Practice Midterm Exam_Solutions_F2023-4

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Practice Midterm Exam Solutions (25 questions, with textbook sections) 3.1 Use the information for the question(s) below. Alaska North Slope Crude Oil (ANS) $71.75/Bbl West Texas Intermediate Crude Oil (WTI) $73.06/Bbl As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude. 1. Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the trade is closest to: A) ($1400) B) $1400 C) ($3908) D) $3908 Answer: B Explanation: B) Total Benefits No trade and refine WTI crude (base case) 10,000 Bbls × $77 of gasoline/Bbl = $770,000 Trade WTI for ANS crude 10,150 Bbls × $76 of gasoline/Bbl = $771,400 Added Benefits = Total Benefits - Base Case Trade WTI for ANS crude = $771,400 - $770,000 = $1400 3.2 2. Suppose you have $1000 today and the risk-free rate of interest ( r f ) is 3.5%. The equivalent value in one year is closest to: A) $965.00 today. B) $966.18 today. C) $1000.00 today. D) $1035.00 today. Answer: D Explanation: D) $1000 × 1.035 = $1035.00 3. When we express the value of a cash flow or series of cash flows in terms of dollars today, we call it the ________ of the investment. If we express it in terms of dollars in the future, we call it the ________.

A) present value; future value B) future value; present value C) ordinary annuity; annuity due D) discount factor; discount rate Answer: A 3.3 Use the information below to answer the following question(s): The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement. The owner is considering the following three alternatives: 1. Sell the restaurant now and retire. 2. Hire someone to manage the restaurant for the next year and retire. This will require the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one year the owner will sell the restaurant for $350,000. 3. Scale back the restaurant's hours and ease into retirement over the next year. This will require the owner to spend $40,000 on expenses now, but will generate $75,000 in profit at the end of the year. In one year the owner will sell the restaurant for $350,000. 4. If the interest rate is 7%, the NPV of alternative #1 is closest to: A) $350,000 B) $357,000 C) $375,500 D) $400,000 Answer: A Explanation: A) There is no TVM for alternative #1. The NPV = $350,000. 5. You have an investment opportunity in Germany that requires an investment of $250,100 today and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk-free rate of interest in Germany is 7% and the current competitive exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the project? A) NPV = -$100; No B) NPV = $100; Yes C) NPV = $2358; Yes D) NPV = $3650; Yes Answer: A Explanation: A) NPV = -$250,100 + (€208,650/1.07) × $1.00/€0.78 = -$100, so since NPV < 0, reject 4.1 6. Which of the following statements regarding the timeline is TRUE? A) Date 1 is the beginning of the first year. B) Date 2 is the beginning of the second year. C) Date 1 is the beginning of the second year.

D) Date 0 is the end of the first year. Answer: C 4.2 7. Which of the following statements is FALSE? A) The process of moving a value or cash flow backward in time is known as discounting. B) FV = C) The process of moving a value or cash flow forward in time is known as compounding. D) The value of a cash flow that is moved forward in time is known as its future value. Answer: B Explanation: B) FV = C (1 + r ) n 4.3 8. Consider the following timeline detailing a stream of cash flows: If the current market rate of interest is 8%, then the future value of this stream of cash flows is closest to: A) $11,699 B) $10,832 C) $12,635 D) $10,339 Answer: A Explanation: A) FV = 1000(1.08) 4 + 2000(1.08) 3 + 3000(1.08) 2 + 4000(1.08) 1 = $11,699 4.4 9. Kampgrounds Inc. is considering purchasing a parcel of wilderness land near a popular historic site. Although this land will cost Kampgrounds $400,000 today, by renting out wilderness campsites on this land, Kampgrounds expects to make $35,000 at the end of every year indefinitely. If the appropriate discount rate is 8%, then the NPV of this new wilderness campsite is closest to: A) -$50,000 B) -$37,500

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C) $37,500 D) $50,000 Answer: C Explanation: C) NPV = -400,000 + $35,000/.08 = 37,500 4.5 10. If the current rate of interest is 8%, then the present value of an investment that pays $1000 per year and lasts 20 years is closest to: A) $18,519 B) $45,761 C) $9818 D) $20,000 Answer: C Explanation: C) PV = C / r (1 - (1 + r) -N ) = 1000/.08 (1 - (1 + 0.08) -20 ) PV = $9818 5.1 11. The effective annual rate (EAR) for a savings account with a stated APR of 4% compounded daily (use 365 day year) is closest to: A) 3.92% B) 4.00% C) 4.08% D) 14.60% Answer: C Explanation: C) EAR = (1 + APR/k ) k - 1 = (1 + .04/365) 365 - 1 = .04088 or 4 .08% 12. You are considering purchasing a new truck that will cost you $34,000. The dealer offers you 1.9% APR financing for 48 months (with payments made at the end of the month). Assuming you finance the entire $34,000 and finance through the dealer, your monthly payments will be closest to: A) $708 B) $725 C) $736 D) $1086 Answer: C Explanation: C) First we need the monthly interest rate = APR/k = .019/12 = .001583 or .1583%. 34,000 = PMT × (1/0.001583) × (1 - 1/(1.001583 48 )) , PMT = $736.15 7.1 Use the following information to answer the question(s) below. You are considering investing in a start up project at a cost of $100,000. You expect the project to return $500,000 to you in seven years. Given the risk of this project, your cost of capital is 20%. 13) The NPV for this project is closest to: A) $29,200 B) $39,500 C) $129,200

D) $139,500 Answer: B Explanation: B) NPV = -100,000 + 500,000/(1.020) 7 = 39,540.82 14) The IRR for this project is closest to: A) 15.60% B) 18.95% C) 20.00% D) 25.85% Answer: D Explanation: D) IRR = - 1 = .25849895 15) The decision you should take regarding this project is A) reject the project since the NPV is negative. B) reject the project since the NPV is positive. C) accept the project since the IRR < 20%. D) accept the project since the IRR > 20%. Answer: D Explanation: D) IRR = - 1 = .25849895 NPV = -100,000 + 500,000/(1.020) 7 = 39,540.82 Therefore, we should accept because NPV > 0 and because IRR > 20%. Use the table for the question(s) below. Consider the following two projects: Project Year 0 C/F Year 1 C/F Year 2 C/F Year 3 C/F Year 4 C/F Year 5 C/F Year 6 C/F Year 7 C/F Discount Rate Alpha -79 20 25 30 35 40 N/A N/A 15% Beta -80 25 25 25 25 25 25 25 16% 16) The NPV for project Alpha is closest to: A) $20.96 B) $16.92 C) $24.01 D) $14.41 Answer: B Explanation: B) NPV = -79 + 20/(1.15) 1 + 25/(1.15) 2 + 30/(1.15) 3 + 35/(1.15) 4 + 40/(1.15) 5 = 16.92 Diff: 2 Section: 7.1 NPV and Stand-Alone Projects Skill: Analytical 17. The NPV for project Beta is closest to: A) $24.01 B) $16.92

C) $20.96 D) $14.41 Answer: C Explanation: C) NPV = -80 + 25/(1.16) 1 + 25/(1.16) 2 + 25/(1.16) 3 + 25/(1.16) 4 + 25/(1.16) 5 + 50/(1.16) 6 + 25/(1.16) 7 = 20.96 7.2 18. Which of the following statements is FALSE? A) The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital. B) The IRR investment rule states that you should take any investment opportunity where the IRR exceeds the opportunity cost of capital. C) Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions. D) There are situations in which multiple IRRs exist. Answer: C 7.4 19. Which of the following statements is FALSE? A) The profitability index measures the value created in terms of NPV per unit of resource consumed. B) The profitability index is the ratio of value created to resources consumed. C) The profitability index can be easily adapted for determining the correct investment decisions when multiple resource constraints exist. D) The profitability index measures the "bang for your buck." Answer: C 7.5 Use the table for the question(s) below. Consider the following list of projects: Project Investment NPV A 135,000 6000 B 200,000 30,000 C 125,000 20,000 D 150,000 2000

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E 175,000 10,000 F 75,000 10,000 G 80,000 9000 H 200,000 20,000 I 50,000 4000 20. Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects, which projects should you invest in and in what order? A) CBFH B) CBGF C) BCFG D) CBFG Answer: A Explanation: A) Project Investment NPV Profitability Index Rank A 135,000 6000 0.0444 8 B 200,000 30,000 0.1500 2 C 125,000 20,000 0.1600 1 D 150,000 2000 0.0133 9 E 175,000 10,000 0.0571 7 F 75,000 10,000 0.1333 3 G 80,000 9000 0.1125 4 H 200,000 20,000 0.1000 5 I 50,000 4000 0.8000 6 This is a tricky problem in that by the rankings CBFG seem optimal, but this combination leaves $120,000 on the table uninvested. By replacing G with H the full $600,000 is invested and the NPV of the combination of projects is increased by $11,000. Therefore, you should invest in projects CBFH. 8.1 21. Which of the following statements is FALSE? A) Project externalities are direct effects of the project that may increase or decrease the profits of other business activities of the firm. B) Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C) The average selling price of a product and its cost of production will generally change over time. D) Any money that has already been spent is a sunk cost and therefore irrelevant in the capital budgeting process. Answer: A Use the information for the question(s) below.

Food For Less (FFL), a grocery store, is considering offering one hour photo developing in their store. The firm expects that sales from the new one hour machine will be $150,000 per year. FFL currently offers overnight film processing with annual sales of $100,000. While many of the one hour photo sales will be to new customers, FFL estimates that 60% of their current overnight photo customers will switch and use the one hour service. 22. Suppose that of the 60% of FFL's current overnight photo customers, half would start taking their film to a competitor that offers one hour photo processing if FFL fails to offer the one hour service. The level of incremental sales in this case is closest to: A) $60,000 B) $150,000 C) $90,000 D) $120,000 Answer: D Explanation: D) = $150,000 - (cannibalized sales) = 150,000 - (.60 × .50) × 100,000 = $120,000 Note that the rate of cannibalization is only 30% (.60 × .50) since the other 30% would have taken their film elsewhere. 8.2 23. You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an increase in inventory of $8000, an increase in Accounts payable of $2500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is: A) $45,500 B) $10,500 C) $6500 D) $5500 Answer: D Explanation: D) NWC = CA - CL = $8000 - $2500 = $5500 8.3 Use the following information to answer the question(s) below. Galt Motors currently produces 500,000 electric motors a year and expects output levels to remain steady in the future. It buys armatures from an outside supplier at a price of $2.50 each. The plant manager believes that it would be cheaper to make these armatures rather than buy them. Direct in- house production costs are estimated to be only $1.80 per armature. The necessary machinery would cost $700,000 and would be obsolete in 10 years. This investment would be depreciated to zero for tax purposes using a 10-year straight line depreciation. The plant manager estimates that the operation would require additional working capital of $40,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. The expected proceeds from scrapping the machinery after 10 years are estimated to be $10,000. Galt Motors pays tax at a rate of 35% and has an opportunity cost of capital of 14%. 24. The incremental cash flow that Galt Motors will incur in year 4 if they elect to manufacture armatures in house is closest to: A) 25,000

B) 252,000 C) 300,000 D) 375,000 Answer: B Explanation: Recall EBIT = Revenues – costs – depreciation Net Income (NI) = (Revenues – costs – depreciation)(1-tax) Free Cash Flow (FCF) = (Revenues – costs)(1-tax) + tax*depreciation – CapEx – ΔNWC Outsourcing, year 4 EBIT^1 = Revenues – 500,000*2.50 NI^1 = (Revenues – 500,000*2.50)(1-0.35) FCF^1 = (Revenues – 500,000*2.50)(1-0.35) In-house, year 4 EBIT^2 = Revenues – 500,000*1.80 – 700,000/10 NI^2 = (Revenues – 500,000*1.80 -700,000/10)(1-0.35) FCF^2 = (Revenues – 500,000*1.80)(1-0.35) + 0.35 *700,000/10 Incremental EBIT: In-house versus outsourcing EBiT^2-EBIT^1 = Revenues – 500,000*1.80 – 700,000/10 -Revenues+ 500,000*2.50 = 500,000*(2.50-1.80) – 700,000/10 Incremental NI: In-house versus outsourcing NI^2-NI^1 = (Revenues – 500,000*1.80 -700,000/10)(1-0.35) - (Revenues – 500,00*2.50)(1-0.35) = 500,000*(2.50-1.80)(1-0.35) -700,000/10(1-0.35) Incremental FCF: In-house versus outsourcing FCF^2-FCF^1 = (Revenues – 500,000*1.80)(1-0.35) + 0.35 *700,000/10 - (Revenues – 500,00*2.50)(1-0.35) = 500,000*(2.50-1.80)(1-0.35) + 0.35 *700,000/10 = 227,500 + 24,500 = 252,000

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C) Incremental cash flow = 500,000 units × ($2.50 - $1.80)(1-.35) + .35 × 700,000/10 = 297,000 8.5 25. Which of the following statements is FALSE? A) We can use scenario analysis to evaluate alternative pricing strategies for our project. B) Scenario analysis considers the effect on NPV of changing multiple project parameters. C) The difference between the IRR of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. D) Scenario analysis breaks the NPV calculation into its component assumptions and show how the NPV varies as each one of the underlying assumptions change. Answer: D

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the answer to this question is Q4.32= (A) T, PW= $96,664 (B)=? DONT KNOW but we just need to find how we get that answer for these questions, please help NO EXCEL

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