, introduced new legislation requiring new mines to pay an equal amount

each year into a trust fund in order to fully fund the estimated clean-up costs. The trust

fund pays a guaranteed rate of interest of 8% (EAR).

What will be BBM's annual payment?

Answer

a. $0.397 Million

b. $1.5 Million

c. $0.472 Million

d. $0.514 Million

e. $0.433 Million

f. $0.431 Million

g. $0.365 Million

h. Insufficient information

i. $3.997 Million

Question 4 Multiple Choice

Problem 1 Continued...

Given that the new legislation has been passed. What is the new NPV of BBM's project?

Answer

a. -$0.587 Million

b. $0.0815 Million

c. -$0.237 Million

d. $0.713 Million

e. -$0.802 Million

f. -$0.741 Million

g. -$3.759 Million

h. $0.587 Million

i. -$35.639 Million

j. Insufficient information 3

Question 5 Multiple Choice

Problem 1 Continued...

If you have solved question 4 correctly, you will notice that the new regulation has lead

to a decline in the NPV. Why has the NPV declined?

Answer

a. Because the new legislation requires firms to invest in the trust fund

at less than their cost of capital.

b. Because government interference is always bad.

c. Because the Cleanup exercise imposes costs (without conferring any

benefits) on the firm.

d. Because firms don't get any time value on the trust fund payments.

e. Because the time values of the payments are now captured by the

trust fund.

f. Because BBM's cost of capital is too high.

g. Insufficient information to answer this question.

Question 6 Multiple Choice

Problem 2

Clean Air Inc. is considering two mutually exclusive projects. Project A requires a

$15,000 machine tool (CCA class 8, 20%) and will increase Clean Air’s sales by $10,000

per year for 4 years. After 4 years the machine tool will have no salvage value. Project B

requires machinery costing $30,000 (CCA class 8, 20%), and will increase sales by

$17,500 per year for 7 years, with no salvage value. Both of these projects can be

repeated indefinitely. Clean Air has a cost of capital (discount rate) of 12% (EAR) and a

marginal tax rate of 33%.

What are the present values of the CCA tax shields for project A?

Answer a. $2,928.01

b. -$2,928.01

c. $3,000.00

d. $2,082.14

e. $1,027.36

f. $1,701.56

g. $3,549.11

h. $3,836.87 4

Question 7 Multiple Choice

Problem 2 Continued...

What are the present values of the CCA tax shields for project B?

Answer

a. $5,856.03

b. -$5,856.03

c. $6,000.00

d. $4,164.29

e. $2,054.72

f. $3,403.13

g. $7,098.21

h. $7,673.75

Question 8 Multiple Choice

Problem 2 Continued...

What is the NPV of the project A?

Answer

a. $15,373.49

b. -$2,048.73

c. $32,422.23

d. $2,422.23

e. $8,350.24

f. $11,380.94

g. $8,808.22

h. $8,278.25

Question 9 Multiple Choice

Problem 2 Continued...

What is the NPV of the project B?

Answer

a. $29,366.07

b. $49,865.74

c. $2,211.72

d. $77,654.02

e. $17,654.02

f. $29,510.05

g. $38,056.88

h. $27,565.43 5

Question 10 Multiple Choice

Problem 2 Continued...

What is the EAA (Equivalent Annual Annuity) of the project A?

Note: The EAC calculation annualizes the total cost of a project over its life. The same

type of calculation can be used to annualize any amount, such as a project's NPV. In

such cases, the amount is called an equivalent annual benefit (EAA).

Answer a. $2,725.49

b. $5,061.48

c. $2,723.11

d. -$674.51

e. $10,674.51

f. $797.48

g. $2,749.18

h. $3,746.99

i. $2,899.96

Question 11 Multiple Choice

Problem 2 Continued...

What is the EAA of the project B?

Answer

a. $6,434.63

b. $10,926.47

c. $484.63

d. $17,015.37

e. $6,439.93

f. $6,466.18

g. $8,338.94

h. $6,040.07

i. $4,195.15

Question 12 Multiple Choice

Problem 2 Continued...

Clean Air managers should choose ____________

Answer

a. Project A

b. Project B

c. Either of the two projects

d. None of the two projects

e. Insufficient information to answer this question 6

Question 13 Multiple Choice

Problem 3

Proctor and Pimple (PP) has 50,000 five-year 7.5% semi-annual coupon bonds with a yield-tomaturity of 8%, 1,000,000 shares of common stock, with β = 1.125, priced at $50 per share,

and 25,000 shares of 8.5% preferred stock, with face value equal to $100, priced at $90 per

share. Your financial analysts report the effective annual yield on short-term government

bonds as 4% and the expected return on the S&P/TSX Composite Index as 10%. The

corporate tax rate is 40%.

You are investigating the feasibility of a new line of cosmetics for PP. The cosmetics

business is a tricky one: the demand on these luxurious products is highly volatile. Your

market analysts have conducted a consumer survey, which cost the firm $20,000, and forecast

the demand for the new product line under high and low demand scenarios. The variable cost

per product unit is $80, while total fixed costs are estimated as $100,000 per year. The

following table summarizes the projected demand schedule:

Projected Sales (Units)

Year High Demand Low Demand

1 10,000 7,500

2 12,000 8,000

3 12,000 8,000

4 11,000 5,000

5 10,000 5,000

Unit Price $120 $100

It costs $750,000 to buy the equipment necessary to begin production. The equipment falls in

Class 10 for depreciation purposes, and the CCA rate is 30%. The equipment will eventually

be worth $50,000 in five years, at which time, the product line will be abandoned (but you

will continue to have Class 10 assets in other divisions).

The project requires a $50,000 upfront investment in inventory. The management estimates

that, at the end of each year, total inventory will be 10% of sales revenue (for that year), while

accounts receivable will equal 5% of sales revenue, and accounts payable will equal 6.25% of

variable costs.

What is the required rate of return for PP?

Answer

a) 0.0774

b) 0.0784

c) 0.0787

d) 0.0789

e) 0.09477

Question 14 Multiple Choice

Problem 3 (Continued)

What is the NPV of the project in the high demand scenario?

Answer

a) $326,465.62

b) $286,162.72

c) $282,686.82

d) $281,144.73

e) $230,640.31

Question 15 Multiple Choice

Problem 3 (continued)

What is the NPV of the project in the low demand scenario?

Answer

a) -$373,222.68

b) -$429,734.84

c) -$430,950.91

d) -$431,490.28

e) -$449,108.79

Question 16 Multiple Choice

Problem 3 (continued)

Suppose that the firm has just approved the project. Assuming that the demand could

be either ‘high’ or ‘low’ over the life of the project (i.e. there are two possible

outcomes), the probability of the high demand scenario must at least be …

Answer a) 0.9114

b) 0.6055

c) 0.6048

d) 0.6039

e) 0.6003

Question 17 Multiple Choice

Problem 4

The weighted average cost of capital for ACME Enterprises is 9%. The typical

ACME bond pays semi-annual coupons at a rate of 10% and has a remaining maturity

of ten years. The firm’s preferred stock has a par value of $100 and pays 5% dividend.

The corporate tax rate (Tc) is 35%, while the effective annual yield on short-term

government bonds and expected return on the market portfolio are 3% and 10%,

respectively. You are also given the following information about ACME’s capital

structure:8

Source Securities Price Value w

i R

i

Debt 50,000 $62,500,000 0.45

Equity 1,000,000 $ 75.00

Preferred 25,000 0.01 0.09

What is the yield-to-maturity on ACME bonds?

Answer a) 9.00%

b) 6.67%

c) 6.55%

d) 6.52%

e) 3.28%

Question 18 Multiple Choice 1 points

Problem 4 (continued)

What is the beta of ACME stock?

Answer

a) 1.4132

b) 1.2165

c) 1.1354

d) 0.9892

e) 0.7948

Question 19 Multiple Choice 1 points

Problem 4 (continued)

What is the price of ACME preferred stock?

Answer

a) $105.00

b) $100.00

c) $95.00

d) $91.74

e) $55.56

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