Subject: Business    / Finance   
Question
1. What is meant by mutually exclusive projects?

a.    projects that clash and would cause the company to exclude the benefits of the project on its cash flows

b.    when the option to invest in future projects occurs sequentially

c.    when the cash flows of one project are excluded because they are uncertain

d.    two competing projects, such as whether to buy a blue delivery truck or a red one

2. Gerhardt Corporation is planning on spending £45 million to build a new plant. They believe the plant will lower costs by £14 million for the next five years. If Gerhardt Corporation’s cost of capital is 15%, should they accept this project?

a.    yes, the NPV is £25 million

b.    yes, the NPV is £1.93 million

c.    yes, the IRR is greater than 15%

d.    b and c

3. The payback of an investment is 2.25 years. The project’s cash flows are as indicated below. What s the IRR of the investment project?

Year Cash Flow
1 $1,000

2 $1,500

3 $2000

4 $2500

a.    not enough information

b.    3.73%

c.    37.3%

d.    29.2%

4. What is the average book value of a project with an initial outlay of $500,000 that is depreciated to a salvage value of $150,000 over 5 years?

a.    $ 30,000

b.    $ 70,000

c.    $100,000

d.    $325,000

5. What is the profitability index of a capital investment project that cost the firm $100,000 and has cash flows of $20,000, $25,000, $40,000, $50,000 in years one through four, respectively? The cost of capital is 9%

a.    1.057

b.    1.350

c.    1.642

d.    1.683

6. What is the reason a project can have a positive net present value, yet the project’s internal rate of return is less than the cost of capital?

a.    this situation cannot exist – NPV and IRR always agree

b.    the cost of capital is less than the two year treasury note rate

c.    the timing of the cash flows

d.    the cash flows were improperly calculated
7. Why is net present value a more reliable indicator of investment suitability than IRR?

a.    it isn’t – IRR is the preferred capital budgeting decision criteria

b.    net present value uses discounted cash flows and internal rate of return does not consider the time value of money

c.    internal rate of return is easily comparable to other investment returns
d.    net present value accurately discounts the cash flows at the firm’s cost of capital.

8. When does the multiple IRR problem occur?

a.    when the heaviest cash flows occur at the beginning of the project

b.    when the smallest cash flows occur at the beginning of the project

c.    when the cost of the investment is greater than the total of all cash flows

d.    when there are multiple cash flow sign changes (from negative to positive cash flows more than once)

Use the following information to answer questions 9 – 13

Vitron Inc. is considering an investment in new capital equipment that will cost €250,000 plus an additional €15,000 investment in inventory to operate the equipment. They expect sales to increase by €177,000 a year for the next 6 years. Vitron executives are expecting expenses and costs to generate those sales will be €93,000 per year for the next 6 years. The company is in a 30% tax rate and is depreciating the equipment using the 5 year convention of Modified Accelerated Cost Recovery System (MACRS). The company expects to recover the investment in inventory in year 6, but expects the equipment will be worthless. The cost of capital for Vitron is 12%.

MACRS 5 year life

|Year: 1 2 3 4 5 6 |

| Rate: 20% 32% 19.2% 11.52% 11.52% 5.76% |

9. How much will Vitron have to spend today to make this investment?

a.    €177,000

b.    €250,000

c.    €265,000

d.    €427,000

10. What are the operating cash flows in year 3?

a.    € 58,800

b.    € 73,200

c.    € 93,000

d.    €106,800

11. What is the NPV of Vitron’s potential investment in capital equipment?

a.    €32,107.99

b.    €41,371.24

c.    €39,707.50

d.    €47,107.98

12. What is the IRR of Vitron’s potential investment in capital equipment?

a.    16.34%

b.    17.22%

c.    18.68%

d.    19.53%

13. If Vitron’s stock is trading for €39 per share on the Italian Borse, and they have 200,000 shares outstanding, in an efficient market by how much will Vitron’s stock increase if they accept this investment?

a.    it will decrease the value of the investment

b.    €0.1605

c.    €0.2069

d.    €0.1985

Capital Structure and Leverage

14. Constable LLC has a high degree of financial leverage. Analysts estimates of Constables’ earnings can be expected to be..

a.    highly reliable and relatively simple to estimate

b.    highly volatile and difficult to estimate

c.    dependant upon Constable’s degree of operating leverage

d.    independent of the market’s expected return

15. Forquay SA and Balister SA both had operating income of £1,000,000 from sales of £4,000,000. Both companies sold 100,000 units of their products. However, Forquay had variable costs per unit of £15 and fixed operating costs of £1,500,000. Balister’s variable costs per unit were £9 and fixed operating costs of £2,100,000. If both Forquay and Balister sell 150,000 units next year and maintain their fixed operating costs, what will be their operating profit?

a.    it’s impossible to determine

b.    £3,750,000 for Forquay and £3,450,000 for Balister

c.    £2,250,000 for Forquay and Balister

d.    £2,250,000 for Forquay and £2,550,000 for Balister

16. If HaloCorp produces 8 million units, and estimates a sales’ price of €80 each. The variable production costs are €35 per unit, whereas the fixed production costs are €200 million. Which of the following statements are true?

a.    If Halo produces and sells 4 million units or more, they will produce an operating profit

b.    Halo’s degree of operating leverage is 2.25

c.    If Halo can increase the units sold by 10%, its operating earnings should increase by 30%

d.    increasing the fixed production costs by 15% will result in a lower sensitivity of operating earnings to changes in the units produced and sold

17. If a company can sell all it produces in a single year and is able to increase the number of units sold from 2,500,000 to 2,625,000 while increasing operating income from ¥865,000,000 to ¥951,500,000, what is their degree of operating leverage.

a.    2

b.    2.5

c.    5

d.    10

18. PSDl, Inc. sold 200,000 units at $50 per unit. They have variable costs of $20 per unit and total fixed operating costs of $200,000. Which of the following is PSDI’s contribution margin?

a.    $50

b.    $2,000,000

c.    $3,000,000

d.    $6,000,000

19. Which of the following defines contribution margin?

a.    the fixed costs contributed to the total expenses
b.    the sales price less variable expenses

c.    the variable expenses times the number of units sold

d.    the sales price less the fixed expenses

20. Syoundia Steel now sells 2 million units of their product at ¥2,500 each. Fixed operating costs are ¥1.75 million and variable operating cost are ¥1,100 per unit. If the company pays ¥600 million in interest, the levels of sales at the operating breakeven point is

a.    ¥1,250,000

b.    ¥1,750,000

c.    ¥3,125,000

d.    ¥4,196,429

21. Helvetica Ltd. expects sales of 500,000 units at €82.5 per unit. Fixed operating costs should be €11,550,000 and variable costs per unit of €27. At what quantity can Helvetica expect to breakeven?

a.    103,296

b.    115,500

c.    208,108

d.    254,142

22. Moldavani SA has a high degree of operating leverage and a high degree of financial leverage and finds its earnings are highly correlated with the Argentine economy. Which of the following statement is true of Moldavani?

a.    when the economy is improving, their earnings are expanding

b.    when the economy is declining, their earnings are expanding

c.    when the economy is flat, their earnings are expanding

d.    there is not enough information to discern a trend

23. Since stockholders have a residual claim on company profits…

a.    companies with a high degree of financial leverage should provide stockholders with high returns

b.    companies with a high degree of financial leverage should provide stockholders with lower returns

c.    companies with a low degree of financial leverage should provide bond holders with higher returns

d.    companies with a low degree of financial leverage should provide creditors with assurances they will be repaid

24. Typically, when a company increases the weight of debt in their capital structure, what happens to their weighted average cost of capital?

a.    it increases

b.    it decreases

c.    it is unaffected by changes in capital structure

d.    not enough information to determine

25. Suquentia Ltd has a weighted average cost of capital of 10%. The weight of debt is 30%, their after tax cost of debt is 4% and they have no preferred stock. What is Suquential’s cost of equity capital?

a.    not enough information to determine

b.    1.2%

c.    8.3%

d.    12.6%

26. Typically, when a company increases the weight of debt in their capital structure, what happens to their cost of equity capital?

a.    it increases

b.    it decreases

c.    it is unaffected by changes in debt

d.    not enough information to determine

27. According to Modigliani and Miller (Proposition I), the change in the value of a corporation…

a.    is not related to its capital structure

b.    is dependant upon the firms capital structure

c.    is related to its capital structure

d.    b & c

28. Zuliaca Ltd. has a market value of £350,000,000. Zuliaca currently has no debt, but they are considering buying back shares through the issuance of £140,000,000. What would you estimate as the value of Zuliaca AFTER they issue the debt if their effective tax rate is 30%?

a.    42,000,000

b.    350,000,000

c.    392,000,000

d.    434,000,000

29. If taxes are considered, but financial distress and bankruptcy costs are not, what is the optimal amount of debt financing for a firm?

a.    zero debt financing is optimal

b.    approximately 50% debt is optimal

c.    approximately 75% debt is optimal

d.    100% debt is optimal

30. Francais Hostels is considering financing their €275,000,000 acquisition of new properties via debt financing. The company has a cost of capital of 14%, a debt-to equity ratio of 0.6, debt costs of 7%, and a tax rate of 35%. What is the company’s cost of equity without the consideration of taxes?

a.    9.8%

b.    18.2%

c.    19.7%

d.    20.9%