LEE Corporation intends to purchase equipment for $1,000,000. The equipment has a 5 year useful life

LEE Corporation intends to purchase equipment for $1,000,000. The equipment has a 5 year useful life

Subject: Business    / Finance   
Question
LEE Corporation intends to purchase equipment for $1,000,000. The equipment has a 5 year useful life
and will be depreciated on a straight-line basis to a salvage value of $250,000. LEE?s marginal tax rate is 30%.
Use of the equipment is expected to change the company?s reported EBIT by $300,000 in year one, $350,000 in
year two, $350,000 in year three, $200,000 in year four, and $150,000 in year five. Net working capital
associated with the new machine is equal to 10% of EBIT.

1) The free cash flow in year 1 is:
A) $395,000 B) $305,000 C) $330,000 D) $390,000

2) The free cash flow in year 2 is:
A) $395,000 B) $305,000 C) $330,000 D) $390,000

3) The free cash flow in year 3 is:
A) $395,000 B) $305,000 C) $330,000 D) $390,000

4) The free cash flow in year 4 is:
A) $395,000 B) $305,000 C) $330,000 D) $390,000

5) The terminal cash flow in year 5 is:
A) $255,000 B) $260,000 C) $510,000 D) $495,000

6) If the risk-adjusted discount rate for this project is 12%, calculate the projects net present value.
A) $355,672 B) $369,922 C) $372,634 D) $381,782

7) The risk free rate of return is 2% and the market risk premium is 10%. Twindle Industries has a
beta of 1.5 and a standard deviation of returns of 18%. Twindle?s marginal tax rate is 35%.
Analyst?s expect Twindle?s dividends to grow by at least 5% per year for the next 5 years. Using
the capital asset pricing model, what is Twindle?s cost of retained earnings?

A) 17% B) 13% C) 12% D) 14%

8) Keys Manufacturing Company paid a dividend yesterday of $1.50 per share (D0 = $1.50). The
dividend is expected to grow at a constant rate of 7% per year. The price of Keys? common stock
today is $19 per share. If Keys decides to issue new common stock, flotation costs will equal
$1.00 per share. Keys? marginal tax rate is 35%. The cost of new common stock is:

A) 11.75% B) 15.92% C) 15.33% D) 8.99%
9) Heston Mfg. has five possible investment projects for the coming year. Each project is indivisible.
They are:
Project Investment (million) IRR
A $ 8 22%
B $10 18%
C $ 4 15%
D $ 4 13%
E $ 2 10%
Heston?s weighted marginal cost of capital schedule is 12 percent for up to $23 million of
investment; beyond $23 million the weighted cost of capital is 14 percent. The optimal capital
budget is:
A) $18 million. B) $22 million. C) $26 million. D) $23 million.
10) Which of the following would be a method of improving a firm?s economic profit? Assume all
else equal.
A) Identify and improve operating efficiencies.
B) Increase sales.
C) Recapitalize the firm to reduce its cost of capital.
D) All of the above.
11) Acme Manufacturing Company reported that its sales increased by 5%, but its net income
increased by 20%. The much larger change in net income could be the result of:
A) a high degree of financial leverage.
B) a high degree of operating leverage.
C) a low degree of operating and financial leverage.
D) either A or B, or both.

12) A plant may remain operating when sales are depressed:
A) to help the local economy.
B) unless variable costs are zero when production is zero.
C) in an effort to cover at least some of the variable cost.
D) if the selling price per unit exceeds the variable cost per unit.

13) Potential applications of the break-even model include:
A) replacement for time-adjusted capital budgeting techniques.
B) optimizing the cash-marketable securities position of a firm.
C) pricing policy.
D) all of the above.
14) Based on the data contained in Table A, what is the break-even point in units produced and
sold?
Table A
Avg. selling price per unit $12.00
Variable cost per unit $9.00
Units sold 150,000
Fixed costs $300,000
Interest expense $ 50,000

A) 100,000 B) 18,182 C) 50,000 D) 116,666
15) Based on the data contained in 9 ? Table A, what is the contribution margin per unit?
A) $27.00
B) $3.00
C) $4.00
D) none of the above
16) Based on the data contained in 9?Table A, what is the degree of operating leverage?
A) 3.00 times B) 1.50 times C) 4.00 times D) 1.33 times

17) Based on the data contained in 31?Table A, what is the degree of financial leverage?
A) 4.50 B) 1.87 C) 1.50 D) 6.67

18) Based on the data contained in 31?Table A, what is the degree of combined leverage?
A) 4.50 B) 1.87 C) 1.50 D) 4.67
19) Which one of the following is not a limitation of break-even analysis?
A) The total revenue curve (sales curve) is presumed to increase linearly with the volume of
output.
B) The break-even chart and the break-even computations are static forms of analysis.
C) Cost-volume-profit relationship is assumed to be linear.
D) Break-even analysis assumes a constant capital structure.