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The most common motive for adding fixed assets to the firm

01 / 10 / 2021 Projects

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The most common motive for adding fixed assets to the firm

Question 1

1. The most common motive for adding fixed
assets to the firm is:

a. Expansion

b. Replacement

c. Renewal

d. Transformation

Question 2

2. ________ is the process of evaluating and
selecting long-term investments consistent with the firm’s goal of wealth
maximization.

a. Recapitalizating assets

b. Capital Budgeting

c. Ratio analysis

d. Restructuring debt

Question 3

3. Consider the following cash flow
pattern. In year zero: capital expense = $100,000; year 1 cash
inflow = $25,000; year 2 cash inflow = $10,000; year 3 cash inflow = $50,000;
year 4 cash inflow = $60,000. This cash
flow pattern is best described as a(n):

a. annuity and a conventional cash flow

b. mixed stream and a non-conventional cash flow

c. annuity and a non-conventional cash flow

d. mixed stream and a conventional cash flow

e. Beats me! – like you expected me to actually
read the book?

Question 4

4. ________________projects do not compete with each
other, the acceptance of one ___________ the others from consideration.

a. Capital projects; eliminates

b. Independent; does not eliminate

c. Mutually exclusive; eliminates

d. Replacement; does not eliminate

Question 5

5. A firm with limited dollars available for
capital expenditures is subject to:

a. Capital dependency

b. Independent projects

c. Working capital constraints

d. Capital rationing

Question 6

6. The ____________ is the exact amount of time
it takes the firm to recover its initial investment

a. Average rate of return

b. Initial rate of return

c. Net Present Value

d. Payback

Question 7

7. All of the following are weaknesses of the
payback method except:

a. it is easy to calculate

b. it ignores cash flow beyond the payback
period

c. present value of cash flows is not used

d. none of the above

Question 8

8. A firm is evaluating a proposal which has an
initial investment of $35,000 and has cash inflows of $10,000 in year one;
$20,000 in year two; and $10,000 in year 3.
The payback period of the project is:

a. 1 year

b. 2 years

c. between 1 & 2 years

d. between 2 & 3 years

e. none of the above

Question 9

9. A firm is evaluating an investment proposal
which has an initial investment of $5,000 and cash inflows presently valued at
$4,000. The NPV pf the investment is:

a. – $1,000

b. $0

c. $1,000

d. 25%

Question 10

10. The _________________ is the discount rate
that equates the present value of the cash inflows with the initial investment.

a. payback

b. NPV

c. cost of capital

d. IRR

Question 11

11. A firm with a cost of capital of 12.5% is
evaluating 3 capital projects. The IRRs
are as follows:

Project IRR

1 12%

2 15%

3 13.5%

The firm should:

a. accept 2; reject 1 & 3

b. accept 2 & 3; reject 1

c. accept 1; reject 2 & 3

d. accept 3; reject 1 & 2

e. accept all
projects

f. reject all projects

Question 12

12. When NPV is negative, the IRR is
______________ the cost of capital.

a. greater than

b. greater than or equal to

c. less than

d. equal to

Question 13

13. In comparing
NPV to IRR:

a. IRR is theoretically superior, but financial
managers prefer NPV

b. NPV is theoretically superior, but financial
mangers prefer IRR

c. Financial managers prefer NPV because it is
presented as a % of the investment

d. I get confused

Question 14

14. In the context of capital budgeting, risk
refers to:

a. the degree of variability of the cash inflows

b. the degree of variability of the initial
investment

c. the chance that NPV will be greater than zero

d. the chance that IRR will exceed the cost of
capital

Question 15

15. The initial investment for replacement
decisions includes all of the following except:

a. the cost of the equipment

b. the installation costs of the new equipment

c. a subtraction of the sale of the old machine
that is being replaced

d. all of the above would be included

Question 16

16. The four basic sources of long-term funds for
a business are:

a. current liabilities, long-term debt, common
stock and preferred stock

b. current liabilities, long-term debt, common
stock and retained earnings

c. current liabilities, paid in capital in
excess of par, common stock and retained earnings

d. long-term debt, common stock, preferred stock
and retained earnings

Question 17

17. The higher the risk of a project, the higher
its RADR and thus the lower the NPV for a given stream of inflows.
True
False

Question 18

18. The firm’s optimal mix of debt and equity is
called its:

a. optimal ratio

b. target capital structure

c. maximum potential wealth, MPW

d. book value

e. Fred

Question 19

19. The ____________________ is the weighted
average cost of funds which relates the interrelationship of financial
decisions.

a. risk premium

b. nominal cost

c. cost of capital

d. risk-free rate

Question 20

20. A tax adjustment must be made in determining
the cost of ____________.

a. long-term debt

b. common stock

c. preferred stock

d. retained earnings

e. b & c

Question 21

21. The before tax cost of debt for a firm which
has a marginal tax rate of 40%, is 12%.
Therefore the interest rate that should be included in the cost of
capital is:

a. 4.8%

b. 6.0%

c. 7.2%

d. 12%

Question 22

22. Debt is generally the least expensive source
of capital. This is primarily due to:

a. the fixed (certain) interest payments

b. its position in the priority of claims on
assets and earnings in the event of liquidation

c. the tax deductibility of interest payments

d. the secured nature of a debt obligation

Question 23

23. The cost of common equity may be estimated by
using the:

a. yield curve

b. NPV method:
NPV = CF (PVIFA) – CF

c. the Gordon model; r = D/P
+ g

d. Dupont analysis

Question 24

24. The investment opportunity schedule (IOS)
combined with thee WACC indicates:

a. the initial investment in the project

b. those projects that will result in the
highest positive cash flows

c. which projects are acceptable

d. that a hotel on Boardwalk costs $2,000

Question 25

25. As the cumulative amount of money invested in
capital projects increases, its return on the projects increases.
True
False

Question 26

26. BONUS
The cost of capital can be thought of as the rate of return required by
market suppliers of capital in order to attract their funds to the firm.
True
False

Question 27

27. BONUS
Sunk costs are cash outlays that may have a substantial impact on the
capital budgeting decision and should be included in the initial investment
calculation.
True
False

Question 28

NOTE: FOR ALL PROBLEMS YOU MUST (as in MUST!) SHOW
ALL WORK – if you just give an answer I will mark it wrong.

P-1. What is the payback for a project that has
anticipated cash inflows of $10,000 for 5 years and a cost of $22,000?

Question 29

P-2. Good old XYZorp (they’re back!) is considering two mutually exclusive
projects, A & B in order to expand their product line. After letting the cost accountants out of
their cages, it was determined that project A’s initial investment must be
$42,400, while project B will cost $60,000.

Project A has
projected cash inflows of $25,000 per year for three years. Project B’s inflows are more variable: $10,000 in year 1; $30,000 in year 2; and
$40,000 in its final year.

The firm’s cost
of capital is 12%. YES – this IS
important!

Using NPV
analysis, if the NPV for project B = + $
1,320 (yes, I did the computation for you!), which project do you prefer? In other words – which project will have the
higher NPV.

Question 30

P-3. Given the information for project A in
problem P-2, what is this project’s IRR?

Question 31

P-4. Assuming a target capital structureof:

40%
debt

20%
preferred stock

40%
common equity

What would be
the WACC given the following: all debt
will be from the sale of bonds with a coupon of 10% (assume no flotation
costs), preferred stock’s associated cost will be 13%, and common equity will
be from retained earnings with an associated cost of 15%. The tax rate for this corporation is 30%.

Question 32

A note to
students on this problem. yes, it is a
bit involved so think about what information you will need to develop in order
to answer the questions. Hint: You
might want to take a look at Figure 12.4 on page 486. I do not expect you to send me a graph, but
you might find figure 12.4 helpful in figuring out what you need to know.

P-5. The Acme Chip Manufacturing Company (potato
not computer) has a target capital structure of 40% debt and 60% common
equity. They also have a 40% tax
rate. HINT: you need this to calculate the
“after-tax” cost of debt!

They have three projects under consideration
code named: Manny, Moe, and Jack. All are independent.

The IRRs for the
three projects:

Manny
16%

Moe 13%

Jack 10%

All three
projects have an initial investment of $1,000,000.

Acme can borrow
up to $2,000,000 from the bank at a quoted interest rate (the
“before-tax” cost of debt) of 8%.
They also have a reported $3,000,000 in Retained Earnings available for
new projects.

Additional
information: The next common stock
dividend they pay will be $4.00 per share.
They also expect a growth rate of 5% on common equity. New common stock can be sold for $50.00 per
share, with flotation costs of $10.00 per share. Now if I were mean I would have you now
calculate the “cost of issuing new common stock” – see page 368 in
your text – as you have all the data you need.
OK – so I’m mean – BUT (hint time) if I were you at this point I’d go to
page 368 and use equation 9.8 to figure out that cost of using new common
stock! But remember – it’s always
cheaper to use retained earnings than issuing new common stock. Soooo as long as they have retained earnings
to use (as they DO in part 1) you don’t have to sell new common for part
1. For part two on the other hand …

Part 1:

a. Which projects would you accept and
why? Yes, I need to see some
“number crunching”.

b. What would be your capital budget?

Part 2: Let’s change one thing. The federal government has decided to
increase the regulations affecting the manufacturing of chips. Complying with these new regulations will
cost Acme $3 million, wiping out their retained earnings. So now:

a. Which
projects would you accept and why? More
number crunching please!

b. What would be their capital budget now?



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