Finance Question, need in 1.5 hours

Introduction to Finance YOUR NAME: _________________________

FIN 301 DATE:

Quiz #3

SHOW ALL WORK and LABEL IT CLEARLY. You MUST provide financial calculator inputs AND the answer. Answer-Only responses, even if correct, WILL NOT receive full credit.

PART I (10 Points) __________

1. Which of the following statements is TRUE?

A. NPV has no serious flaws and it the preferred Capital Budgeting decision technique.

B. IRR and NPV rarely given the same/accept decision for a particular project.

C. The primary flaw of the Discounted Payback (DPB) technique is that it overvalues Cash Flows which occur after the standard Payback (PB) period.

D. Modified Internal Rate of Return (MIRR) is sued when there are AT LEAST THREE sign changes for Project Cash Flows.

2. The capital budgeting decision model MOST CLOSELY RELATED to Net Present Value (NPV) is :

a. Internal Rate of Return (IRR)

b. Payback (PB)

c. Profitability Index (PI)

d. Average Accounting Return (AAR) 

3. The LEAST USED and MOST UNRELIABLE capital budgeting decision methodology is:

a. PAYBACK (PB)

b. INTERNAL RATE OF RETURN (IRR)

c. AVERAGE ACCOUNTING RETURN (AAR)

d. MODIFIED NET PRESENT VALUE (MNPV)

4. Which of the following is NOT TRUE about the PAYBACK decision methodology?

A. It IGNORES the Time Value of Money

B. It IGNORES Cash Flow AFTER the calculated payback period

C. It is biased in favor of projects with BACK LOADED cash flows

D. It is simple and easy to understand

5. The term “crossover rate” means:

A. The rate of returns on two mutually exclusive projects

B. The reinvestment rate assumption in IRR calculations

C. The discount rate which makes the NPVs of two projects equal to 0.

D. The discount rate which makes the NPVs of two projects equal to each other.

6. ( TRUE or FALSE ) For a capital budgeting project to be acceptable, it must generate POSITIVE Operating Cash Flow (OCF) at some time during the project life cycle.

7. ( TRUE or FALSE ) Under MACRS, the asset’s salvage value and its economic (useful) life ARE NOT explicitly considered in calculation of the allowable depreciation deduction.

8. ( TRUE or FALSE ) Sale of an Asset which has been depreciated for more than its BOOK VALUE will result in a negative cash flow in the Year of Sale because the Asset Sale will increase the Company’s tax liability in the year of Sale.

9. ( TRUE or FALSE ) The Payback (PB) Period is more widely used than Discounted Payback (DPB); but it is RARELY used as the PRIMARY capital budgeting decision making methodology.

10. ( TRUE or FALSE ) An Independent Project is one the acceptance or rejection of which is independent of the acceptance or rejection of other projects.

Part II (40 points) _________

A. You are considering a $50,000 project and feel that a 9 percent rate of return is reasonable given the project’s risk. The project will generate Cash Flows of $8,000 in Year 1, $17,200 in Year 2, $46,000 in Year 3, and $6,500 in Year 4. What is the Net Present Value (NPV) of the project? (4) ANS: CF0 = -50,000 CF1=8000(F1) CF2 = 17,200 (F1) CF3= 46000 (F1) CF4 = 6500 (F1) I =9 CPT NPV = 11,941.55

What is the project’s Profitability Index (PI)? (2)

ANS: 61,941/50,000 = 1.24

B. Project A requires an Initial (Year 0) Investment of $470,000 and will generates positive Net Cash Flows of $120,000 for the first 3 years of its life, $140,000 for the next three years and 75,000 in its last year (Year 7). (6)

What is the Internal Rate of Return (IRR) of Project A?

ANS: 17.98%

ANS: CF0 = -470,000; CF1 = 120,000 F=3; CF2 = 140000 F =3, CF3 = 75,000

CPT IRR = 17.98%

C. A proposed overseas expansion project has the following projected Cash Flows:

Year Cash Flow

0 - $ 2,500,000

1 575,000 x .8333 = 479,148

2 625,000 x .6944 = 434,000

3 1,000,000 x .5787 = 578,700

4 1,200,000 x .4823 = 578,760 2,070,608

5 6,500,000 x .4019 = 2,612,350

At 20%, what is the project’s Discounted Payback (DPB) period? (4)

ANS : 4 + (2,500,000 - 2,070,608)/2,612,350 = 4.16 periods

What is the project’s Profitability Index (PI)? (3)

ANS: NPV = (2,070,608 + 2,612,350) – 2,500,000 = 1.8732

D. You are considering a project for which the required rate of return is 8% return; and which is expected to generate the following periodic Cash Flows:

YR CASH FLOW

0 $ -1,125,000 -246,088 = -1,371,088

1 670,000

2 850,000

3 -310,000 (PV = -246,088) becomes 0

4 400,000

What is the project’s Modified Internal Rate of Return (MIRR)? (5)

ANS: CF0 = -1,371,088; CF 1= 670,000 F=1; CF2 = 850,000 F=1; CF3 = 0 F=1;

CF4 = 400,000 CPT IRR = 18.61%

What is primary objection to use of the MIRR decision model? (2)

ANS: It values a CF (Yr3) at a rate of return other than IRR. Remember that the IRR model presumes that all project CFs will be reinvested at IRR.

E. Stone & Mason, Inc.’s Sales projections indicate that it needs a new manufacturing facility. The company owns vacant land which it purchased 4 years ago for $3.8Million on which the new building could be erected; but the company recently received a $6.1 Million cash offer for the land. Construction costs for the new plant will be $10.75 Million; and the company expects to spend $825,000 to prepare the site for construction. The construction project will also require investment in an upfront Working Capital Line of Credit of $250,000. What is the Yr0 Cash Flow which should be used to evaluate the project? (4)

ANS: 10.75 + 6.1 + ..825 + .25 = 17.925 Million

Using you answer above, what is the minimum annual TOTAL CASH FLOW which the project must generate each year of its seven years of operation to justify proceeding with the project if its required rate of return is 16%? (3) (This is a simple question; don’t read too much into it!!)(4)

@ 16% PV = -17.925 FV = 0 I = 16 N = 7 PMT = 4,438,457

F. The 3 year class MACRS depreciation rates are (Yr1 = .3333; Yr2 = .4445; Yr3 = .1481;

Yr4 = .0741). LeBow, Inc. is considering investment in a project which will involve purchase of a $2,700,000 3 year class fixed (depreciable) asset; and an upfront investment in NWC of $300,000. The firm expects to be able to dispose of the asset at the end of Year 3 for $210,000; when it also expects to recover ½ of its upfront NWC investment. The project supported by the fixed assets is expected to generate annual Sales of $2,080,000, with associated costs of

$ 775,000. LeBow’s tax rate is 35%. MACRS depreciation deductions will be taken.

What is the Yr 1 project Net (Total) Cash Flow? (4)

Yr1 = (2,080,000 – 775,000)(1 -- .35) + (.3333 x 2,700,000)(.35)

= 848,250 + 315,000 = 1,163,250

What is the Yr 3 project Net (Total) Cash Flow?(2)

Yr 3 = 848,250 + (.1481 x 2,700,000)(.35) + AT Salvage value + NWC Recovery

AT Salvage = (210,000 -- (210,000 -- $200,070(Book Value))(.35) = 206,525

NWC Recovery = 150,000

Therefore Y3 CF = 848,250 + 139,955 + 150,000 = 1,138,205