PRACTICE TEST

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Texas A&M University, Corpus Christi *

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Apr 3, 2024

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PRACTICE TEST #1  Section 2.5 Cash Flow of the Firm  McSherry Interiors has beginning net fixed assets of $ 234,100 and ending net fixed assets of $ 243,600 . Assets valued at $42,500 were sold during the year. Depreciation was $62,500 . What is the amount of net capital spending? Explanation Net capital spending = $243,600 − 234,100 + 62,500 Net capital spending = $72,000  Section 2.5 Cash Flow of the Firm   Zhao Pediatrics has operating cash flow of $11,618 . Depreciation is $2,345 and interest paid is $395. A net total of $485 was paid on long-term debt. The firm spent $6,180 on fixed assets and decreased net working capital by $420 . What is the cash flow of the firm? Explanation CF( A ) = $11,618 − 6,180 − (−$420) CF( A ) = $5,858  Section 2.5 Cash Flow of the Firm   Grimaldi, Incorporated, has total revenue of $ 4,116 , depreciation of $319, selling and administrative expenses of $554 , interest expense of $162, dividends of $75, cost of goods sold of $2,354 , and taxes of $186 . What is the operating cash flow? OCF = $4,116 − 2,354 − 554 − 186 OCF = $1,022  Section 5.2 The Payback Period Method   You are considering a project with an initial cost of $10,140. What is the payback period for this project if the cash inflows are $2,300, $4,500, $9,100, and $13,000 for Years 1 to 4, respectively? Explanation Payback = 2 + ($10,140 − 2,300 − 4,500)/$9,100 Payback = 2.37 years  Section 5.3 The Discounted Payback Period Method 

 A project has an initial cost of $10,600 and produces cash inflows of $ 3,700 , $ 4,900 , and $ 2,500 for Years 1 to 3, respectively. What is the discounted payback period if the required rate of return is 7.5 percent? Explanation PV = $3,700/1.075 + $4,900/1.075 2 + $2,500/1.075 3 PV = $9,694.39 The project will never pay back on a discounted basis.  Section 5.5 Problems with the IRR Approach  An analyst is considering two mutually exclusive projects that have been assigned the same discount rate of 10.5 percent. Project A has an initial cost of $54,500 , and should produce cash inflows of $16,400 , $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $79,400 , and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. What is the incremental IRR? Explanation 0 = [−$79,400 − (−$54,500)] + ($0 − 16,400)/(1 + IRR) + ($48,300 − 28,900)/(1 + IRR) 2 + ($42,100 − 31,700)/(1 + IRR) 3 IRR = −15.40% Calculation of incremental internal rate of return Formula: A B C D 1 Difference 2 Years A B 3 0 -54500 -79400=B3-C3 4 1 16400 0=B4-C4 5 2 28900 48300=B5-C5 6 3 31700 42100=B6-C6 7 IRR =IRR(B3:B6) =IRR(C3:C6) =IRR(D3:D6)

Computation: A B C D 1 Differen ce 2Years A B 3 0 -54500 -79400 24900 4 1 16400 0 16400 5 2 28900 48300 -19400 6 3 31700 42100 -10400 7IRR 17.43% 5.42% -15.40% Explanation: The incremental IRR is calculated by equating the present value of the incremental cash flows to the incremental initial investment. The incremental cash flow is the difference between the annual cashflows of the two projects.  Section 5.5 Problems with the IRR Approach  Project A has an initial cost of $75,000 and annual cash flows of $33,000 for three years. Project B costs $60,000 and has cash flows of $25,000, $30,000, and $25,000 for Years 1 to 3, respectively. Projects A and B are mutually exclusive. The incremental IRR is _______ percent and if the required rate is higher than the crossover rate then Project _______ should be accepted. Explanation 0 = [−$75,000 − (−$60,000)] + ($33,000 − 25,000)/(1 + IRR) + ($33,000 − 30,000)/(1 + IRR) 2 + ($33,000 − 25,000)/(1 + IRR) 3 IRR = 12.89% Using a discount rate of 15 percent: NPV A = −$75,000 + $33,000{1 − [1/(1 + .15) 3 ]}/.15 NPV A = $346.43 NPV B = −$60,000 + $25,000/1.15 + $30,000/1.15 2 + $25,000/1.15 3 NPV B = $861.35

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 Section 8.1 Bonds and Bond Valuation   Consider a bond with an annual coupon rate of 7 percent that pays semiannual interest and matures in ten years. The market rate of return on bonds of this risk is currently 3.5 percent. What is the current value of a $1,000 face value bond? Explanation Bond value = [.07($1,000)/2]{[1 − 1/(1 + .035/2) 10(2) ]/(.035/2)} + $1,000/(1 + .035/2) 10(2) Bond value = $1,293.18 Look for an excel  Consider a bond with a coupon rate of 8 percent that pays semiannual interest and matures in eight years. The market rate of return on bonds of this risk is currently 11 percent. What is the current value of a $1,000 face value bond? ???? ??? https://www.omnicalculator.com/finance/pvifa Face Value = $1,000 Annual Coupon = 8%*$1,000 = $80 Semi-annual Coupon = $80 / 2 = $40 Annaul Market rate = 11% Semi-annual Market rate = 5.5% Maturity in 8 years Price = $40*PVIFA(5.5%, 16) + 1,000*PVIF(5.5%, 16) Price = $40*(1-(1/1.055)^16)/0.055 + 1,000/1.055^16 Price = $843.07 So, current price of bond is $843.07

 Section 8.1 Bonds and Bond Valuation   A corporate bond has a coupon of 7.5 percent and pays interest annually. The face value is $1,000 and the current market price is $1,108.15. The bond matures in 14 years. What is the yield to maturity? Face value = 1,000 Coupon rate = 7.50% Coupon payment=1,000×0.075=75 Years to maturity = 14 Current value = 1,108.15 Explanation: The coupon payments are the product of coupon rate and the face value. Now refer to the following Excel sheet, A B C D E F G 1 2 Face value 1000 3 Coupon rate 7.50% 4 PMT 75=D2*D3 5 Years 14 6 Current value 1,108.1 5 7 8 YTM 6.31%=RATE(D5,D4,-D6,D2) 9  Section 8.1 Bonds and Bond Valuation  A firm offers a zero coupon bond with a face value of $1,000 that matures in 10 years . What is the current market price if the yield to maturity is 7.6 percent , given semiannual compounding?

Explanation Price = $1,000/(1 + .076/2) 10(2) Price = $474.30  Section 8.1 Bonds and Bond Valuation   Jackson’s has $1,000 face value, zero-coupon bonds outstanding that mature in 13.5 years. What is the current value of one of these bonds if the market rate of interest is 7.6 percent? Assume semiannual compounding. Explanation Price = $1,000/(1 + .076/2) 13.5(2) Price = $365.32 #14  Section 9.2 Estimates of Parameters in the Dividend Discount Model  Cadar Security recently paid an annual dividend of $6.60 on its common stock. This dividend increases by 3 percent per year . What is the market rate of return if the stock is selling for $42.21 per share ? Explanation R = $6.60(1.03)/$42.21 + .03 R = .1911, or 19.11%  Section 9.2 Estimates of Parameters in the Dividend Discount Model  Javelina Corporation just announced its next annual dividend will be $3.43 per share and all future dividends will increase by 3.8 percent annually . What is the market rate of return if this stock is currently selling for $44.73 per share ?

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Explanation R = $3.43/$44.73 + .038 R = .1147, or 11.47%  Section 9.2 Estimates of Parameters in the Dividend Discount Model    Shares of Ramirez Corporation offer an expected total return of 12 percent. The dividend is increasing at a constant 3.25 percent per year. What is the value of the next dividend if the stock is selling at $28 per share? Explanation .12 = D 1 /$28 + .0325 D 1 = $2.45

 Section 4.5 Loan Amortization     Assume mortgage rates increase to 7.5 percent and you borrow $329,000 for 30 years to purchase a house. What will your loan balance be at the end of the first 15 years of monthly payments? Explanation $329,000 = C {[1 − 1/(1 + .075/12) 30(12) ]/(.075/12)} C = $2,300.42 PV = $2,300.42{[1 − 1/(1 + .075/12) (30 − 15)(12) ]/(.075/12)} PV = $248,153.73  Step 1 - Borrowing Amount = $329,000 - The loan is amortized with monthly payment over 30 years - Interest rate = 7.50%

 Section 4.6 What Is a Firm Worth?     A small craft store located in a kiosk expects to generate annual cash flows of $6,800 for the next three years. At the end of the three years, the business is expected to be sold for $15,000. What is the value of this business at a discount rate of 15 percent? Explanation PV = $6,800[(1 − 1/1.15 3 )/.15] + $15,000/1.15 3 PV = $25,388.67  Section 4.2 The Multiperiod Case   The government imposed a fine on a firm that requires a payment of $100,000 today, $150,000 one year from today, and $200,000 two years from today. The government will hold the funds until the final payment is collected and then donate the entire amount to charity. How much will be donated if the government pays 3 percent interest on the held funds? Explanation FV = $100,000(1.03 2 ) + $150,000(1.03) + $200,000 FV = $460,590  Section 4.2 The Multiperiod Case   If you invest $15,000 today, an investment guarantees that 24 years from today you will have $54,750. What annual rate of interest will you earn? Explanation $54,750 = $15,000(1 + r ) 24 r = .0554, or 5.54%

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 All else equal, the payback period for a project will decrease whenever the: cash inflows are moved earlier in time. Section 5.2 The Payback Period Method   The market price of a bond increases when the: discount rate decreases.  Section 8.1 Bonds and Bond Valuation 