F19 Exam 3 Solved (by Rachel Dexter)

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i e C/’ FINANCE 341 - Fall 2019 Print Name: EXAM #3 - Form A ‘ Directions: Read all choices, and choose the best answer. (Keep 4 decimals unless told otherwise.) Use the following data to answer the next 3 questions: Bryce Ford.han'l is evaluating two mutually exclusive projects (expected cash flows shown below). The firm's cost of capital is 11 percent. (Round each amount to the nearest cent.) Year Project A ProjectB _A 0 (800) (800) 0 1 450 250 100 2 420 350 10 3 380 500 ‘é’(; 4 300 600 - A npy (1], -900, {459,420, 5€0, 300¢) NPV? Y1].70 1005 iy (1, ~000, 250,350,877, w$) ) A vy (900, §Us0, 420,380, 3003) IRR? vy b i A I 3017 % 357 ®: vy (- §U, 180,350, S00, w00} 1 Calculate the Discounted Payback Period for Project B. a. 2.19years —$00 o b. 2.40 years s ¥ 218-23 280years 20N TTY oA & LIS S e Ty d. 3.09 years 350 /111" =840 v 294.010 26§06 - . ‘ e. 3.22years SOU/L 1Y = 308 o ____,_% bou /1111 =398 =240. ; 410.| 2 Calculate the Internal Rate of Return for Project A. a. 32.35 percent b. 29.41 percent Yy . 30.98 percent 35.72 percent ‘ . e. 33.64 percent 32 3S 3 Draw the NPV profiles for the mutually exclusive projects A and B. Which of the following statements is most FALSE? Project A’s NPV profile intercepts the vertical axis at $421.76.F wpV (0,~%00, 450,424 3§9;309¢ ) 5. The NPV profiles for Projects A and B cross at 19.7362 percent. T =70 ¢. Since NPV and IRR disagreed on whether A or B was the better project, you knew that if a crossover rate existed in the positive quadrant, it had to be greater than the cost of capital. T d. Project B’s NPV profile intercepts the vertical axis at $900. T npv ( 0,-gw ' {‘zgo‘ 350, S0, ng) >90D e. Project A is less sensitive to a change in the cost of capital. T 4SS sieep (LR (0, 400,70, 104, -308) = \1. 736 7. page 1

4 McCool Incorporated is considering sponsoring a pavilion at the upcoming World's Fair. The pavilion project's cash flows are as follows: o Year Cash Flow \R% (<, §12, 10,20¢) = 24.049 ¥, 0 (86 million) 1 + 2million wpV (100,-6,%12,10720¢ =0 2 + 10 million 3 (20 million) 210 1007- Which of the following statements is most CORRECT? I/ a. The project should be accepted if the cost of capital is in the relevant range. f b. The project should be accepted if the firm's cost of capital is more than 29.0994 percent. F c. The project should be accepted if the firm's cost of capital is between 29.0994 and 373.2452 percent. £ nwpv (373. 2452 -6, {1,10,-26%) = -3. 107 d. The project should be accepted if the firm's cost of capital is between 0 and 29.0994 percent. F The project should be accepted if the cost of capital is between 29.09944 and 100.00 percent. T 5 Morgan Bush invested in a project that has the following quarterly cash flows over the next 1.5 years. If interest is compounded quarterly, what is the effective annual rate of return for this project? (Round to 6 decimal places throughout.) 0 0.25 0.50 0.75 1 1.25 1.50 I I I I I I | ‘ (650) 45 160 185 125 200 225 a. 76.59 percent 1R (-6S0, §4s,160,1€€, 125, 200, WSR) = 4. 94|71/, (quaneriyrate) 46.10 percent y C. 20.87 percent . L0441 T = = Y6.09997. d. 14.32 percent WIYL (I v.04 ) 1 1 / e. 9.94 percent 6 Help Blake West calculate the MIRR for the following project. The cost of capital is 12%. (Round to the nearest cent.) 0 1 2 3 4 S 6 | [ | | | I I (850) 280 300 (150) 500 (100) 600 PV = npv (12 -950,§0,0,-150,0,-100,0% = -] 0]3.5] a. 731 percent ¢, (v (1%, 0, §180309, 0,507, 0, €003 (1.12) b. 11.89 percent o (c.) 13.73 percent 10,8951 (1-12)" = 1]191.7] . d. 18.22 percent nel e. 23.61 percent 121 13.718§ pv=-J013.$l Fv= 9Ll pege? tMT=0

Use the following information for the next 4 questions. Jeff Neely,, Inc. is analyzing the replacement of a color copier. The old machine was purchased 2 years ago for $10,000; it falls into the MACRS 5-year class; and it has 4 years of remaining life and a $2,000 salvage price of $15,000, plus an additional $300 for installation and modification. Delivery of the machine will ‘ value 4 years from now. The current market value of the old machine is $8,500. The new machine has a require $200. The new machine falls into the MACRS 5-year class, has a 4-year economic life, and can be salvaged for $7,000. The new machine will mean inventory can decrease by $1,000 and accounts payable is expected to increase by $1,800. The new machine is expected to increase revenue by $5,000 per year and increase costs by $3,000 per year. The firm has an 9 percent cost of capital and a marginal tax rate of 40 percent. The MACRS S-year class uses the following percentages: 20%, 32%, 19%, 12%, 11%, and 6% (in that order). (Round all CFs to the nearest dollar.) WTE = (1,000)(-4) = 800 Work Space: 0 | Y . 2 % ; 207- /. 127 % 14/ ll nj } 'ﬂf ll 172 _71 %0 2104 1939 " 000 bwynaw (] 5,500) w7, | WPM §,500 TE (1,746 ! TE (1,4%0) MSold (1000) CANWC 2,400 MTE <00 | ( 0 ANWC (2,300) 5,09 ;: : 1,264 ? ] +170Y 1%, = (9,500 - (:49)(10,000)) (.Yo) = |190 Ty = (1,000 - (17) (15,500)) (-49) = V140 0CF, = (3,000)(-6) + ((-20)(19500) ~(19)010,000)) (M) =1 §0- 0UF,= 1200 + (32X 16600 —.12 ¥ 10,00 0) (1) =1104 OUF, = 1200 + (.19 % 15500 —-11 ¥ 10,000)(:\f) = 143§ OUFy = WUO + (1 X15500 -0 X 10,000) () = 1704 v (4, 75090, $1690, 1704, 1438, 1254+ 17045 <[, 729 10| page 3

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. 10 ‘) 11 K What is the initial investment outlay at Year 0? a. outflow of $6,440 (b.) outflow of $5,680 c. outflow of $11,280 d. outflow of $7,680 e. outflow of $9,220 If they switch out the old machine for the new one, how much more tax savings will the company get from the change in depreciation expense in Year 1 (t=1)? a. $1,240 > oo (-2X 15500 =19 ¥10,000 ) (-4) >490 $480 e. $1,680 What is the tax effect from selling the new machine at the end of the project? a. inflow of $1,746 b. inflow of $2,248 c. outflow of $2,248 (4.) outflow of $1,746 €. none of the above Should the firm replace its older machine with the new machine? Yes, buying the new machine will increase the firm’s value by $1,729 expressed in today's dollars. 5. No, buying the new machine will decrease the firm’s value by $3,871 expressed in today's dollars. c. Yes, buying the new machine will increase the firm’s value by $1,623 expressed in today's dollars. d. No, buying the new machine will increase the firm’s value by $1,092 expressed in today's dollars. e. None of the above is within $100 of the correct answer. the-folowing mutually exclusive projects it should accept. Assume that the firm’s cost of capital nd that both projects have normal cash flows and equal lives. Which of the following statements is most CORRECT? Project A Project B | NPV $650 $700 100 - IRR 22% 19% (¥S0 == == The crossover rate is less than 15%. 15 11 11 The crossover rate has to be between 15% and 19%. c. The crossover rate has to be between 19% and 22%. d. The crossover rate has to be between 15% and 22%. e. The sum of Project A’s cash flows is greater than the sum of Project B’s cash flow. page 4

12 Harrison Burks of Burks, Inc. is choosing between two mutually exclusive projects that have the following cash flows and a cost of capital of 12%. Which of the following is most CORRECT? (Round to the nearest cent.) n=5 ‘ 0 1 2 3 4 5 el Project A: | | | | | | hpv:‘l?:l'.b\?—/,s’vﬂzl‘il;l : (10,000) 1,000 2,500 3,000 5,000 5,500 m\ré 30660 F z 0 1 2 net Project B: | I | Ve -qo.qYy LEIt (10,000) 6,500 6,700 " V= -640.94 PMT>2 319U FV:0 13 a. Project B should be chosen since its profit per year is $311.28 higher than Project A’s profit per year. b. Since the projects have equal size but different lengths of life, you should use IRR to decide between the projects. c. Project A should be chosen since its profit per year is $678.68 higher than Project B’s profit per year. If you compare the NPV of A directly against the NPV of B to decide between the projects, you are assuming that the manager of B will lose money in years 3, 4 and 5 since it doesn’t make anything to cover the cost of capital. e. Project A should be chosen since its NPV is higher and would add more value to the firm. Geng, Inc. wants to choose the best group of independent projects (with equal lives) competing for the firm's fixed capital budget o1 150,0( >Using the summary of key data about the proposed projects below, which projects should the choose if it wants to do its best to maximize the firm's stock price? PV of Inflows Project Initial Investment IRR (k=18%) ypVv A ($56,000) 24.3% $75.000 14K 8 B (82,000) 20.2 102,500 204K C (48,500) 22.8 56,500 K D (63,500) 22.1 85,000 usx ( E (45,000) 239 62,000 11K (4) F (59,000) 212 68,000 4K () a. Projects A,D AD m b g:gfizmts:g,g cost: 114,500 cost: 204,500 / Projects B,D v+ 40,600 (OVEF BUDGET) . None of the above ) ALE cost: 199,500 wsts HS,SU0 WPV 44,000 npv -4, 000 page 5

: Use the following information for the next 2 questions. ’ Clayton Nugent, the CFO of Nugent Technology Incorporated is planning next year's capital budget. It is at | its optimal capital structure, which is 35 percent debt and 65 percent common equity, and the company's ‘ earnings and dividends are growing at a constant rate of 9 percent. The last dividend, Do, was $0.80, and the company’s stock currently sells at a price of $23 per share. The firm can raise debt at an 8 percent before-tax cost, and is projecting net income to be $3,800,000 with a dividend payout ratio of 20 percent. If the firm issues new common stock, a 3 percent flotation cost will be incurred. The firm's marginal tax rate is 30 percent. 14 15 16 If the company ends up spending $6,000,000 of new capital, how much new common stock must be sold? a. $0, the firm still has some retained earnings to use b. $1,924,000 c. $2,674,000 N\ =3, 800,000 = b WNSW) d. $3,140,000 2N -;S/\g' $860,000 divs RE 5 400,070 3)0”'()‘ Wo ! /\ [ D Calculate WACC? in the MCC schedule. K¢ * jgi-p * 9 Ll (560,00 ] a. 10.14 percent .50 (1-04) b. 9.40 percent Ke ¥ (q +.04 = 129090 - 11.19 percent 13(-47) ) 10.35 percent €. None of the above. \ WA ULy > Wd Kq (1-T) + Wee Ke - (3)(.09)(.7) + (-6)(-129080) 2.1035] arlo3sy. The table below provides the earnings per share value for Kemper & Co. over the past seven years. With 8 million shares outstanding, the firm’s common stock is now (1/1/19) selling for $19.50 per share, and the expected dividend at the end of the current year (2019) is 40 percent of the 2018 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 6 years of compounded growth are reflected in the data.) YEAR EPS 2015 1.50 2012 1.20 2016 1.65 2013 1.37 2017 1.72 2014 1.40 2018 1.90 The current interest rate on new debt is 8 percent. The firm’s marginal tax rate is 35 percent. The firm’s capital structure, considered to be optimal, is 20 percent debt and 80 percent common equity. Calculate the weighted average cost of capital (assume that no new common stock has to be sold). a. 10.77 percent l. 1(\+g) | ‘1 . 12.53 percent 1A % _ @ 10.53 percent N (TT) = 071599 11.86 percent - D . (q)(| (4)(1.4) e. None of the above is within 0.2 percent. KS Po +(J T T19.50 +.079698 = 1) 8568 WAL = Wl Kd (1-T) +wpe ks = (1) (- 08)(6S)+ (9 (118572) = . [051570 page 6 oL [0-537/.

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O 17 18 Camarillo, Incorporated estimates that its break point (BPgy) is $20 million, and its WACC is 12.10 percent if common equity comes from retained earnings. However, if the company issues new stock to raise new common equity, it estimates that its WACC will rise to 13.50 percent. The company is considering the following equal-life investment projects (with normal cash flows): Project Size IRR A $8 million 15.00% B 5 million 14.20 A c 4 million 1470 ©® . D 3 million 200 @ “ 18 E 2 million 12.30 (M7 F X 6 million 1270 W 1 What is the firm's optimal capital budget? w3 £ a. $23million . (3,1 4 (3Y/13.9) - 2.0 7127 X b. $22million (f)(‘”)"(“){'”) o7l | $20 million ¥ * (3) (12.0) + (3) (13:5) = B03>12 X ‘ $19 million L (L e. $17 million % 12 15 \l“‘ab Which of the following is most FALSE? a. Sensitivity analysis is by far the most commonly used type of risk analysis. It starts with a base- case NPV, and then asks a series of what-if questions. b. Operating leverage is caused by fixed costs not staying proportional to sales in the projected year. Monte Carlo simulation allows us to change more than one variable at a time when establishing a best-case scenario, a worst-case scenario, and a base-case scenario. d. The most common type of negative externality is a project’s impact on the environment. e. The Replacement Chain approach to deciding between mutually exclusive projects that have different lengths of life will always choose the same project that the Equivalent Annual Annuity approach will choose. Which of the following statements are FALSE? If the sum of the cash flows of a non-normal project is negative and the last cash flow is negative, the project must have two IRRs. ¥ If two equal-sized and equal-length profitable normal projects are mutually exclusive, MIRR must agree with NPV as to which project to choose. T As the cost of capital approaches infinity for a non-normal or normal project, the NPV of that project will approach its t=0 cash flow value. T If a project has normal cash flows (whose sum exceeds zero) and has an MIRR that is greater than the IRR, the project would have to have a negative NPV. T The MIRR will always be to the left of IRR because of the reinvestment rate assumption. F An NPV cannot be calculated for a project that does not have both negative and positive cash flows. F If the NPV of a project with normal cash flows is positive, then both the IRR and MIRR will be less = han k for the project. @) i,v,vi,vii i, vi, vii ii, iv, v, vi, U. ¢ d. i, i, iii, iv, vii e. None of the above answers is correct. page 7

20 Kimberly Baranger , CFO for Baranger’s Equipment recently purchased a tractor. The new tractor costs $53,000, and is expected to generate net after-tax operating cash flows, including depreciation, of $28,000 per year for the 4 years that the firm is thinking about keeping it. The expected year-end abandonment values for the tractor are given below. The company’s cost of capital is 12 percent. What is the optimal economic life? YEAR CASH FLOW ABANDONMENT VALUE 0 (53,000) 1 28,000 45,000 2 28,000 38,000 3 28,000 30,000 4 28,000 20,000 a. The EAA method confirms that the economic life is 1 year. . The EAA method confirms that the economic life is 2 years. The EAA method confirms that the economic life is 3 years. . The EAA method confirms that the economic life is 4 years. e. An economic life of 3 years ties with an economic life of 4 years. (D) wev (12,-63070, 28,070 +45000}) = 12,179.51 n=l L=It PV=11]79.67 V=0 pMT T =2 13,0640 () v (1, -$3070, § 28000, 15070 + 330008 = 14014 -§0 BneLl L= V=268 V=0 PMT2 7 1460H1.S3 (® wpv (12, ~$3070, 318000, 15010, L4VVD +30000%) = 356046 ne3, 1212 Ve 5560 b PV >0 PMT? =2 1492397 (D wpv (12, ~53000, 25070, L4000, RUUD, 1000 £ 240005) =44 756 I naU =12 PV YqIS61Y py=0 PMTY=) IMT3S 10 21 Given the following information, which of the following statements is most FALSE? Historical Yr | Projected Yr - [ sales 185,000 215000 | “iw * L 0ULL Y pois ";‘“‘" ST RS ERR RN (A EBIT 115,000 140000 | S = 1) 9341 eiciis > y . mo - 7 opy - L0 = 1.6L EBT 79,000 99,000 |43 = 5316/ OFL =g = 116S NI 60,000 75,190 530 EPS 1.22 1.5289 L1531 604 poL=1-34 a. The degree of total leverage is 1.5610. T DRL=116S b. The degree of operating leverage is 1.3403. T DTL=1.50 c. The degree of financial leverage is 1.1647. T d. Itis appropriate that EBT and NI increased by the same percentage. T The financial leverage was caused by the fixed cost not staying proportional to Sales. INTEREST page 8

22 Jacob Arrell Corporation has sales revenue of $9,500,000. The company's fixed costs total | $5,000,000, its variable costs are 15 percent of sales, and its interest expense is $1,000,000. If the company wants to increase its EPS by 30%, how much will it need to increase its Sales? i a. 20.24 percent o T N8 - S ' e 7.71 percent %j“ ! sve |, As-usD) g . 11.42 percent Eez‘;r 230/ WL s-v—’c_-?:l 4.5-115%9.5) -5-1 d. 48.19 percent . 4B 30 . e. 16.75 percent m = 1.117/. 23 Kyle Sanders is interested in building a new hotel in Christchurch, New Zealand. His company estimates that the hotel would require an initial investment of $58 million, would produce positive cash flows of $14.5 million a year at the end of each of the next 10 years and can be salvaged (after- tax) for $50 million at t=10. The company recognizes that the cash flows could, in fact, be much higher or lower, depending on whether that area becomes a popular tourist area. It is believed that at the end of two years, a 40 percent chance exists that tourism will NOT be spreading in that direction and yearly cash flows will be only $10 million for 10 years with an after-tax salvage value of $30 million, and a 60 percent chance exists that tourism WILL be heading that way and the yearly cash flows will be $20 million for 10 years with an after-tax salvage value of $80 million. If the firm waits two years, the initial investment will be $60 million. The project’s cost of capital is 13 percent. Should the firm proceed with the project today or should it wait two years before deciding? (Round NPVs to the nearest dollar.) a. Wait 2 years; the NPV of building today is $1,744,254 worse than the NPV for waiting two years. b. Wait 2 years; the NPV of building today is $48,613 worse than the NPV for waiting two years. Build now since the NPV of building today is $563,682 better than the NPV for waiting two years. ‘ Build now since the NPV of building today is $1,224,614 better than the NPV for waiting two years. e. Build now since the NPV of building today is $1,534.811 better than the NPV for waiting two ears. Y (0] \ Z 10 137\ | NN { ! ' ' 4.S S : L L 50 45,404,941.9] = .61 npv (13,758, {145, 14.5 +60F §4,1% z,q,;:t:.zzsle =35 404,947. ¢ ) 0 \ 1 3 4 pat 4 —1— o @ W W 30 () (242191 4 6) npv (13,0, 50,760, 10, 10¥30%, §1,1,9,11) ¥ (16) (5649850 6S) =% 1,411, 81 .45 . 424 846,265.57 r 3 ey —— W — Less ﬂaamaw o 0 -L,o 0 10 -ég NPV of N ’ npv (13,0, £0,760,20, 20+0041,1,4)) - 464,458,501 . 65 page 9

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24 25 Which of the following statements is most FALSE? a. The passage of the new Tax Cuts & Jobs Act reduces the value of the tax deduction associated with debt financing because the new tax rate for corporations is a flat 21%. T b. A mature firm that issues a bond to finance an upcoming project is giving a positive signal regarding the prospects of the project. % T c. The text says that increasing a firm’s debt makes managers less frivolous because if the debt is not serviced as required, the firm will be forced into bankruptcy, in which case its managers would lose their jobs. T d. Managers’ preferred pecking order for raising funds is first accounts payable and accruals, then retained earnings from the current year, then issuing debt, and issuing new common stock as a last resort. T @ When a company’s stock is overvalued (trading for more than its intrinsic value), its managers like to take this opportunity to repurchase the company’s stock. ¥ Sophie Schultz & Co. is trying to estimate its optimal capital structure. Right now, the firm has a capital structure that consists of 64 percent debt and 36 percent equity. The risk-free rate is 1.4% and the market risk premium is 6%. Currently the company’s cost of equity, which is based on the SML, is 12.78% and its tax rate is 35%. What would be the firm"s estimated cost of equity if it were to change its capital structure to 55% debt and 45% equity? a. 9.96 percent b. 10.11 percent c. 10.52 percent @ 10.87 percent €. 11.93 percent 1279 = 14+ 6b b= 1.09067 P2 - - 879841 Q+0-TUP] (1F (69 (50)] bo® o [T+ 0] - 979997 [1+ (6OEE)] = 157191 Koz 14+ 6(1:5799) +10.97 '/.}

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ISBN:9780077861759

Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor

Publisher:McGraw-Hill Education

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