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FINA CH.7 Discounted Cash Flow Techniques Exam
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Which of the following is not a significant step in the financial evaluation of an investment opportunity?
- ANSWER B. Estimate the accounting rate of return for the investment.
Which of the following figures of merit may not use all possible cash flows in its calculations? I. Payback period II. Internal rate of return III. Net present value (NPV) IV. Accounting rate of return - ANSWER D. I & IV only
Which of the following figures of merit does NOT directly consider the time value of money?
I. Payback period II. Internal rate of return III. Net present value (NPV) IV. Accounting rate of return ANSWER E. I & IV only
Ian is going to receive $20,000 six years from now. Sunny is going to receive $20, 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 - ANSWER C. In today's dollars, Ian's money is worth more than Sunny's
You want to purchase a new Mercedes in four years. You know that the car cost $82,
today and that the price is increasing at an annual rate of 4.8 percent per year over the next four years. How much will your dream car will cost by the time that you are ready to purchase it? n= i=4. PV=-82, FV? - ANSWER FV=99,517. Future value = $82,500 x (1 +.048)4 = $99,517.
Your grandmother invested a lump sum 26 years ago at 4.25 percent interest. Today, she gave you the proceeds of that investment which total $51,480.79. How much did she originally invest? n= i=4. PV=? FV=51,480.79 - ANSWER PV=17,444.
Present value = $51,480.79 x [1/(1 +.0425)26] = $17,444.
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? n= i=. PV=? PMT=1400 - ANSWER E. You should accept the $200,000 lump sum because the monthly payments are only worth $195,413 to you today.
The number of monthly periods = 20 x 12 = 240; the monthly interest rate = 6%/12 = 0.5%.
PMT=
FV=2500 - ANSWER B. $2,168.
Solve for the PV of the cash inflows, and then subtract the initial investment: 1111,668.02-9,500 = 2,168.
Which of the following should be included in the analysis of a new product?
I. Money already spent for research and development of the new product II. Reduction in sales for a current product once the new product is introduced 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 - ANSWER A. II and III only
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. - ANSWER B. II and III only
Which of the following statements about IRR are TRUE?
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 understand.
IV. The IRR is the best tool available for deciding between mutually exclusive investments - ANSWER B. I and III only
You expect to buy a share of preferred stock for $50 that pays a $2.40 dividend every year forever. What annual rate of return will you earn? - ANSWER C. 4.80 percent
r = A/P = $2.40/$50 = 4.80%
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? n= 4 i= PV=? PMT=26, FV=3,000 - ANSWER E. $32,409. The initial investment includes the fixed assets and incremental working capital: $39,000 + $3000 = $42,000. The working capital amount is recovered at the end of year
- Solve for the PV of the cash inflows, and then subtract the initial investment:
What is the benefit-cost ratio for an investment with the following cash flows at a 14. percent required return?
y0 = -46, y2 = 12, y3 = 11,300 - ANSWER C. 1. PV inflows = (12,200/1.145) +(38,400/1.145^2) + (11,300/1.145^3) = 47,472.
BCR = 47, 472.78/46,500 = 1.
