a

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

1

TBUS 350 Homework #3 Directions:

1. There are 40 multiple choice questions. There is only one correct answer for each question. Please

choose the best answer.

2. Please mark your answers (A, B, C, D) in the Excel HW #3 Answer Template provided.

3. Please name the Excel file in the following format: your name (last, first), hyphen, “TBUS 350 HW

#3”. So, my Excel HW file would be named: Viers, Gary – TBUS 350 HW #3. Incorrectly named files will

receive a 2-point reduction for errors in naming convention.

4. Due date is July 21st. Email completed HW answers in Excel template to [email protected] no later

than 11:59 pm. Homework submitted late will not be graded.

1. Which of the following is NOT a discounted cash flow technique?

a. payback period b. internal rate of return c. net present value d. profitability index

2. Which of the following is NOT a flaw of the payback period method? a. It ignores time value of money and risk. b. It assumes that the early cash flows will be reinvested at a rate equal to the cost of capital. c. It discards some useful information. d. It uses a subjective cutoff point for decisions. 3. If project X and project Y are mutually exclusive, then the company manager is able to make all of

the following decisions EXCEPT _____.

a. accept both X and Y b. accept X and reject Y c. reject X and accept Y d. reject both X and Y

4. A firm can create value for shareholders by _____.

a. accepting projects with short payback periods, thereby reducing risk b. accepting projects with an IRR that is greater than the required rate of return c. accepting all projects with positive IRRs d. accepting large projects over small ones

5. Which one of the following statements is correct?

a. The net present value is a measure of profits expressed in today's dollars.

b. The net present value is positive when the required return exceeds the internal rate of return.

c. If the initial cost of a project is increased, the net present value of that project will also increase.

d. If the internal rate of return equals the required return, the net present value will equal zero.

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

2

6. Given the following cash flows for a capital project and a required rate of return of 8 percent,

calculate the NPV and IRR.

Year 0 1 2 3 4 5

Cash flow ($) –50,000 15,000 15,000 20,000 10,000 5,000

NPV IRR

a. $1,905 10.9% b. $1,905 26.0% c. $3,379 10.9% d. $3,379 26.0%

7. Projects 1 and 2 have similar initial outlays, although the patterns of future cash flows are different.

The cash flows, along with the NPV and IRR for the two projects, are shown in the following table.

For both projects, the required rate of return is 10 percent. The two projects are mutually exclusive.

What is the appropriate investment decision?

Cash Flows NPV IRR

Year 0 1 2 3 4

Project 1: –50 20 20 20 20 $13.40 21.86%

Project 2: –50 0 0 0 100 $18.30 18.92%

a. Invest in Project 1 because it has the higher IRR b. Invest in Project 2 because it has the higher NPV c. Invest half in each project d. Invest in both projects

8. Your firm is considering two mutually exclusive projects, code-named X and Y, that would each

require an initial cash outflow of $10,000. They would generate the following incremental, after-tax,

operating cash flow:

Project X Project Y Year 1 $5,000 $3,000 Year 2 $4,000 $4,000 Year 3 $3,000 $6,000

If the firm’s required rate of return is 14 percent, which would you select?

a. Project X because it has the shorter payback period b. Project X because it has the higher net present value c. Project Y because it has the higher internal rate of return d. Neither project because neither adds value to the firm

9. The net present value of a project's cash inflows is $2,716 at a discount rate of 12 percent. The

profitability index is 1.09 and the firm's tax rate is 34 percent. What is the initial cost of the project?

a. $2,314.07

b. $2,018.50

c. $2,428.32

d. $2,491.74

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

3

Questions 10-11 are based on the following information. Profitability Index The Black Horse is currently considering a project that will produce cash inflows of $11,000 a year for

three years followed by $6,500 in Year 4. The cost of the project is $38,000.

10. What is the profitability index if the discount rate is 9 percent?

a. .85

b. .93

c. 1.04

d. 1.09

11. What is your decision for this project based on the above information?

a. Accept

b. Reject

End of Questions 10-11.

12. A pro forma financial statement is a financial statement that:

a. expresses all values as a percentage of either total assets or total sales.

b. compares actual results to the budgeted amounts.

c. projects future years' operating results.

d. values all assets based on their current market values.

13. The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to

as the depreciation:

a. tax shield.

b. tax credit.

c. tax return.

d. IRS cost.

14. Which one of the following terms is most commonly used to describe the cash flows of a new project

that are simply an offset of reduced cash flows for a current project?

a. Opportunity cost

b. Erosion

c. Offset flows

d. Pirated flows

15. The analysis of a new project should exclude:

a. tax effects.

b. erosion effects.

c. sunk costs.

d. opportunity costs.

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

4

16. Custom Tailored Shirts is a specialty retailer offering T-shirts, sweatshirts, and caps. Its most recent

annual sales consisted of $21,000 of T-shirts, $18,000 of sweatshirts, and $2,900 of caps. The company is

adding polo shirts to the lineup and projects that this addition will result in sales next year of $18,000 of

T-shirts, $16,000 of sweatshirts, $11,500 of Polo shirts, and $2,100 of caps. What sales amount should

be used when evaluating the Polo shirt project?

a. $11,500

b. $5,700

c. $4,900

d. $5,800

17. Floral Shoppes has a new project in mind that will increase accounts receivable by $19,000, decrease

accounts payable by $4,000, increase fixed assets by $27,000, and decrease inventory by $2,000. What

is the amount the firm should use as the initial cash flow attributable to net working capital when it

analyzes this project?

a. -$6,000

b. -$17,000

c. -$21,000

d. -$40,000

18. A nine-year project is expected to generate annual revenues of $137,800, variable costs of $82,600,

and fixed costs of $11,000. The annual depreciation is $23,500 and the tax rate is 34 percent. What is

the annual operating cash flow?

a. $14,301

b. $13,662

c. $35,052

d. $37,162

19. Your local athletic center is planning a $1.08 million expansion to its current facility. This cost will be

depreciated on a straight-line basis over a 20-year period. The expanded area is expected to generate

$489,000 in additional annual sales. Variable costs are 46 percent of sales, the annual fixed costs are

$129,400, and the tax rate is 34 percent. What is the operating cash flow for the first year of this

project?

a. $118,336.82

b. $92,509.15

c. $107,235.60

d. $106,666.67

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

5

20. Better Chocolates has a new project that requires $838,000 of equipment. What is the depreciation

in Year 6 of this project if the equipment is classified as seven-year property for MACRS purposes? The

MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93,

8.92, 8.93, and 4.46 percent.

a. $74,749.60

b. $74,833.40

c. $89,108.00

d. $89,327.08

21. Western Steer purchased some three-year MACRS property three years ago. What is the current

book value of this equipment if the original cost was $94,250? The MACRS allowance percentages are as

follows, commencing with Year 1: 33.33, 44.45, 14.81, and 7.41 percent.

a. $11,506.15

b. $6,983.93

c. $20,842.35

d. $8,868.20

22. Unsystematic risk can be defined by all of the following except:

a. diversifiable risk.

b. market risk.

c. unique risk.

d. asset-specific risk.

23. The amount of systematic risk present in a particular risky asset relative to that in an average risky

asset is measured by the:

a. squared deviation.

b. beta coefficient.

c. standard deviation.

d. variance.

24. Portfolio diversification eliminates:

a. all investment risk.

b. the portfolio risk premium.

c. market risk.

d. unsystematic risk.

25. The security market line is a linear function that is graphed by plotting data points based on the

relationship between the:

a. risk-free rate and beta.

b. market rate of return and beta.

c. expected return and beta.

d. market rate of return and the risk-free rate.

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

6

26. PL Lumber stock is expected to return 22 percent in a booming economy, 15 percent in a normal

economy, and lose 2 percent in a recession. The probabilities of an economic boom, normal state, or

recession are 5 percent, 92 percent, and 3 percent, respectively. What is the expected rate of return on

this stock?

a. 14.84 percent

b. 14.23 percent

c. 14.51 percent

d. 15.47 percent

27. Bruno’s stock should return 14 percent in a boom, 11 percent in a normal economy, and 4 percent in

a recession. The probabilities of a boom, normal economy, and recession are 8 percent, 90 percent, and

2 percent, respectively. What is the variance of the returns on this stock?

a. .011387

b. .000169

c. .001506

d. .001538

28. Westover stock is expected to return 36 percent in a boom, 14 percent in a normal economy, and

lose 75 percent in a recession. The probabilities of a boom, normal economy, and a recession are 2

percent, 93 percent, and 5 percent, respectively. What is the standard deviation of the returns on this

stock?

a. 19.90 percent

b. 20.52 percent

c. 20.41 percent

d. 19.74 percent

29. You would like to invest $24,000 and have a portfolio expected return of 11.5 percent. You are

considering two securities, A and B. Stock A has an expected return of 18.6 percent and B has an

expected return of 7.4 percent. Approximately how much should you invest in Stock A if you invest the

balance in Stock B?

a. $7,807

b. $8,786

c. $7,411

d. $8,626

30. A stock has a beta of 1.32, the expected return on the market is 12.72, and the risk-free rate is 4.05.

What must the expected return on this stock be?

a. 16.67 percent

b. 14.75 percent

c. 17.10 percent

d. 15.49 percent

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

7

31. You own a stock that has an expected return of 15.72 percent and a beta of 1.33. The U.S. Treasury

bill is yielding 3.82 percent and the inflation rate is 2.95 percent. What is the expected rate of return on

the market?

a. 12.07 percent

b. 12.77 percent

c. 13.64 percent

d. 14.09 percent

32. City Rentals has 44,000 shares of common stock outstanding at a market price of $32 a share. The

common stock just paid a $1.50 annual dividend and has a dividend growth rate of 2.5 percent. There

are 7,500 shares of $9 preferred stock outstanding at a market price of $72 a share. The outstanding

bonds mature in 11 years, have a total face value of $825,000, a face value per bond of $1,000, and a

market price of $989 each, and a pretax yield to maturity of 8.3 percent. The tax rate is 35 percent.

What is the firm's weighted average cost of capital?

a. 7.76 percent

b. 8.68 percent

c. 9.29 percent

d. 7.43 percent

33. The weighted average cost of capital is defined as the weighted average of a firm's:

a. return on all of its investments.

b. cost of equity, cost of preferred, and its aftertax cost of debt.

c. pretax cost of debt and its preferred and common equity securities.

d. common and preferred stock.

34. An increase in a levered firm’s tax rate will:

a. decrease the cost of preferred stock.

b. increase both the cost of preferred stock and debt.

c. decrease the firm’s cost of capital.

d. increase the firm’s WACC.

35. Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the

firm requires a rate equal to WACC plus one percent, while another set of projects is assigned rates

equal to WACC minus some amount. Which one of the following factors should be the key factor the

firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a

specific project?

a. The current market rate of interest

b. Actual source of funds used to finance the project

c. The perceived risk level of project

d. The firm’s current debt-equity ratio

Due July 21, 2020 Professor Viers TBUS 350 Summer 2020

8

36. The 7.5 percent preferred stock of Rock Bottom Floors is selling for $84 a share. What is the firm's

cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

a. 7.50 percent

b. 8.13 percent

c. 8.93 percent

d. 9.14 percent

37. Musical Charts just paid an annual dividend of $1.84 per share. This dividend is expected to increase

by 2.1 percent annually. Currently, the firm has a beta of 1.12 and a stock price of $31 a share. The risk-

free rate is 4.3 percent and the market rate of return is 13.2 percent. What is the cost of equity capital

for this firm?

a. 13.28 percent

b. 11.21 percent

c. 12.29 percent

d. 11.95 percent

38. K's Bridal Shoppe has 4,000 shares of common stock outstanding at a price of $13 a share. It also has

500 shares of preferred stock outstanding at a price of $22 a share. There are 50 bonds outstanding that

have a semiannual coupon payment of $25. The bonds mature in four years, have a face value of $1,000,

and sell at 98 percent of par. What is the capital structure weight of the common stock?

a. 48.20 percent

b. 49.68 percent

c. 48.15 percent

d. 46.43 percent

39. Western Electric has 21,000 shares of common stock outstanding at a price per share of $61 and a

rate of return of 15.6 percent. The firm has 11,000 shares of $8 preferred stock outstanding at a price of

$48 a share. The outstanding debt has a total face value of $275,000 and currently sells for 104 percent

of face. The yield to maturity on the debt is 8.81 percent. What is the firm's weighted average cost of

capital if the tax rate is 35 percent?

a. 14.52 percent

b. 13.44 percent

c. 14.19 percent

d. 14.37 percent

40. A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following

would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its

numerous proposed investments?

a. Assign every project a rate equal to the firm's cost of equity

b. Assign every investment a random rate that varies between the firm's cost of debt and cost of equity

c. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

d. Assign every project a rate equal to the market rate of return at the time of the proposal