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FIN20150: Fundamentals of Finance
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1. The FAR Corporation is considering a new project to manufacture solar powered widgets. Last
year, the company paid a consulting firm $120,000 to conduct a market survey that suggested
there is demand for solar powered widgets. The cost of the manufacturing equipment is
$175,000. The cost of shipping and installation is an additional $12,000. The manufacturing
equipment will be depreciated to $0 over its four year life using straight line depreciation. Sales
are expected to be $308,000 per year and the cost of goods sold is expected to be 80% of sales.
The project will require FAR to increase its inventory of raw materials from $0 to $5,000 at
time t=0. At the end of three years, FAR plans on ending the project and selling the
manufacturing equipment for $58,000. The marginal tax rate is 30% and the appropriate cost
of capital for this project is 10%.
1 point ֜ Free Cash Flow at time t = 0:
1 point ֜ Free Cash Flow at time t = 1:
1 point ֜ Free Cash Flow at time t = 2:
1 point ֜ Free Cash Flow at time t = 3:
2 points ֜ NPV:
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2. Yezi Inc. is considering a proposal to manufacture high-end cereal bars that provides dietary
fiber supplements.
The project requires use of an existing warehouse, which the firm acquired 3 years ago for
$1.5 million and currently rents out for $220,000/year, collecting rent at the beginning of
each year. Rental rates are expected to remain constant for the next 10 years.
In addition to using the warehouse, the project requires an upfront investment into
machines and other equipment of $1.8 million. This investment can be fully depreciated
under the straight-line method over the next 10 years for tax purposes. However, Yezi
expects to terminate the project at the end of 8 years and to sell the machines and equipment
for $475,000.
Finally, the project requires a net working capital equal to 10% of projected sales (i.e. net
working capital requirement at t=0 is 10% of sales at t=1). After the project is terminated,
the investment in net working capital can be recovered in full.
Sales of cereal bars are expected to be $3.6 million in the first year and are projected to
stay constant throughout the 8 years life of the project. The first sales revenue will arrive
at t=1 and the last at t=8 for the total of 8 years.
Cost of goods sold and operating expenses (excluding depreciation) are 84% of sales, and
profits are taxed at 21%.
The discount rate for projects of this sort is 13% per year, compounded annually.
Please provide me the Free Cash Flow for each year of this project (times t=0 through t=8)
and compute the project’s NPV.
Time Free Cash Flow
0
1
2
3
4
5
6
7
8
PROJECT NPV:
2 points
2 points
1 point
1 point
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3. Samuelson Electronics has a required payback period of three years for all of its projects.
Currently, the firm is analyzing two independent projects. Project A has an expected payback
period of 2.9 years and a net present value of -$4,200. Project B has an expected payback
period of 3.1 years with a net present value of $86,400. Which project(s) should be accepted
based on the payback decision rule?
a. Project A only
b. Project B only
c. Both A and B
d. Neither A nor B
e. Either, but not both projects
4. A venture will provide a net cash inflow of $57,000 in Year 1. The annual cash flows are
projected to grow at a rate of 7 percent per year forever. The project requires an initial
investment of $739,000 and has a required return of 15.6 percent. The company is somewhat
unsure about the growth rate assumption. At what constant rate of growth would the company
just break even?
a. 9.48 percent
b. 9.29 percent
c. 7.89 percent
d. 8.49 percent
e. 7.75 percent
5. $SURMHFWKDVFDVKIORZVRIíDQG$75,000 for Years 0 to 3,
respectively. The required rate of return is 13 percent. Based on the internal rate of return
of ________ percent, you should ________ the project. USE EXCELTO WORK THIS.
AN IRR CALCULATION LIKE THIS WILL NOT BE ON THE FINAL.
a. 14.67; accept
b. 13.96; accept
c. 14.67; reject
d. 17.91; reject
e. 18.46; reject
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6. HH Companies has identified two mutually exclusive projects. Project A has cash
IORZVRIí,200, $16,800, and $14,000 for Years 0 to 3, respectively.
Project B has a cost of $38,000 and annual cash inflows of $25,100 for 2 years. At
what rate would you be indifferent between these two projects? USE EXCELTO
WORK THIS. A PROBLEM LIKE THIS WILL NOT BE ON THE FINAL.
7. A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and
$16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based
on IRR, should this project be accepted? Why or why not?
a. No; The IRR exceeds the required return.
b. No; The IRR is less than the required return.
c. Yes; The IRR exceeds the required return.
d. Yes; The IRR equals the required return.
e. No; The IRR equals the required return.
8. Alicia is considering adding toys to her gift shop. She estimates the cost of new inventory will
be $9,500. Toy sales are expected to produce net cash inflows of $1,300, $4,900, $4,400, and
$4,100 over the next four years, respectively. Should Alicia add toys to her store if she assigns
a 3-year payback period to this project? Why or why not?
a. No; The payback period is 3.79 years.
b. No; The payback period is 2.75 years.
c. Yes; The payback period is 3.94 years.
d. Yes; The payback period is 3.09 years.
e. Yes; The payback period is 2.75 years.
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9. Projects A and B are mutually exclusive and have an initial cost of $82,000 each. Project A
provides cash inflows of $34,000 a year for three years while Project B produces a cash inflow
of $115,000 in Year 3. Which project(s) should be accepted if the discount rate is 11.7 percent?
What if the discount rate is 13.5 percent?
a. Accept A at both discount rates
b. Accept A at 11.7 percent and neither at 13.5 percent
c. Accept B at both discount rates
d. Accept both at 11.7 percent and neither at 13.5 percent
e. Accept B at 11.7 percent and neither at 13.5 percent
10. Western Beef Exporters is considering a project that has an NPV of $32,600, an IRR of 15.1
percent, and a payback period of 3.2 years. The required return is 14.5 percent and the required
payback period is 3.0 years. Which one of the following statements correctly applies to this
project? Assume the project has conventional cash flows.
a. The net present value indicates accept while the internal rate of return indicates reject.
b. Payback indicates acceptance.
c. The payback decision rule should override the accept decision indicated by the net present
value.
d. The net present value decision rule is the only rule that matters when making the final
decision.
11. Keyser Mining is considering a project that will require the purchase of $479,000 of
equipment. The equipment will be depreciated straight-line to a zero book value over the five-
year life of the project after which it will be worthless. The required return is 12 percent and
the tax rate is 30 percent. What is the value of the depreciation tax shield in Year 4 of the
project (in time t=4 dollars) assuming no bonus depreciation is taken?
a. $28,740
b. $32,200
c. $78,600
d. $138,400
e. $143,700
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12. Which one of the following is the best example of two mutually exclusive projects?
a. Building a furniture store beside a clothing outlet in the same shopping mall
b. Producing both plastic forks and spoons on the same assembly line
c. Using an empty warehouse to store both raw materials and finished goods
d. Promoting two products during the same television commercial
e. Waiting until a machine finishes molding Product A before being able to mold Product B
13. You are comparing two mutually exclusive projects that both have conventional cash flows.
The crossover point is 12.3 percent. You have determined that you should accept project A if
the required return is 13.1 percent. This implies you should:
a. always accept Project A.
b. be indifferent to the projects at any discount rate above 13.1 percent.
c. always accept Project A if the required return exceeds the crossover rate.
d. accept Project B only when the required return is equal to the crossover rate.
e. accept Project B if the required return is less than 12.3 percent.
14. Country Breads uses specialized ovens to bake its bread. One oven costs $249,000 and lasts
about 15 years before it needs to be replaced. The annual operating cost per oven is $44,000.
Assume there are no taxes. What is the equivalent annual cost of an oven if the required rate
of return is 14 percent?
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15. A five-year project has an initial fixed asset investment of $613,600, an initial net working
capital investment of $22,200, and an annual operating cash flow of –$76,540. The fixed asset
is fully depreciated over the life of the project and has no salvage value. The net working
capital will be recovered when the project ends. The required return is 11.7 percent. What is
the project’s free cash flow at time t=0?
16. Home Furnishings is expanding its product offerings to reach a wider range of customers. The
expansion project includes increasing floor inventory by $476,000 and increasing its accounts
payable to suppliers by 90 percent of that amount. The company will also spend $947,000 to
expand the size of its showroom. As part of the expansion plan, the company expects accounts
receivable to rise by $205,000. For the project analysis, what amount should be used as the
initial cash flow for net working capital?
17. A new molding machine is expected to produce operating cash flows of $109,000 a year for 4
years. At the beginning of the project, inventory will decrease by $8,700, accounts receivables
will increase by $9,500, and accounts payable will decrease by $5,200. All net working capital
will be recovered at the end of the project. The initial cost of the molding machine is $319,000.
The equipment will be depreciated straight-line to a zero book value over the life of the project.
No bonus depreciation will be taken. The equipment will be salvaged at the end of the project
creating an aftertax cash inflow of $51,600. What is the net present value of this project given
a required return of 14.2 percent?
a. $25,162.45
b. $24,061.87
c. $28,336.01
d. $22,863.16
e. $27,925.54
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18. Cool Comfort currently sells 340 Class A spas, 465 Class C spas, and 125 deluxe model spas
each year. The firm is considering adding a mid-class spa and expects that, if it does, it can sell
360 of them. However, if the new spa is added, Class A sales are expected to decline to 235
units while the Class C sales are expected to decline to 275 units. The sales of the deluxe model
will not be affected. Class A spas sell for an average of $10,700 each. Class C spas are priced
at $18,700 and the deluxe model sells for $27,000 each. The new mid-range spa will sell for
$13,500. What is the value of the erosion (e.g., cannibalization) effect?
19. Kelly's Corner Bakery purchased a lot in Oil City six years ago at a cost of $98,700. Today,
that lot has a market value of $128,900. At the time of the purchase, the company spent $6,500
to level the lot and another $12,000 to install storm drains. The company now wants to build a
new facility on the site at an estimated cost of $494,200. What amount should be used as the
initial cash flow for this project?
20. A firm is evaluating two investment proposals. The following data is provided for the two
investment alternatives.
Initial Cash Outflow IRR NPV (at 18%)
Project TERRA $250,000,000 28% $80,000,000
Project BYTE $50,000,000 36% $20,000,000
If the two projects are mutually exclusive and the firm’s cost of capital is 18%, which project
should the firm choose?
a. Project TERRA
b. Project BYTE
c. The firm should not accept either project.
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21. A company’s investment in net working capital decreases when
a. Inventory falls, accounts receivable falls, or accounts payable increases
b. Inventory increases, accounts receivable increases, or accounts payable falls
c. Cost of goods sold falls or interest rates rise
d. Inventory falls, accounts receivable increases, or accounts payable increases
e. Inventory increases, accounts receivable falls, or depreciation falls
f. Inventory falls, accounts receivable falls, or depreciation increases
22. Fox Entertainment is evaluating the NPV of launching a new iPet product. Fox paid a market
research firm $120,000 last year to test the market viability of iPet. Fox Entertainment should
treat this $120,000 as _________ for the capital budgeting decision now confronting the firm.
a. a sunk cost
b. an opportunity cost
c. a fixed cost
d. an erosion (e.g., cannibalization) cost