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Principles of Finance, 6e
Besley/Brigham
Chapter 13
Cengage Learning Testing, Powered by Cognero
Page 41
e.
None of the above statements is correct.
ANSWER:
c
RATIONALE:
Cash flow time lines: Project A
Project B Project A: rAverage risk =
12%. Project B: rHigh risk = 12% + 2% = 14%. Equation solution:
Financial
calculator solution: Project A Inputs: CF0 = −5,000; CF1 = 2,000; CF2 = 2,500; CF3 =
2,250; I% = 12. Output: NPV = $380.20 ≈ $380. Project B Inputs: CF0 = −5,000; CF1 =
3,000; CF2 = 2,600; CF3 = 2,900; I% = 14. Output: NPV = $1,589.61 ≈ $1,590.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Risk-Adjusted NPV
74. Assume you are the director of capital budgeting for an all-equity firm. The firm's current required rate of return is 16
percent; the risk-free rate is 10 percent; and the market risk premium is 5 percent. You are considering a new project that
has 50 percent more beta risk than your firm's assets currently have, i.e., its beta is 50 percent larger than the firm's
existing beta. The expected return (IRR) on the new project is 18 percent. Should the project be accepted if beta risk is the
appropriate risk measure? Choose the most correct statement.
a.
Yes; its IRR is greater than the firm's required rate of return.
b.
Yes; the project's risk-adjusted required return is less than its IRR.
c.
No; a 50% increase in beta risk gives a risk-adjusted required return of 24%.
d.
No; the project's risk-adjusted required return is 2 percentage points above its IRR.
e.
No; the project's risk-adjusted required return is 1 percentage point above its IRR.
ANSWER:
e
RATIONALE:
Calculate the beta of the firm, and use to calculate project beta: rs = 0.16 = 0.10 + (0.05)β
Firm. βFirm = 1.2. βProject = (βFirm)1.5 (βProject is 50% greater than current βFirm) βProject =
(1.2)1.5 = 1.8. Calculate required return on project, rProject, and compare to IRR. Project:
rProject = 0.10 + (0.05)1.8 = 0.19 = 19%. IRR = 0.18 = 18%. Because the required return
is one percentage point greater than the expected IRR, the firm should not accept the
new project.
POINTS:
1
DIFFICULTY:
Moderate
Principles of Finance, 6e
Besley/Brigham
Chapter 13
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Risk-Adjusted Discount Rate
75. The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects. The
discount rate used for Project A is 12 percent. Further, Project A costs $15,000, and it would be depreciated using
MACRS. It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash
flows (including depreciation) of $4,000 for each of the 6 years. Project B costs $14,815 and would also be depreciated
using MACRS. B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows
(including depreciation) of $5,100 each year for 6 years. The Unlimited's marginal tax rate is 40 percent. What risk-
adjusted discount rate will equate the NPV of Project B to that of Project A?
a.
15%
b.
16%
c.
18%
d.
20%
e.
12%
ANSWER:
b
RATIONALE:
Cash flow time lines: Project A
Project B Financial
calculator solution: Project A Inputs: CF0 = −15,000; CF1 = 4,000; Nj = 5; CF2 = 9,000; I =
12. Output: NPV = $3,978.78. Project B Inputs: CF0 = −18,793.78; CF1 = 5,100; Nj = 6.
Output: IRR = 15.997% ≈ 16%.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
Principles of Finance, 6e
Besley/Brigham
Chapter 13
adds 3 percent for high risk projects but subtracts 3 percent for low risk projects. The two projects in question meet the
criteria for high and average risk, but the financial manager is concerned about applying the normal rule to such cost-only
projects. You must decide which project to recommend, and you should recommend the one with the lower PV of costs.
What is the PV of costs of the better project?
Cash Outflows
Years:
0
1
2
3
4
Project New Tech
1,500
315
315
315
315
Project Old Tech
600
600
600
600
600
a.
2,521
b.
2,399
c.
2,457
d.
2,543
e.
2,422
ANSWER:
e
RATIONALE:
Cash flow time line: Recognize that
(1) risk outflows must be discounted at lower rates, and (2) since Project New Tech is
risky, it must be discounted at a rate of 12% − 3% = 9%. Project Old Tech must be
discounted at 12%. Equation solution:
NPVOld
Tech is a smaller outflow than NPVNew Tech, thus, Project Old Tech is the better project.
Principles of Finance, 6e
Besley/Brigham
Chapter 13
will be the firm's new overall required rate of return, and what rate of return must the new assets produce in order to leave
the stock price unchanged?
a.
15.645%; 15.645%
b.
15.75%; 14.7%
c.
15.645%; 14.7%
d.
15.75%; 15.645%
e.
14.75%; 15.75%
ANSWER:
c
RATIONALE:
βOld, firm
= 1.25.
rOld, firm
= 0.07 + (14 − 7)1.25 = 15.75%.
βNew, firm
= 0.9(1.25) + 0.1(1.1) = 1.235.
rNew, firm
= 0.07 + 1.235(0.07) = 15.645%.
rNew, assets
= 0.07 + 1.1(0.07) = 14.7%.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Required Rate of Return
78. Klott Company encounters significant uncertainty with its sales volume and price in its primary product. The firm uses
scenario analysis in order to determine an expected NPV, which it then uses in its budget. The base case, best case, and
worse case scenarios and probabilities are provided in the table below. What is Klott's expected NPV, standard deviation
of NPV, and coefficient of variation of NPV?
Probability
of Outcome
Unit Sales
Volume
Sales
Price
NPV (In
Thousands)
Worst case
0.30
6,000
$3,600
−$ 6,000
Base case
0.50
10,000
4,200
+ 13,000
Best case
0.20
13,000
4,400
+ 28,000
a.
Expected NPV = $35,000; σNPV = 17,500; CVNPV = 2.0.
b.
Expected NPV = $35,000; σNPV = 11,667; CVNPV = 0.33.
c.
Expected NPV = $10,300; σNPV = 12,083; CVNPV = 1.17.
d.
Expected NPV = $13,900; σNPV = 8,476; CVNPV = 0.61.
e.
Expected NPV = $10,300; σNPV = 13,900; CVNPV = 1.35.
ANSWER:
c
RATIONALE:
Calculate expected value of NPV:
Probability of
Outcome, Pri
Unit Sales
Volume
Sales Price
NPV (In
1000s)
Pri(x)
Worst case
0.30
6,000
$3,600
−$6,000
0.3(−6,000) =
−1,800
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Base case
0.50
10,000
4,200
13,000
0.5(13,000) =
6,500
Best case
0.20
13,000
4,400
28,000
0.2(28,000) =
5,600
Expected NPV = $10,300
Calculate standard deviation of NPV:
Pr i(x − )2
(x − )2
Pr i(x − )2
Worst case
0.3(−6 − 10.3)2
265.69
79.707
Base case
0.5(13 − 10.3)2
7.29
3.645
Best case
0.2(28 − 10.3)2
313.29
62.658
Sum
146.01
(146.01)1/2 = 12,083 thousand. Calculate coefficient of variation (CV) of NPV: CVNPV =
sNPV/E(NPV) = 12,083/10,300 = 1.17.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Scenario Analysis
79. Two fellow financial analysts are evaluating a project with the following net cash flows:
Year
Cash Flow
0
−$10,000
1
100,000
2
−100,000
One analyst says that the project has an IRR of between 12 and 13%. The other analyst calculates an IRR of just under
800%, but fears his calculator's battery is low and may have caused an error. You agree to settle the dispute by analyzing
the project cash flows. Which statement best describes the IRR for this project?
a.
There is a single IRR of approximately 12.7 percent.
b.
This project has no IRR, because the NPV profile does not cross the X axis.
c.
There are multiple IRRs of approximately 12.7 percent and 787 percent.
d.
This project has two imaginary IRRs.
e.
There are an infinite number of IRRs between 12.5 percent and 790 percent that can define the IRR for this
project.
ANSWER:
c
RATIONALE:
Cash flow time line: Numerical solution: This
problem can be solved numerically but requires an iterative process of trial and error
using the possible solutions provided in the problem. Investigate first claim: Try r = IRR =
13% and r = 12.5%
NPVr = 13%
= −10,000 + 100,000/1.13 − 100,000/(1.13)2 = 180.91.
Principles of Finance, 6e
Besley/Brigham
Principles of Finance, 6e
Besley/Brigham
Chapter 13
c.
16.5%
d.
20.0%
e.
The NPV profiles of these two projects do not cross.
ANSWER:
b
RATIONALE:
[MACRS table required] Financial calculator solution: Solve for IRRA Inputs: CF0 =
−50,000; CF1 = 15,990; Nj = 5. Output: IRR = 18.0%. Solve for IRRB Inputs: CF0 =
−50,000; CF1 = 0; Nj = 4; CF2 = 100,560. Output: IRR = 15.0%. Solve for crossover rate
using the differential project CFs, CFA-B Inputs: CF0 = 0; CF1 = 15,990; Nj = 4; CF2 =
−84,570. Output: IRR = 11.49% The crossover rate is 11.49%.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
NPV Profiles
81. Topsider Inc. is considering the purchase of a new leather-cutting machine to replace an existing machine that has a
book value of $3,000 and can be sold for $1,500. The old machine is being depreciated on a straight-line basis, and its
estimated salvage value 3 years from now is zero. The new machine will reduce costs (before taxes) by $7,000 per year.
The new machine has a 3-year life, it costs $14,000, and it can be sold for an expected $2,000 at the end of the third year.
The new machine would be depreciated over its 3-year life using the MACRS method. Assuming a 40 percent tax rate and
a required rate of return of 16 percent, find the new machine's NPV.
a.
−$2,822
b.
$1,658
c.
$4,560
d.
$15,374
e.
$9,821
ANSWER:
b
RATIONALE:
[MACRS table required] Cash flow time line:
Depreciation cash flows:
Year
MACRS
New Asset
Old Asset
Change in
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Cengage Learning Testing, Powered by Cognero
Page 48
machine
4)
Total net inv.
($11,900)
*(3,000 − 1,500) = Loss; Loss × Tax rate = Savings; 1,500 ×
0.40 = 600.
II
Supplemental operating cash flows
Year:
0
1
2
3
5)
Reduction in cost
$7,000
$7,000
$7,000
6)
After-tax decrease
in
cost (line 5 × 0.60)
4,200
4,200
4,200
7)
Deprec. new
machine
4,620
6,300
2,100
8)
Deprec. old
machine
1,000
1,000
1,000
9)
Change in
depreciation
(line 7 − 8)
3,620
5,300
1,100
10)
Tax savings from
deprec.
(line 9 × 0.40)
1,448
2,120
440
11)
Net operating cash
flows
(line 6 + 10)
$5,648
$6,320
$4,640
III
Terminal CF
12)
Estimated salvage
value
$2,000
13)
Tax on salvage
value
(2,000 − 980)(0.4)
(408)
14)
Return of NWC
--
15)
Net CF
1,592
IV
Net CFs
16)
Total Net CFs
($11,900)
$5,648
$6,320
$6,232
Equation solution:
Financial calculator solution: Inputs: CF0 = −11,900; CF1 = 5,648; CF2 = 6,320; CF3 =
6,232; I = 16. Output: NPV = $1,658.33 ≈ $1,658.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Replacement Decision
82. Meals on Wings Inc. supplies prepared meals for corporate aircraft (as opposed to public commercial airlines), and it
Principles of Finance, 6e
Besley/Brigham
Chapter 13
needs to purchase new broilers. If the broilers are purchased, they will replace old broilers purchased 10 years ago for
$105,000 and which are being depreciated on a straight line basis to a zero salvage value (15-year depreciable life). The
old broilers can be sold for $60,000. The new broilers will cost $200,000 installed and will be depreciated using MACRS
over their 5-year class life; they will be sold at their book value at the end of the 5th year. The firm expects to increase its
revenues by $18,000 per year if the new broilers are purchased, but cash expenses will also increase by $2,500 per year. If
the firm's required rate of return is 10 percent and its tax rate is 34 percent, what is the NPV of the broilers?
a.
−$61,019
b.
$17,972
c.
$28,451
d.
−$44,553
e.
$5,021
ANSWER:
a
RATIONALE:
[MACRS table required] Cash flow time line:
Depreciation cash flows*:
Year
MACRS
New Asset
Old Asset
Change in
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Cengage Learning Testing, Powered by Cognero
Page 50
8)
AT change in
earnings
((line 6 + 7) ×
0.66)
10,230
10,230
10,230
10,230
10,230
9)
Deprec. on new
mach.
40,000
64,000
38,000
24,000
22,000
10)
Deprec. on old
mach.
7,000
7,000
7,000
7,000
7,000
11)
Change in
deprec.
(line 9 − 10)
33,000
57,000
31,000
17,000
15,000
12)
Tax savings from
deprec.
(line 11 × 0.34)
11,220
19,380
10,540
5,780
5,100
13)
Net operating
CFs
(line 8 + 12)
$21,450
$29,610
$20,770
$16,010
$15,330
III
Terminal CF
14)
Estimated
salvage value
$12,000
15)
Tax on salvage
value
--
16)
Return of NWC
--
17)
Net CF
12,000
IV
Net CFs
18)
Total Net CFs
($148,500)
$21,450
$29,610
$20,770
$16,010
$27,330
Equation solution:
NPV =
−$61,019.29 ≈ −$61,019 Financial calculator solution: Inputs: CF0 = −148,500; CF1 =
21,450; CF2 = 29,610; CF3 = 20,770; CF4 = 16,010; CF5 = 27,330; I = 10. Output: NPV =
−$61,019.29 ≈ −$61,019.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Replacement Decision
83. Mom's Cookies Inc. is considering the purchase of a new cookie oven. The original cost of the old oven was $30,000;
it is now 5 years old, and it has a current market value of $13,333.33. The old oven is being depreciated over a 10-year
life towards a zero estimated salvage value on a straight line basis, resulting in a current book value of $15,000 and an
annual depreciation expense of $3,000. The old oven can be used for 6 more years but has no market value after its
depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $25,000 and whose
estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a year over its full
Principles of Finance, 6e
Besley/Brigham
Chapter 13
MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the required rate of return is 10
percent. Assume a 40 percent tax rate. What is the net present value of the new oven?
a.
−$2,418
b.
−$1,731
c.
$1,568
d.
$163
e.
$1,731
ANSWER:
c
RATIONALE:
[MACRS table required] Cash flow time line:
Depreciation cash
flows:
MACRS
New Asset
Old Asset
Change In
Principles of Finance, 6e
Besley/Brigham
Chapter 13
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11)
Tax savings
from deprec.
(line 10 × 0.4)
800
2,000
700
0
(100)
600
12)
Net operating
CFs
(line 7 + 11)
$3,200
$4,400
$3,100
$2,400
$2,300
$3,000
III
Terminal CF
13)
Estimated
salvage value
0
14)
Net CF
0
IV
Net CFs
15)
Total Net CFs
($11,000)
$3,200
$4,400
$3,100
$2,400
$2,300
$3,000
Equation solution:
Financial
calculator solution: Inputs: CF0 = −11,000; CF1 = 3,200; CF2 = 4,400; CF3 = 3,100; CF4 =
2,400; CF5 = 2,300; CF6 = 3,000; I = 10. Output: NPV = $2,635.30 ≈ $2,635.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Replacement Decision
84. Tech Engineering Company is considering the purchase of a new machine to replace an existing one. The old machine
was purchased 5 years ago at a cost of $20,000, and it is being depreciated on a straight line basis to a zero salvage value
over a 10-year life. The current market value of the old machine is $14,000. The new machine, which falls into the
MACRS 5-year class, has an estimated life of 5 years, it costs $30,000, and Tech plans to sell the machine at the end of
the 5th year for $1,000. The new machine is expected to generate before-tax cash savings of $3,000 per year. The
company's tax rate is 40 percent. What is the IRR of the proposed project?
a.
4.1%
b.
2.2%
c.
0.0%
d.
−1.5%
e.
−3.3%
ANSWER:
c
Principles of Finance, 6e
Besley/Brigham
Chapter 13
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© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
13)
Estimated
salvage value
$1,000
14)
Tax on salvage
value
(1,000 −
1,800)(0.4)
320
15)
Return of NWC
--
16)
Net CF
$1,320
IV
Net CFs
17)
Total Net CFs
($17,600)
$3,400
$4,840
$3,280
$2,440
$3,640
Equation solution: (Note that if the cash inflows are summed, they exactly equal the cash
outflow at time zero.) NPVr = 0% = 0 = −$17,600 + $3,400 + $4,840 + $3,280 + $2,440 +
$3,640. This implies an IRR of 0.0% Financial calculator solution: Inputs: CF0 = −17,600;
CF1 = 3,400; CF2 = 4,840; CF3 = 3,280; CF4 = 2,440; CF5 = 3,640. Output: IRR = 0.0%.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
IRR of Replacement Project
85. California Mining is evaluating the introduction of a new ore production process. Two alternatives are available.
Production Process A has an initial cost of $25,000, a 4-year life, and a $5,000 net salvage value, and the use of Process A
will increase net cash flow by $13,000 per year for each of the 4 years that the equipment is in use. Production Process B
also requires an initial investment of $25,000, will also last 4 years, and its expected net salvage value is zero, but Process
B will increase net cash flow by $15,247 per year. Management believes that a risk-adjusted discount rate of 12 percent
should be used for Process A. If California Mining is to be indifferent between the two processes, what risk-adjusted
discount rate must be used to evaluate B?
a.
8%
b.
10%
c.
12%
d.
14%
e.
16%
ANSWER:
e
RATIONALE:
Financial calculator solution: Process A: Inputs: CF0 = −25,000; CF1 = 13,000; Nj = 3;
CF2 = 18,000; I = 12. Output: NPVA = 17,663.13. Process B: Inputs: CF0 = −42,663.13;
CF1 = 15,247; Nj = 4. Output: IRR = 16.0% = r.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Risk-Adjusted Discount Rate
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Real Time Inc.
The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's
price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net
working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would
also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for
$25,000. The firm's marginal tax rate is 40 percent, and the project's required rate of return is 14 percent.
[MACRS table required]
86. Refer to Real Time Inc. What is the initial investment outlay required at t = 0?
a.
−$42,000
b.
−$40,000
c.
−$38,600
d.
−$37,600
e.
−$36,600
ANSWER:
a
RATIONALE:
Initial investment outlay:
Cost
($40,000)
Change in NWC
(2,000)
($42,000)
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
New Project Investment
87. Refer to Real Time Inc. What is the supplemental operating cash flow in Year 2?
a.
$9,000
b.
$10,240
c.
$11,687
d.
$13,453
e.
$16,200
ANSWER:
e
RATIONALE:
Depreciation schedule: Depreciable basis = $40,000.
Year
MACRS
Percent
Depreciable Basis
Annual
Depreciation
1
0.33
$40,000
$13,200
2
0.45
40,000
18,000
3
0.15
40,000
6,000
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Principles of Finance, 6e
Besley/Brigham
Chapter 13
e.
$6,438
ANSWER:
c
RATIONALE:
Cash flow time line: Equation solution:
Financial
calculator solution: Inputs: CF0 = −42,000; CF1 = 14,280; CF2 = 16,200; CF3 = 29,520; I
= 14. Output: NPV = $2,916.85 ≈ $2,917.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
New Project NPV
Truck Acquisition
You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose
truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The
truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require
an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is
expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40
percent.
[MACRS table required]
90. Refer to Truck Acquisition. What is the initial investment outlay for the truck? (That is, what is the Year 0 net cash
flow?)
a.
−$50,000
b.
−$52,600
c.
−$55,800
d.
−$62,000
e.
−$65,000
ANSWER:
d
RATIONALE:
Initial investment outlay:
Cost
($50,000)
Modification
(10,000)
Change in NWC
(2,000)
Total net investment =
($62,000)
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
New Project Investment
91. Refer to Truck Acquisition. What is the supplemental operating cash flow in Year 1?
a.
$17,820
b.
$18,254
c.
$19,920
d.
$20,121
e.
$21,737
ANSWER:
c
RATIONALE:
Depreciation schedule: Depreciable basis = $60,000.
Year
MACRS
Percent
Depreciable
Basis
Annual
Depreciation
1
0.33
$60,000
$19,800
2
0.45
60,000
27,000
3
0.15
60,000
9,000
4
0.07
60,000
4,200
$60,000
Supplemental operating cash flows:
Year
1
2
3
1)
Before-tax cost reduction
$20,000
$20,000
$20,000
2)
After-tax cost reduction
(line 1 × 0.6)
12,000
12,000
12,000
3)
Depreciation
19,800
27,000
9,000
4)
Tax savings from deprec.
(line 3 × 0.4)
7,920
10,800
3,600
5)
Net operating CFs
$19,920
$22,800
$15,600
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Principles of Finance, 6e
Besley/Brigham
Chapter 13
Principles of Finance, 6e
Besley/Brigham
Chapter 13
The company's required rate of return is 12 percent, and it can get an unlimited amount of funds at that rate. What is the
IRR of the better project, i.e., the project which the company should choose if it wants to maximize the price of its stock?
a.
12.00%
b.
15.53%
c.
18.62%
d.
19.08%
e.
20.46%
ANSWER:
d
RATIONALE:
Because the two projects are mutually exclusive, the project with the higher positive NPV
is the "better" project. Project L is the "better"
project; its IRR = 19.08%.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
IRR & Mutually Exclusive Projects
95. An investment project has an initial cost, and then generates inflows of $50 a year for the next five years. The project
has a payback period of 3.6 years. What is the project's internal rate of return?
a.
11.18%
b.
12.05%
c.
13.47%
d.
14.66%
e.
15.89%
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
