Deck 7: Discounted Cash Flow Techniques

Question 1

You plan to buy a new Mercedes four years from now.Today,a comparable car costs $82,500.You expect the price of the car to increase by an average of 4.8 percent per year over the next four years.How much will your dream car cost by the time you are ready to buy it?

A) $98,340.00
B) $98,666.67
C) $99,517.41
D) $99,818.02
E) $100,023.16
F) None of the above.

Answer 1

$99,517.41

Question 2

When making a capital budgeting decision,which of the following is/are NOT relevant?
I.The size of a cash flow.
II.The risk of a cash flow.
III.The accounting earnings from a cash flow.
IV.The timing of a cash flow.

A) I only
B) II only
C) III only
D) II and III only
E) III and IV only
F) They are all relevant

Answer 2

III only

Question 3

What is the benefit-cost ratio for an investment with the following cash flows at a 14.5 percent required return?

A) 0.94
B) 0.98
C) 1.02
D) 1.06
E) 1.11
F) None of the above.

Answer 3

1.02

Question 4

Which of the following figures of merit does not directly take into consideration the time value of money?
I.Payback period
II.Internal rate of return
III.Net present value (NPV)
IV.Accounting rate of return

A) IV only
B) I & III only
C) II & III only
D) I & II only
E) I & IV only
F) I, II, III, and IV

Question 5

Which of the following should be included in the analysis of a new product?
I.Money already spent for research and development of the new product
II.Reduction in sales for a current product once the new product is introduced
III.Increase in working capital needed to finance sales of the new product
IV.Interest expense on the loan used to finance the new product launch

A) II and III only
B) II and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV
F) None of the above.

Question 6

Which of the following is not an important step in the financial evaluation of an investment opportunity?

A) Calculate a figure of merit for the investment.
B) Estimate the accounting rate of return for the investment.
C) Estimate the relevant cash flows.
D) Compare the figure of merit to an acceptance criterion.
E) All of the above are important steps.

Question 7

EAC Nutrition offers a 9.5 percent coupon bond with annual payments,maturing 11 years from today.Your required return is 11.2 percent.What price are you willing to pay for this bond if the face (or par)value is $1,000?

A) $895.43
B) $896.67
C) $941.20
D) $946.18
E) $953.30
F) None of the above.

Question 8

Which of the following figures of merit might not use all possible cash flows in its calculations?
I.Payback period
II.Internal rate of return
III.Net present value (NPV)
IV.Accounting rate of return

A) III only
B) I & III only
C) II & III only
D) I & IV only
E) III & IV only
F) I, II, III, and IV

Question 9

A project will produce after-tax operating cash inflows of $3,200 a year for 5 years.The after-tax salvage value of the project is expected to be $2,500 in year 5.The project's initial cost is $9,500.What is the net present value of this project if the required rate of return is 16 percent?

A) -$311.02
B) $2,168.02
C) $4,650.11
D) $9,188.98
E) $21,168.02
F) None of the above.

Question 10

You are the beneficiary of a life insurance policy.The insurance company informs you that you have two options for receiving the insurance proceeds.You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years.You can earn a 6 percent annual rate on your money,compounded monthly.Which option should you take and why?

A) You should accept the monthly payments because they are worth $209,414 to you.
B) You should accept the $200,000 lump sum because the monthly payments are only worth $16,057 to you today.
C) You should accept the monthly payments because they are worth $336,000 to you.
D) You should accept the $200,000 lump sum because the monthly payments are only worth $189,311 to you today.
E) You should accept the $200,000 lump sum because the monthly payments are only worth $195,413 to you today.
F) None of the above.

Question 11

19.An investment costing $100,000 promises an after-tax cash flow of $36,000 per year for 6 years.
a.Find the investment's accounting rate of return and its payback period.
b.Find the investment's net present value at a 15 percent discount rate.
c.Find the investment's benefit-cost ratio (profitability index)at a 15 percent discount rate.
d.Find the investment's internal rate of return.
e.Assuming the required rate of return on the investment is 15 percent,which of the above figures of merit indicate the investment is attractive?
Which indicate it is unattractive?

Question 12

You plan to pay $50 for a share of preferred stock that pays a $2.40 dividend per year forever.What annual rate of return will you realize?

A) 0.48 percent
B) 2.40 percent
C) 4.80 percent
D) 5.10 percent
E) 20.83 percent
F) None of the above.

Question 13

At $1,000 par value,10 percent coupon bond matures in 20 years.If the price of the bond is $1,196.80,what is the yield to maturity on the bond?
Assume interest is paid annually.

Question 14

Which of the following statements related to the internal rate of return (IRR)are correct?
I.The IRR is the discount rate at which an investment's NPV equals zero.
II.An investment should be undertaken if the discount rate exceeds the IRR.
III.The IRR tends to be used more than net present value simply because its results are easier to comprehend.
IV.The IRR is the best tool available for deciding between mutually exclusive investments.

A) I and II only
B) I and III only
C) II and III only
D) I, II, and IV only
E) I, II, III, and IV
F) None of the above.

Question 15

Sol's Sporting Goods is expanding,and as a result expects additional operating cash flows of $26,000 a year for 4 years.This expansion requires $39,000 in new fixed assets.These assets will be worthless at the end of the project.In addition,the project requires an additional $3,000 of net working capital throughout the life of the project; Sol expects to recover this amount at the end of the project.What is the net present value of this expansion project at a 16 percent required rate of return?

A) $18,477.29
B) $21,033.33
C) $28,288.70
D) $29,416.08
E) $32,409.57
F) None of the above.

Question 16

Your grandmother invested a lump sum 26 years ago at 4.25 percent interest.Today,she gave you the proceeds of that investment which totaled $51,480.79.How much did she originally invest?

A) $15,929.47
B) $16,500.00
C) $17,444.86
D) $17,500.00
E) $17,999.45
F) None of the above.

Question 17

Your brother will borrow $17,800 to buy a car.The terms of the loan call for monthly payments for 5 years at an 8.6 percent annual interest rate,compounded monthly.What is the amount of each payment?

A) $287.71
B) $296.67
C) $301.12
D) $342.76
E) $366.05
F) None of the above.

Question 18

Naomi plans on saving $3,000 a year and expects to earn an annual rate of 10.25 percent.How much will she have in her account at the end of 45 years?

A) $1,806,429
B) $1,838,369
C) $2,211,407
D) $2,333,572
E) $2,508,316
F) None of the above.

Question 19

Pro forma free cash flows for a proposed project should:
I.exclude the cost of employing existing assets that could be sold anyway.
II.exclude interest expense.
III.include the depreciation tax shield related to the project.
IV.exclude any required increase in operating current assets.

A) I and II only
B) II and III only
C) II and IV only
D) I, III, and IV only
E) I, II, III, and IV
F) None of the above.

Question 20

Ian is going to receive $20,000 six years from now.Sunny is going to receive $20,000 nine years from now.Which one of the following statements is correct if both Ian and Sunny apply a 7 percent discount rate to these amounts?

A) The present values of Ian and Sunny's monies are equal.
B) In future dollars, Sunny's money is worth more than Ian's money.
C) In today's dollars, Ian's money is worth more than Sunny's.
D) Twenty years from now, the value of Ian's money will be equal to the value of Sunny's money.
E) Sunny's money is worth more than Ian's money given the 7 percent discount rate.
F) None of the above.

Question 21

A company is considering two alternative methods of producing a new product.The relevant data concerning the alternatives are presented below. At the end of the useful life of whatever equipment is chosen the product will be discontinued.The company's tax rate is 50 percent and its cost of capital is 10 percent.
a.Calculate the net present value of each alternative.
b.Calculate the benefit cost ratio for each alternative.
c.Calculate the internal rate of return for each alternative.
d.If the company is not under capital rationing,which alternative should be chosen?
Why?

Question 22

Consider the following investment opportunity. Assume the annual figures are unchanged for the expected life of the investment.What is the rate of return on this investment?

Question 23

Your brother,age 40,is the regional manager at an office supply company.He thinks he might want to leave his job to go back to school for an MBA.He expects that his current job,if he were to stay at it,would pay him a real income stream of $75,000 per year until retirement at age 65.If he goes back to school,he would forego two years of income,but his real income after graduation would be $110,000 per year until retirement at age 65.He has been accepted to an MBA program that costs a real $22,000 per year.If his real opportunity cost is 8 percent,would leaving his job to get an MBA be a smart financial decision?

Question 24

Ten years ago you invested $1,000 for 10 shares of Steeze,Inc.common stock.You sold the shares recently for $2,000.While you owned the stock it paid $10.08 per share in annual dividends.What was your rate of return on Steeze stock?

Question 25

Given the following information about a possible average-risk,new product investment,calculate the investment's net present value.