Fine 3010 Exam 2

Fine 3010 Exam 2 | Tulane University 

Question 1

In class we talked about the choice that a firm faces regarding net income. They can pay the earnings out as a dividend or retain the earnings within the firm to support firm growth.  Most firms actually pay out some and retain some, thereby avoiding an “all or nothing” approach.  

Think about the relationship between the market rate of return (“r”) and the return from the firm’s internal investment opportunities (“ROE”).  How does this relationship affect the firm’s decision whether to pay out dividends or not?  If all else is held constant, explain the expected movement of the stock price given the payout decision and the relationship between the above-described returns (“r” and “ROE”).

Give a numerical example to support your answer above. Use your own assumptions for “r,” “ROE.” Then change the payout ratio while using the dividend discount model to show whether value is affected.

 

Question 2

Your company has come up with a new product with a 3-year life (pretend you’re introducing a trendy product, which will not survive long in the marketplace). Your firm paid $50,000 for a Tulane intern to perform a financial analysis last month to determine the potential demand for the product (not bad pay, eh?). It is felt that the new product will generate sales of $400,000 per year.  The fixed costs associated with this will be $100,000 per year, and variable costs will amount to 20 percent of sales.  The equipment necessary for production of the product will cost $360,000 and will be depreciated in a straight-line manner for the three (3) years of the product’s life to a salvage value of 0. (In reality, you predict that your equipment will be able to be sold for $60,000 at the end of year 3). Needed Net Working Capital levels are projected as follows:  $10,000 for Year 1;  $15,000 for Year 2;  $0 for Year 3. Your firm has a marginal tax rate of 30% and an average tax rate of 20%. Your firm’s required rate of return on projects with the same risk as this product is 12%. Calculate the NPV of this project. Should you accept or reject it?

 

Question 3

A new machine will cost $200,000 and generate after-tax cash inflows of $70,000 for four (4) years. Calculate the NPV, IRR, Profitability Index and Payback Period for this project, given a 12% opportunity cost of capital. Tell me whether you'd “accept or reject” this project using each of these 4 methods. Support your decision using each method.

 

Question 4

A small technology firm currently pays no dividends. You overhear the CFO tell the CEO that the plan is to begin paying dividends in 3 years. The first dividend will be $2.00. Dividends are expected to grow at 10% for the following two years and then 4% thereafter, forever. Given a required return of 16%, what would you pay for the stock today?

 

Question 5

A parcel of corporate land that your firm owns will be used for a new plant site.  Based on the following information, which item(s) would be included in the initial investment for your NPV analysis?

•             Your firm originally bought the land in 2004 for $200,000

•             The land’s current fair market value is $300,000

•             A recent offer was made to purchase the land from your firm for $250,000.

 

Question 6

Look at the following stock table from the close of today. What price must Gap have closed at on the previous trading day?

 

       52 Weeks                                                                                           Vol

       Hi           Lo         Stock     Sym         Div           Yld%         PE         100s              Hi             Lo             Close             Chg.

      126.25   72.5       Gap       GPS         1.30         1.32         16        20925        98.375    97.875          98.375      +0.125

 

Question 7

A firm generates sales of $300,000, depreciation expense of $60,000, taxable income of $120,000, and has a 21% tax rate.  By how much does operating cash flow deviate from net income for this company?

 

Question 8

2 / 4 pts

What is the EAC (Equivalent Annual Cost) of the following stream of expenses? Assume an interest rate of 15%

Period 0:                     - $60,000

Period 1:                     - $10,000

Period 2:                     - $20,000

Period 3:                     + $30,000

 

Question 9

You are going to choose 1 of 2 investments. Both investments cost $80,000, but investment A pays $40,000 a year for 3 years and investment B pays $30,000 a year for 4 years. If your required return is 13%, which should you choose? Support your choice of evaluation method and answer.

 

Question 10

Suppose Disney, Inc. has just paid a dividend of $2.40 per share. Sales and profits for Disney are expected to grow at a rate of 6% per year. Its dividend is expected to grow by the same rate. If the required return is 14%, what is the value of a share of Disney today?

 

Question 11

Which of the following is a characteristic of a dealer market, rather than auction market, for common stock?  

·         Dealer markets operate as primary, not secondary, markets.  

·         Dealer markets are more likely to be centralized.  

·         Dealers may not all offer the same price for the same security.  

·         Dealer markets specialize in trading income stocks.

 

 

Question 12

Ranking conflicts can arise in IRR versus NPV when  

·         projects are independent of one another    

·         projects are mutually exclusive  

·         the initial investment cash flow is negative and the remaining cash flows are positive  

·         a project has more than one NPV

 

 

Question 13

Which of the following is a characteristic of secondary markets for common stock?  

·         Secondary markets are where corporations borrow funds.  

·         Secondary-market trades do not provide funds for corporations whose stock is traded.  

·         Only high-risk shares are traded in these markets. 

·         Only low-priced shares are traded in these markets.

 

 

Question 14

Which of the following statements regarding NPV analysis is correct?  

·         NPV calculations will be correct if the wrong discount rate is used  

·         NPV calculations are only as good as the information that goes into their calculation  

·         Negative NPV projects should be scrutinized to make sure there is a sound economic basis underlying them  

·         NPV calculations do not depend critically on cash flow projections  

·         Positive NPV projects that have relatively low levels of fixed costs should be more heavily scrutinized than projects with relatively high levels

 

Question 15

Net present value ____________________.  

requires the firm set an arbitrary cutoff point for determining whether an investment is a good one or not  

·         is equal to the initial investment in a project  

·         is equal to zero when the discount rate used is less than the IRR  

·         is simplified by the fact that future cash flows are easy to estimate  

·         compares project cost to the present value of the project benefits

 

 Question 16

An 8-year project costs $475 and has cash flows of $100 for the first three years and $75 in each of the project's last five years. What is the payback period of the project?  

·         4.333 years  

·         4.75 years 

·         5.333 years

·         Not enough information is given to solve  

Question 17

What is the decision rule for IRR? 

·         Accept a project if the IRR exceeds the firm's required rate of return  

·         Reject any project if the IRR is below 10% 

·         Accept a project when IRR > 0  

·         Accept a project if at the IRR the NPV is positive  

·         Accept a project if the IRR exceeds the firm's bank borrowing rate

 

Question 18

Which of the following is true about the differences between debt and common stock?  

·         periodic payments made to either class of security are tax deductible for the issuer  

·         interest payments are promised while dividend payments are not  

·         creditors have voting power while stockholders do not  

·         debt is ownership in a firm but equity is not

 

 Question 19

Reinvesting earnings into a firm will not increase the stock price unless 

·         the ROE of new investments exceeds the firm's required return.  

·         true depreciation is less than reported depreciation.  

·         the firm's dividends are growing also.  

·         the stockholders can better invest the earnings on their own via a cash dividend.

 

Question 20

Which of the following consider the time value of money in their computation?

·         Payback

·         Net Present Value

·         Profitability index  

·         II and III only  

·         III only  

·         I and III only  

·         I only

 

Question 21

Which of the following is NOT a right of an owner of a share of common stock?  

·         the right to vote for directors  

·         preference over preferred shareholders in the payment of dividends  

·         the right to share proportionately in dividends paid  

·         the right to share proportionately in assets remaining after liabilities have been paid in a liquidation  

·         the right to vote on stockholder matters of great importance

 

Question 22

A grant of authority by a shareholder allowing for another individual to vote his/her shares is a _____________.  

·         dual class stock  

·         cumulative voting right  

·         specialist  

·         preferred stock  

·         proxy

 

Question 23

Which of the following describes a seasoned equity offering?  

·         An IPO of common stock for a well known firm.  

·         An additional equity issue from a publicly-traded firm.  

·         Any shares traded in the secondary market are seasoned offerings.  

·         An IPO that is offered during the best buying season.

 

Question 24

To find the ___________ we begin by setting the NPV of a project equal to zero.

I. Payback period

II. Future Value

III. Profitability index

IV.  Internal rate of return  

 

·         I only

·         II and IV only  

·         II only   

·         IV only  

·         III and IV only

 

 

Question 25

When projects are mutually exclusive, selection should be made according to the project with the...?  

·         longer life.  

·         highest NPV.  

·         larger initial size.  

·         highest IRR.

 

Question 26

Which of the following statements is correct for a single project with a positive NPV and a “normal” stream of cash flows?  

·         The discount rate exceeds the cost of capital.  

·         Accepting the project has an unknown effect on shareholders.  

·         The profitability index equals one.  

·         IRR exceeds the hurdle rate.

 

 Question 27

Which of the following is NOT considered a relevant cash flow in capital budgeting analysis?  

·         Fixed asset salvage values at end of project  

·         Additional operating cash flows generated from a project 

·         Erosion 

·         Sunk cost  

·         Opportunity cost

 

Question 28

What is meant by a “normal” stream of cash flows for a project?  

·         The project must have cash flows like an ordinary annuity.  

·         The project has two outflows – one at time 0 and one at the end of the project.

·         The project must have cash flows like a perpetuity.   

·                    The project has one outflow (initial investment) at time 0, followed by non-negative inflows thereafter.