FINC620 – Quiz – Week 2 – A Graded Solution

1.      Taussig Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data:

  Project X Project Y
Expected NPV $350,000 $350,000
Standard deviation (sNPV) $100,000 $150,000
Project beta (vs. market) 1.4 0.8

Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are notcorrelated with the cash flows from existing projects. Cash flows are highly correlated with the cash flows from existing projects.

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Which of the following statements is CORRECT?

2.      Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less than the WACC (and even negative), in which case it will be rejected.

WACC: 10.00%      
Year 0 1 2 3
Cash flows -$1,000 $450 $450 $450

 

3.       Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

 

4.       Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one cash outflow at t = 0 followed by a series of positive cash flows.

 

5.       You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project’s risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

6.       A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?

 

7.       Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B’s IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is CORRECT?

 

8.       Which of the following statements is CORRECT?

 
9.      Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%
Opportunity cost $100,000
Net equipment cost (depreciable basis) $  65,000
Straight-line deprec. rate for equipment 33.333%
Sales revenues, each year $123,000
Operating costs (excl. deprec.), each year $  25,000
Tax rate 35%

 

10.  Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s expected NPV can be negative, in which case it will be rejected.

WACC: 10.00%      
Year 0 1 2 3
Cash flows -$950 $500 $400 $300

 

11.  Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

 

12.  Mansi Inc. is considering a project that has the following cash flow data. What is the project’s payback?

Year 0 1 2 3
Cash flows -$750 $300 $325 $350

 

13.   Which of the following statements is CORRECT?

14.  Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true?

 

15.  Resnick Inc. is considering a project that has the following cash flow data. What is the project’s payback?

Year 0 1 2 3
Cash flows -$350 $200 $200 $200

 

 

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