VIEWS: 12 PAGES: 36 POSTED ON: 10/18/2012 Public Domain
A Which of the 1 following statement is correct? 2 >One drawback of the discounted payback is that this method does not consider 3 the time value of money, while the regular payback overcomes this drawback. >If project's payback is positive, then the project 4 should be accepted because it mush have a positive NPV. >The shorter a 5 project's pay back period, the less desirable the project is normally considered to eb by this criterion. >The regular payback ignores cahs flows beyond the payback 6 period, but the discounted payback method overcomes this problem. >One drawback of the discounted payback criterion is that this 7 method does not take account of cash flows beyond the payback period 8 A Which of the 1 followign statements is correct? 2 >The modified internal rate of return method (MIRR) is generally regarded by 3 academics as being the best single method for evaluating capital budgeting projects. >The internal rate of return method (IRR) is generally regarded by 4 academics as being the best single method for evaluation capital budgeting projects. >The net present value method (NPV) is generally regarded by 5 academics as being the best single method for evaluating capital budgeting projects. >The payback method is generally regarded by academics 6 as being the best single method for evaluating capital budgeting projects. >The discounted payback method is generally 7 regarded by academics as being the best single method for evaluating capital budgeting projects 9 A B C D E F Berhman Foods is evaluating a 1 project with the following annual net cash flows: 2 3 4 0 1 2 3 4 5 ($600) $50 $100 $150 $350 6 Because Behrmann is a small firm with limited resources, its managers 7 worry about how long capital will be tied up in projects. What is this project's payback period? Assume that Behrmann's cash flows are spaced evently throughout the year. 8 3.51 years 9 4.12 years 10 4.24 years 11 3.86 years 12 3.69 years 13 14 15 Some fo Behrmann's 16 managers use a general guideline when evaluating projects: accept projects that pay back their investment in less than four years. If you use this "payback rule" to evaluate the project described above, should Behrmann accept the project? 17 18 No 19 Yes 20 21 22 If the 23 prokect's WACC is 10.9%, what is its NPV? 24 25 ($53.07) 26 ($72.63) 27 ($69.44) 28 ($62.98) 29 ($75.79) 30 31 If Behrmann's 32 managers decide to accept the project based on its impact on shareholder value, should they accept the project? 33 34 No 35 Yes 36 10 A B C D E F Ford Industries is evaluating two mutually 1 exclusive projects with the following net cash flows: 2 3 0 1 2 3 4 4 Project A ($2,000) $300 $500 $800 $1,200 5 Project B ($2,000) $1,000 $800 $500 $200 6 Ford's WACC is 8.7% and both projects have the same risk as the firm's 7 average prject. Calculate each project's net present value (NPV) 8 9 NPV A 10 $146.50 11 $101.01 12 $134.99 13 $193.44 14 $181.56 15 16 NPV B $78.96 17 $93.21 18 $129.58 19 $139.99 20 $100.39 21 Ford CFO has instructed managers 22 to use the IRR method when choosing between mutually exclusive projects. If managers choose the project with the highest IRR, ho much value will be lost? (Hint: If the project with the highest IRR also has the highest NPV, then no value is lost because the firm selects the project that adds the most value. Otherwise, the difference between the two project' NPVs is the value lost from using the IRR method instead of the NPV method). 23 24 $51.98 25 $43.20 26 $47.57 27 $30.37 28 $0 29 11 A B C D E F Calvert Constructio n is analyzing a 1 highly profitable project with the following cash flows: 2 3 0 1 2 3 4 4 ($8,000) $4,500 $4,500 $3,000 $3,000 5 6 The project has the same risk as the firm's 7 average project. Calculate the project IRR. 8 27.89% 9 29.12% 10 36.61% 11 25.46% 12 34.35% 13 14 Some managers think the "expected rate of return" on the project will be overstated if they use the IRR Method. 15 They think that intermediat ed cash flows received from the project can only be reinvested at the firm's WACC of 14.0%. Calculate the MIRR. 16 24.54% 17 25.04% 18 23.03% 19 27.57% 20 24.04% 21 12 A B C D E F 1 2 3 You are evaluating the project with cash 4 inflows as shown below. Your boss 5 6 0 1 2 3 4 5 7 $500 $800 $800 $800 $600 8 9 If the 10 project WACC is 9.9%, what is its NPV? 11 $142.67 12 $170.75 13 $101.39 14 $47.90 15 $128.80 16 13 A B C D E Brandy Inc. is analyzing with 1 the following cash flows: 2 3 4 0 1 2 3 4 5 ($3,000) $1,200 ($400) $1,800 $1,800 6 This project has ? Cash flows. Brandy's WACC is 10.6% and the project has the same risk as 7 the firm's average project.Calcula te this project's modified internal rate of return (MIRR). 8 >normal 9 >non-normal 10 11 12.57% 12 12.80% 13 12.72% 14 12.87% 15 12.95% 16 17 18 If Brandy's managers select projects 19 based on the MIRR criterion, should they accept this independent project? 20 21 No 22 Yes 23 14 A Conclusion s about 1 capital budgeting Which of the following conclusion s about 2 capital budgeting are valid? Check all that apply. 3 >Managers have been slow to adopt the IRR because 4 percentage returns are a harder concept for them to grasp. >The NPV is the best project criterion because it shos how 5 much value the company is creating for its shareholders . >The 6 discounted payback period improves on the regular payback period accounting for the time value of money. >Because the MIRR and NPV use the same reinvestment rate assumption, 7 they always lead to the same accept/reject decision for mutually exclusive projects >BecauseN PV is the best project criterion, only it 8 should be used and the other criteria should be ignored. Chapter 12----> 15 A B 1 Hunter Industries is evaluating a capital budgeting project and has come across a few issues that require special attention. Classify each item as a 2 sunk cost, externality, opportunity cost, or a change in net operating working capital (NOWC). Then, in the last column, indicate whether the item should be included in the project's analysis or not. 3 Sun 4 Cos The new project is expected to reduce sales revenue for one of the company's 5 other product lines. 6 The project will use some equipment that the firm owns but isn't using 7 currently. However, a used equipment dealer has offered to buy the equipment 8 Hunter spent nearly $1.1 million in market research to develop new product 9 ideas. 10 11 Many of the new sales from this project will be made on credit, causing account receivable to increase. 12 The factory that the project will use could be used for another project that is 13 expected to have a slightly positive net present value (NPV) 14 15 16 17 Suppose Hunter will be issuing debt to support this project and other 18 capital budgetting projects this year. The firm's interest expense will increase by $700,000. Should the change in interest expense be included in the analysis? 19 20 Yes 21 No 22 16 A B C D E 1 Bancroft Inc. has summarized 2 the expected cash flows from a proposed project below. 3 t=0 t=1 t=2 t=3 4 Total Investment outlay ($400,000) 5 Operating Cash flow, OCF $120,000 $120,000 $120 6 Total Termination cash flow 7 8 9 10 If the project's WACC is 10.5% , what is the project NPV? 11 12 $18,911.39 13 $13,193.42 14 $15,085.40 15 $7,599.93 16 $9,450.82 17 18 19 The firm used its WACC of 10.5% to evaluate this project because it believes the project is of average risk. Support the 20 project actually had lower- than-average-risk, and the CFO thinks the WACC should be risk-adjusted. What effect would this have on the project's NPV? 21 22 >Decrease NPV 23 >No effect on NPV 24 >Increase NPV 25 26 Bancroft Inc. is going to use factory space for this project that it usually rents to other firms. If this project is accepted, Bancroft will not be able to rent the space any 27 time. If the firm usually generates $10,000 a year in after-tax leasing revenuw from the factory space, what is the value of the prject when you consider this factor? Assume Bancroft still considers the project to have average risk and uses a WACC of 10.5% 28 29 ($19,908.96) 30 ($11,059.94) 31 ($18,165.16) 32 ($9,250.49) 33 ($21,640) 34 35 36 Suppose Bancroft's management team discloses that nearly $400,000 in 37 research and development costs were incurred before the new project proposal was put together. What effect would this have on the project's NPV? 38 39 >Decrease NPV 40 >No effect on NPV 41 >Increase NPV 42 17 A 1 Grant Publishing just undertook a project that required a $290,000 investment in NOWC, which will recovered fully at the end of the project's life in five years. At 2 that time, the required equipment will not be depreciate d fully and still will have a book value of $100,000. The firm's tax rate is 40%. If the salvage value at the end of five years turns out to be $100,000, what will be the project's total terminatio n cash flow? 3 4 $370,000 5 $410,000 6 $400,000 7 $360,000 8 $390,000 9 10 Suppose that in five years, Grant Publishing 11 actually is able to get $140,000 for the equipment even thought it has a book value of only $100,000. What is the project's terminal year cash flow now? 12 13 $480,000 14 $398,000 15 $414,000 16 $464,000 17 $406,000 18 19 Now suppose the equipment gets sold for $50,000 20 in five years,. What is the project's terminal year cash flow now? 21 22 $356,000 23 $336,000 24 $360,000 25 $414,000 26 $340,000 18 A Durning Inc. is evaluating a new capital budgeting project and conductin g some basic risk 1 analysis. First, it calculated the project's NPV at various levels for the project's key inputs: price per unit, variable cost per unit, and the project's WACC. This process is a 2 >simulation 3 analysis >sensitivity 4 analysis >scenario 5 analysis 6 whose results are 7 graphed below 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 According to this analysis, which 38 variable is the key value driver for the project? 39 40 >WACC >Variable 41 cost per unit >Price per 42 unit 43 44 At the current input value 45 estimated, does this project have a positive or negative NPV? >Negative 46 NPV >Positive 47 NPV 48 49 Which type of firm is 50 more likely to base its decision on stand- alone risk? >A small, closely held firm whose owners 51 have much of their wealth tied up in the firm >A large, widely held firm whose owners are well diversified 52 and do not have very much of their wealth tied up in the firm