Deck 7: Discounted Cash Flow Techniques

Question 1

The accounting rate of return is deficient as a figure of merit because it is insensitive to the timing of cash flows.

Answer 1

True

Question 2

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

Answer 2

$366.05

Question 3

When conducting a discounted cash flow analysis of a project,it is important to always include a careful estimate of financing costs in the project's cash flows.

Answer 3

False

Question 4

Which of the following should be included in the cash flow projections for a new product?
I.Money already spent for research and development of the new product
II.Capital expenditures for equipment to produce the new product
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

Question 5

The IRR is the discount rate at which an investment's NPV equals its initial cost.

Question 6

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

Question 7

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

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.Benefit-cost ratio

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

Question 9

When evaluating investments under capital rationing that are independent and can be acquired fractionally,ranking by the BCR is the appropriate technique.

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.

Question 11

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

Question 12

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 13

Which of the following is NOT a reason why a dollar today is worth more than a dollar in the future?

A) Inflation reduces the purchasing power of future dollars.
B) The value of a dollar in the future will be compounded more than the value of a dollar today.
C) There is more uncertainty of receiving dollars further into the future.
D) A dollar today can be productively invested in the time before receiving a dollar in the future.

Question 14

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

Question 15

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.

Question 16

The IRR and NPV always yield the same investment recommendations.

Question 17

As a noncash expense,depreciation is irrelevant in the determination of a project's cash flows.

Question 18

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

Question 19

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

Question 20

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

Question 21

What is the difference in the value of a $5,000 annual perpetuity and an annuity of $5,000 for 100 years? Assume that the discount rate is 8% and that cash flows are received at the end of the year.

A) $28
B) $656
C) $1,656
D) $5,000
The present value of the perpetuity is 5,000/0.08 = $62,500.For the annuity:
The difference = 62,500 - 62,472 = $28

Question 22

In a discounted cash flow analysis of Giant Corp.'s project described in the problem above,what would be the projected Year 1 free cash flow?

A) $300
B) $600
C) $750
D) $900

Question 23

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%
B) 2.40%
C) 4.80%
D) 5.10%
E) 20.83%

Question 24

In a discounted cash flow analysis of Giant Corp.'s project described in the problem above,what would be the projected Year 2 free cash flow?

A) $1,300
B) $1,450
C) $1,700
D) $1,750

Question 25

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

Question 26

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 27

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 28

You are to receive an annuity of $1,000 per year for 10 years.You will receive the first payment two years from today.At a discount rate of 10%,what is the present value of this annuity?

A) $5,078.15
B) $5,585.97
C) $6,144.57
D) $6,759.03
The PV = $6,144.57.But the first payment is received in two years,not one year,so discount the PV by one more year: 6,144.57/1.1 = $5,585.97

Question 29

What is the benefit-cost ratio for an investment with the following cash flows at a 14.5 percent required return?
$\begin{array}{cc}\hline \text { Year } & \text { Cash Flow } \\0 & \$(46,500) \\1 & \$ 12,200 \\2 & \$ 38,400 \\3 & \$ 11,300 \\\hline\end{array}$

A) 0.94
B) 0.98
C) 1.02
D) 1.06
E) 1.11

Question 30

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? Assuming the investor wants to earn at least 12 percent,is this investment an attractive one?

Question 31

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 32

Ten years ago you invested $1,000 for 10 shares of Providien,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 Providien stock?

Question 33

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

Question 34

Giant Corp.is considering a project that requires a $1,500 initial cost for a new machine that will be depreciated straight line to a salvage value of 0 on a 5-year schedule.The project will require a one-time increase in the level of net working capital of $300.The project will generate an additional $1,600 in revenues and $700 in operating expenses each year.The project will end at the end of year 2,at which time the machinery is expected to be sold for $800.Giant's tax rate is 50%.In a discounted cash flow analysis of this project,what would be the projected Year 0 free cash flow?

A) -$1,200
B) -$1,500
C) -$1,800
D) -$2,100

Question 35

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 $115,000 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 36

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

Question 37

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

Question 38

Given the spreadsheet below,what value would Excel return if you entered the following formula? =NPV(B2,B5:D5)

A) $577.57
B) $629.56
C) $750.00
D) #VALUE!
-250/1.09 + 500/1.09² + 500/1.09³ = $577.57

Question 39

A divisional manager submitted a project proposal to the chief financial officer,complete with a calculated NPV for the project.The chief financial officer studied the proposal and pointed out that the divisional manager had failed to account for a one-time increase in net working capital of $60,000 that will be required over the life of the seven-year project.Assuming the full value of net working capital will be recovered at the end of the project,how will the project's NPV change after making the chief financial officer's adjustment? Assume a discount rate of 9%.

A) The NPV will decrease by $16,411.
B) The NPV will decrease by $32,822.
C) The NPV will decrease by $60,000.
D) The NPV will not be affected.
E) None of the abovE.