This document contains 9 practice problems related to capital budgeting. Problem 9 provides details on a project being considered by Acme Mfg including the probability distribution of annual cash flows under different scenarios. Based on the coefficient of variation of NPV, the risk-adjusted discount rate for the project would be 12%. Using this rate, the expected NPV is negative $32.35 so the project should be rejected.
Show the application of the NPV rule in the choice between mutually exclusive projects, replacement decisions, projects with different lives etc.
Understand the impact of inflation on mutually exclusive projects with unequal lives.
Make choice between investments under capital rationing.
Illustrate the use of linear programming under capital rationing situation.
Show the application of the NPV rule in the choice between mutually exclusive projects, replacement decisions, projects with different lives etc.
Understand the impact of inflation on mutually exclusive projects with unequal lives.
Make choice between investments under capital rationing.
Illustrate the use of linear programming under capital rationing situation.
Definition of Cash concentration
Concentration banks
Concentration mechanism
Frequency of transfer
Depository or lock-box banks
Regional concentration banks
Central concentration banks
Definition of Cash concentration
Concentration banks
Concentration mechanism
Frequency of transfer
Depository or lock-box banks
Regional concentration banks
Central concentration banks
1. Susmel Inc. is considering a project that has the following cas.docxjackiewalcutt
1. Susmel Inc. is considering a project that has the following cash flow data. What is the project's payback?
Year
0
1
2
3
Cash Flows
-$500
$150
$200
$300
a.
2.03 years
b.
2.25 years
c.
2.50 years
d.
2.75 years
e.
3.03 years
2. As assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow?
Sales Revenues
$13,000
Depreciation
$4,000
Other operating costs
$6,000
Tax rate
35.0%
a.
$5,950
b.
$6,099
c.
$6,251
d.
$6,407
e.
$6,568
3. Francis Inc.'s stock has a required rate of return of 10.25%, and it sells for $57.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D1?
a.
$2.20
b.
$2.44
c.
$2.69
d.
$2.96
e.
$3.25
4. If a typical company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely
a.
become riskier over time, but its intrinsic value will be maximized
b.
become less risky over time, and this will maximize its intrinsic value
c.
accept too many low-risk projects and too few high-risk projects
d.
become more risky and also have an increasing WACC. Its intrinsic value will not be maximized
e.
continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital
5. Qualcomm Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now?
a.
$40.17
b.
$41.20
c.
$42.26
d.
$43.34
e.
$44.46
6. Schnusenberg Corporation just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price?
a.
$14.52
b.
$14.89
c.
$15.26
d.
$15.64
e.
$16.03
7. Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?
WACC: 10.00%
Year
0
1
2
3
4
Cash Flows
-$950
$525
$485
$445
$405
a.
1.61 years
b.
1.79 years
c.
1.99 years
d.
2.22 years
e.
2.44 years
8. Bilulu Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher MIRR rather than the one with the higher NPV, how much value will be forgone Note that under some conditions choosing projects on the basis of the MIRR will cause $0.00 value to be lost.
WACC: 8.75%
Year
0
1
2
3
4
CFS
-$1,100
$375
$375
$375
$375
CFL
-$2,200
$725
$725
$725
$725
a.
$32.12
b.
$35.33
c.
$38.87
d.
$40.15
e.
$42.16
9. Assume that Ki ...
MECH 3330 Project 2 Due 12116 Design a tube bank that .docxARIV4
MECH 3330 Project 2 Due: 12/1/16
Design a tube bank that will increase the temperature of a 1200 CFM flow of air from 35⁰F to
100⁰F. Assume a constant pressure of 1atm. Each tube will have a diameter of 0.5in and a
length of 24in. The tube configuration must fit in an area of 18in by 18in. Assume reasonable
uniform surface temperature for the outside of the tubes.
Finding will be presented in a report with a memo cover sheet. A narrative including an
Introduction, Analysis Methods, Results, and Conclusions needs to be provided.
Introduction: Describe the problem
Analysis Methods: Describe the methods used to analyze the problem. Include equations used
and any other tools used.
Results: Provide a dimensioned drawing of the design along with any results obtained from
calculations or other analysis methods. The drawing should include the tube configuration,
number of tubes, and tub spacing.
Conclusions: Provide a summary of the problem, analysis, and results. Also discuss what
measurements and controls should be added to insure 100⁰F air at the exit.
Notes:
The report must be created in a word processing program.
All drawings must be created with a computer aided drafting program.
Internally Reference all research sources and also include a reference page
FINAL EXAM MGT 5002
MULTIPLE CHOICE CHAPTER 9
(9-5) Required return
1). If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
a. the stock is experiencing supernormal growth.
b. the stock should be sold.
c. the stock is a good buy.
d. management is probably not trying to maximize the price per share.
e. dividends are not likely to be declared.
(9-1) Preemptive right
2). The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
(9-2) Classified stock
3). Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
a. All common stocks fall into one of three classes: A, B, and C.
b. All common stocks, regardless of class, must have the same voting rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common stock are entitled to more votes per share than other classes.
(9-5) Constant growth model
4). If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
a. The expected return on the stock is 5% a year.
b. The stock’s ...
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1. Capital budgeting practice problems.
1. Evaluation of Cash Flows. Below are the cash flows for two mutually exclusive
projects.
year CFX CFY
0 (5,000) (5,000)
1 2,085 0
2 2,085 0
3 2,085 0
4 2,085 9,677
a. Calculate the payback for both projects.
b. Initially, the cost of capital is uncertain, so construct NPV profiles for the two projects
(on the same graph) to assist in the analysis. The profiles cross at what cost of capital?
What is the significance of that?
c. It is now determined that the cost of capital for both projects is 14%. Which project
should be selected? Why?
d. Calculate the MIRR for both projects, using the 14% cost of capital.
Answers: a. 2.4 yrs, 4 yrs; b. 10%; c. X; d. MIRRX = 19.69%
2. More practice with Cash Flow Evaluation. Cash flows for two mutually exclusive
projects are shown below:
year CFM CFN
0 (100) (100)
1 10 70
2 60 50
3 80 20
Both projects have a cost of capital of 10%.
a. Calculate the payback for both projects.
b. Calculate the NPV for both projects.
c. Calculate the IRR for both projects.
d. Calculate the MIRR for both projects.
Answers: a. 2.4 yrs, 1.6 yrs; b. $18.78, $19.98; c. 18.1%, 23.56%; d. 16.5%, 16.9%;
2. 3. Expansion Project. A machine has a cost of $180. It will have a life of 3 years, and
will be depreciated straight line to zero salvage value. It will result in sales revenue of
$200 per year and cash operating costs of $110 per year. Use of the machine will
require an increase in working capital of $70 for the 3 years, beginning at year 0. The
appropriate discount rate is 8% and the firm’s tax rate is 40%.
a. Calculate the initial cash flow at time 0.
b. Calculate the annual operating cash flows (they are identical each year).
c. Calculate the relevant terminal cash flows at the end of year 3.
d. What is the NPV for the machine?
Answers: a. -250; b. 78; c. 70; d. $6.58
4. Inflation adjustment: A project requires an initial investment of $8,000, has a 4-year
life and provides expected cash flows as follows, based on year 1 prices and costs:
annual revenue = $5,000
annual cash operating costs = $2,000
annual depreciation = $2,000
terminal cash flow = 0
cost of capital = 14%
T = 30%
a. Calculate the annual operating cash flows without adjusting for inflation. (Are these
cash flows real or nominal?) Calculate the associated NPV.
b. Adjust the cash flows to reflect the effects of inflation, which is expected to affect sales
revenue and cash operating expenses at the rate of 4% annually. (Are these cash flows
real or nominal?) Calculate the associated NPV.
c. Which NPV is the correct one for evaluating the project?
a. -$133; b. $202
5. Mutually Exclusive Projects with Unequal Lives. Murray’s Coffee House is trying
to choose between two new coffee bean roasters. The required rate of return for either
machine is 10%. Shown below are the after-tax cash flows associated with each
machine:
year CFX CFY
0 (50,000) (30,000)
1 20,000 20,000
2 20,000 20,000
3 20,000
4 20,000
a. Calculate the replacement chain NPV for each project.
b. Calculate the equivalent annual annuity for each project.
c. Which project should be selected? Why?
Answers: a. RCNPVX = $13,397, RCNPVY = $8,604; b. EAAX = $4,226, EAAY = $2,714
3. 6. Risk Adjustment and Project Selection. Acme Mfg is considering two projects, A &
B, with cash flows as shown below:
period CFA CFB
0 -50,000 -100,000
1 20,000 60,000
2 20,000 25,000
3 20,000 25,000
4 20,000 25,000
The opportunity cost of capital for A is 14 percent. The opportunity cost of capital for B is
10 percent.
a. Calculate the NPV for each project.
b. Calculate the IRR for each project.
c. Which project(s) should be accepted in each of the following situations:
(1) The projects are mutually exclusive and there is no capital constraint.
(2) The projects are independent and there is no capital constraint.
(3) The projects are independent and there is a total of $100,000 of financing for
capital outlays in the coming period.
d. Explain why the cost of capital for A might be higher than for B.
Answers: a. NPVA = $8,274, NPVB = $11,065; b. IRRA = 21.86%, IRRB = 16.08%
7. Cost of Capital. Delta, Inc. has a stock price of $50. In the fiscal year just ended,
dividends were $2.00. Earnings per share and dividends are expected to increase at an
annual rate of 8 percent. The risk-free rate is 4 percent, the market risk premium is 6.4
percent and the beta on Delta’s stock is 1.25. Delta’s target capital structure is 40% debt
and 60% common equity. Delta’s tax rate is 40 percent.
New common stock can be sold to net $40 per share after flotation costs.
Delta can sell bonds that mature in 25 years with a par value of $1,000 and an 8%
coupon rate paid annually for $960.
a. Calculate the before-tax interest rate on new debt financing.
b. Calculate the after-tax cost of debt financing.
c. Calculate the required return on the firm’s stock using CAPM.
d. Calculate the required return on the firm’s stock using the discounted cash flow
approach.
e. Calculate the cost of financing from the sale of common stock.
f. Calculate the WACC if equity financing is from retained earnings.
g. Calculate the WACC if equity financing is from the sale of common stock.
Answers: a. 8.39%; b. 5.03%; c. 12%; d. 12.3%; e. 13.4%; f. 9.3%; g. 10%
4. 8. Replacement project: Existing machine was purchased 2 years ago at a cost of
$3,200. It is being depreciated straight line over its 8 year life. It can be sold now for
$3,000 or used for 6 more years at which time it will be sold for an estimated $500. It
provides revenue of $5,000 annually and cash operating costs of $2,000 annually.
A replacement machine can be purchased now for $7,800. It would be used for 6 years,
and depreciated straight line. It will result in additional sales revenue of $1,500 annually,
but because of its increased efficiency it would reduce cash operating costs by $600 per
year. The new machine would require additional inventories of $700, and accounts
receivable would increase by $300. Its expected salvage value in 6 years is $2,000.
The tax rate is 40% and the required rate of return is 13%. Should the old machine be
replaced?
a. Calculate the incremental cash flow at time 0.
b. Calculate the incremental annual operating cash flows that result from the new
machine.
c. Calculate the incremental terminal cash flow.
d. Show the incremental CFs in the table below.
Year Cash Flow
0 ________
1 ________
2 ________
3 ________
4 ________
e. Calculate the NPV for this project.
Answers: a. –$6,040; b. $1,620; c. 1,900; e. 1,349
9. Capital Budgeting Scenario Analysis
Acme Mfg. is considering a project that requires initial investment of $9,600 and has a 4-
year life. Acme’s corporate weighted average cost of capital (WACC) is 10%.
The probability distribution of annual operating cash flows (over its 4-year life) is shown
below. There are no other cash flows associated with the project.
Scenario prob Ann CF NPV @ that Ann CF
Worst Case .3 $2,500 -$1,675
Most Likely .4 3,000 -90
Best Case .3 4,000 $3,079
a. Calculate the expected NPV.
b. Calculate the standard deviation of NPV.
c. Calculate the coefficient of variation (CV) of NPV.
Acme classifies projects into high, average, or low risk according to the CV of NPV as
shown below:
5. CV risk
Below 2 low
Between 2 and 3 average
Above 3 high
To determine the risk-adjusted discount rate (RADR) for each project, Acme adds or
subtracts 2% to the corporate WACC based on the CV.
d. What is the RADR for this project?
e. Calculate the expected NPV using the RADR.
f. Should the project be accepted or rejected? State what your decision is based on.
Answers: a. $385.08; b. $1,881.65; c. 4.89; e. -$32.35
6. CV risk
Below 2 low
Between 2 and 3 average
Above 3 high
To determine the risk-adjusted discount rate (RADR) for each project, Acme adds or
subtracts 2% to the corporate WACC based on the CV.
d. What is the RADR for this project?
e. Calculate the expected NPV using the RADR.
f. Should the project be accepted or rejected? State what your decision is based on.
Answers: a. $385.08; b. $1,881.65; c. 4.89; e. -$32.35