Deck 3: Opportunity Cost of Capital and Capital Budgeting

Question 1

Mirtha Mudflat has sufficient funds to choose one of two investments.The same amount will be invested in either case.Choice one: ten year $100,000 5% Treasury bonds issued to yield 4% per annum,the market rate.Choice two: a risky bond of the same amount that has expected cash flows of $9,000 per year for the same period. What is the issue price of the Treasury bond?

A)$100,000
B)$108,110
C)$92,278
D)$125,000
E)None of the above

Answer 1

B

Question 2

Samuel Survivor is planning to save for retirement 35 years from now.He expects to live 25 years beyond that,and would like an annual retirement income of $38,500 after tax of 30%.How much must Samuel Survivor save each year to accumulate the lump sum needed to fund retirement,at an expected annual return of 11.2%?

A)$893
B)$4,062
C)$1,339
D)$937
E)None of the above

Answer 2

E

Question 3

Mirtha Mudflat has sufficient funds to choose one of two investments.The same amount will be invested in either case.Choice one: ten year $100,000 5% Treasury bonds issued to yield 4% per annum,the market rate.Choice two: a risky bond of the same amount that has expected cash flows of $9,000 per year for the same period.Assume Mirtha purchased the risky bond for $105,000 and the market rate is 6%.Which is false?

A)Net present value is $17,080
B)Payback occurs at the end of year 10
C)IRR is 8.25%
D)Present value of the cash flows is $122,080
E)None of the above

Answer 3

E

Question 4

Which is true?

A)The present value of a 20-year annuity of $1,900 at 8% is $16,854
B)A $100,000 bond with a 5% coupon will sell at a premium when the market rate of interest is 6%
C)The issue price of a $150,000 zero coupon bond that matures in 6 years when the market rate of interest is 6% is $105,744
D)The present value of a perpetual income stream of $4,000 when the market rate of interest is 8% is $50,000
E)None of the above

Question 5

Harriet Harvester (HH)plans to buy a haymaker.It costs $180,000 and is expected to last for five years.She presently hires 10 workers at $3,000 per month for each of the six harvesting months each year.The equipment would eliminate the need for six workers.HH uses straight-line depreciation and projects a salvage value of $23,000.Her tax rate is 21% and opportunity cost of funds is 8.0%.Which is true?

A)The present value of cash flows in year 5 is $24,466
B)NPV is −$24,466
C)NPV is $155,534
D)NPV is −$155,534
E)None of the above

Question 6

Cash of $12,000 will be received in year 6.Assuming an opportunity cost of capital of 7.2%,which of the following is true?

A)The future value is $18,212
B)The present value is $7,996
C)The present value is $7,907
D)Provide data for tax purposes
E)None of the above

Question 7

Peter Pontificator is proposing to purchase a paddle machine,which will cost $1 million,last eight years and have a salvage value of 20%.Given a tax rate of 35%,and a cost of capital of 6%: If double-declining balance depreciation is used,and PP switches to straight-line depreciation in year 6,the present value of the depreciation tax shield is:

A)$287,506
B)$230,005
C)$286,513
D)$229,211
E)none of the above

Question 8

Gorgeous George is evaluating a five-year investment in an oil-change franchise,which costs $120,000 paid up front.Projected net operating cash flows are $60,000 per year.If Gorgeous George buys shares instead of the franchise,he expects an annual return of 12%.Which is true?

A)The future value of the franchise is $216,287
B)The net present value of the franchise is $216,287
C)The future value of the franchise is $138,900
D)The net present value of the franchise is $96,287
E)None of the above

Question 9

Mirtha Mudflat has sufficient funds to choose one of two investments.The same amount will be invested in either case.Choice one: ten year $100,000 5% Treasury bonds issued to yield 4% per annum,the market rate.Choice two: a risky bond of the same amount that has expected cash flows of $9,000 per year for the same period. What is the risk premium that makes Mirtha indifferent between the two investments?

A)7.80%
B)5.66%
C)3.80%
D)5.00%
E)None of the above

Question 10

Furious Fred expects cash flows from an investment as follows: Yr 1 $3,000,Yr 2 $5,000,Yr 3 $8,000
Using an opportunity cost of capital of 5.6%,the present value is:

A)$14,118
B)$14,523
C)$14,361
D)$14,909
E)none of the above

Question 11

A lump sum of $5,000 is invested at 10% per year for five years.The company's cost of capital is 8%.Which is true?

A)The investment has a future value of $7,347
B)The investment has a future value of $8,053
C)The investment has a present value of $5,000
D)The investment has a net present value of $5,000
E)None of the above

Question 12

Peter Pontificator is proposing to purchase a paddle machine,which will cost $5 million,last ten years and have a salvage value of $80,000.Given a tax rate of 21%,and a cost of capital of 8%: What is the present value of the tax shield if straight-line depreciation is used?

A)$600,000
B)$643,234
C)$745,671
D)$693,286
E)None of the above

Question 13

Samuel Survivor is planning to save for retirement 35 years from now.He expects to live 25 years beyond that,and would like an annual retirement income of $38,500 after tax of 30%.What is the lump sum needed to fund retirement,at an expected annual return of 11.2%?

A)$357,888
B)$319,561
C)$456,515
D)$479,118
E)None of the above