Exam 4

Instructor: Dr. Trainor

 

THIS IS AN EXAMPLE ONLY:  IT IS NOT EVERYTHING YOU NEED TO KNOW!

Name ________________________________

 

Net Present Value, IRR, Payback, Discounted Payback, Profitability Index, Cash Flows, Weighted Cost of Capital, Cost of Financing 

 

Use the following for the next 6 questions.

Required Rate of Return is 10%.

Year     Expected After Tax Net Cash Flow

0                      (1,000)

1                      500

2                      400

3                      300

4                      200

5                      100

 

1.  When is the project=s payback?

A.  Greater than 0 and less than or equal to 1.

B.  Greater than 1and less than or equal to 2.

C.  Greater than 2 and less than or equal to 3.

D.  Greater than 3 and less than or equal to 4

E.  Greater than 4.

 

2.  When is the discounted payback?

A.  Greater than 0 and less than or equal to 1.

B.  Greater than 1and less than or equal to 2.

C.  Greater than 2 and less than or equal to 3.

D.  Greater than 3 and less than or equal to 4

E.  Greater than 4.

 

3.  What is the project=s NPV?

A.  Less than 0.

B.  Greater than 0 and less than or equal to 100.

C.  Greater than 100 and less than or equal to 300.

D.  Greater than 300 and less than or equal to 400.

E.  Greater than 500.

 

4.  What is the project=s profitability Index?

A.  Less than 0

B.  Greater than 0 and less than or equal to 1.

C.  Greater than 1and less than or equal to 2.

D.  Greater than 2 and less than or equal to 3.

E.  Greater than 3


 

5.  What is the project=s IRR?

A.  Less than 0

B.  Greater than 0 and less than or equal to 5%.

C.  Greater than 5% and less than or equal to 10%.

D.  Greater than 10%

 

6.  Based on your analysis, should you accept or reject this project?

A.  Accept

B.  Reject

 

Use the following for the next 6 questions?

Required Rate of Return is 10%.

Year     Expected After Tax Net Cash Flow

0                      (1,000)

1                      200

2                      200

3                      200

4                      200

5                      200

6                      200

7                      200

8                      200

 

7.  When is the project=s payback?

A.  Greater than 0 and less than or equal to 1.

B.  Greater than 1 and less than or equal to 3.

C.  Greater than 3 and less than or equal to 5.

D.  Greater than 5 and less than or equal to 6

E.  Greater than 6.

 

8.  When is the discounted payback?

A.  Greater than 0 and less than or equal to 1.

B.  Greater than 1and less than or equal to 3.

C.  Greater than 3 and less than or equal to 5.

D.  Greater than 5 and less than or equal to 6

E.  Greater than 6.

 

9.  What is the project=s NPV?

A.  Less than 0.

B.  Greater than 0 and less than or equal to 200.

C.  Greater than 200 and less than or equal to 400.

D.  Greater than 400 and less than or equal to 600.

E.  Greater than 600.

 

10.  What is the project=s profitability Index?

A.  Less than 0

B.  Greater than 0 and less than or equal to 1.

C.  Greater than 1and less than or equal to 2.

D.  Greater than 2 and less than or equal to 3.

E.  Greater than 3

 

11.  What is the project=s IRR?

A.  Less than 0

B.  Greater than 0 and less than or equal to 5%.

C.  Greater than 5% and less than or equal to 10%.

D.  Greater than 10%

 

12.  Based on your analysis, should you accept or reject this project?

A.  Accept

B.  Reject

 

13.  A Profitability Index number of .95 means that for every dollar you invest in the project you

A.  Receive $1.95

B.  Make $.05 after accounting for the cost of capital.

C.  Receive $0.98

D.  Receive $1.05

e.  Lose $.05 after accounting for the cost of capital.

 

Use the following for the next 5 questions.

DEBT: The firm can sell a 10‑year, $1,000 par value, 9 percent bond for $960.  A flotation cost of 2 percent of the par value would be required.

PREFERRED STOCK: The firm has determined it can issue preferred stock at $95 per share par value.  The stock will pay a $12 annual dividend.  The cost of issuing and selling the stock is $3 per share.

COMMON STOCK:  A firm's common stock is currently selling for $20 per share.  The dividend expected to be paid at the end of the coming year is $2.  Its dividend payments are expected to grow  a constant rate of 5%.   It is expected that to sell, a new common stock issue must be underpriced $1 per share in floatation costs.  Additionally, the firm's marginal tax rate is 40 percent.

 

14.       The firm's before‑tax cost of debt is

 

15.       The firm's after‑tax cost of debt is


 

16.       The firm's cost of preferred stock is

 

17.       The firm's cost of a new issue of common stock is


 

18.       The firm's cost of retained earnings is

 

19.  A firm had $25 million in debt outstanding yielding 10%, $10 million in preferred stock yielding 9%, and $65 million in common stock outstanding with a cost of capital estimated at 14%.  The firm is in the 30% tax bracket.  What is this firm’s WACC?

 

20.  If the risk free rate is 9%, the equity risk premium is 6%, and a firm has a beta of 1.2, what is the cost of equity capital for this firm?

 

Use the following for the next 4 questions:

You buy a transporter for $50 million.  It will cost another $5 million to install.  You will depreciate it over 10 years, (10% each year).  You expect to make $15 million each year in revenues.  Operating costs will be $2 million each year.  Increase in working capital is expected to be $30 million which will be reversed at the end of 10 years when you get out of the transporting business.  At the end of 10 years, the transporter will be salvaged for $10 million.  You are in the 30% tax bracket.

 

21.  What is your initial outlay?

 

22.  What is your net income for the first nine years?

 

23.  What is your operating cash flow each year?

 

24.  What is your terminal cash flow at the end of year 10?  Do not include the operating cash flow.

 

There may also be something on there about a replacement machine. 

 

Answers:

 

1.  c, 2.33

2.  c, 2.95

3.  c, 209.21

4.  c, 1.21

5. d, 20.27%

6.  a

7.  c, 5

8.  e, 7.27

9.  b, 66.98

10.  c, 1.06

11.  d, 11.81%

12.  a

13.  e

14.  9.98%

15.  9.98(1-.4) = 5.99%

16.  $12/92 = 13%

17.  P0 = D1/(k-g), solve for k, k = (D1 + P0g)/P0, k = (2+19*.05)/19 = 15.53%, divide by 19 because of floatation cost.

18.  Retained earnings have no floatation cost so k = k = (2+20*.05)/20 = 15.0%.  Will always be a little less expensive.

19.  .25(10%(1-.3) + .1(9%) + .65(14%) = 11.75%.

20.  9 + 1.2(6) = 16.2.

21.  $85 million, 50 + 5 + 30.

22.  Operating income $15 – $2 = $13 – depreciation(10% of 55 = 5.5) = $7.5 million before tax.  $7.5(1-.3) = $5.25 million after tax.

23.  Operating cash flow is 5.25 + 5.5(depreciation) = $10.25 million.

24.  Sell for $10 million, book value is zero at this time so you have a gain of $10 million minus $3 million in taxes for $7 million.  Add back working capital of $30 million(no longer will need it so working capital is now reduced by $30 million) so terminal cash flow is $37 million.