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Date Posted: 12:27:56 10/06/00 Fri
Author: Charles Hodges
Subject: Quiz 4 with solutions

Here is the inclass quiz. The solutions are at the bottom of the quiz.

Quiz 4 Fall 2000 FI 4300 Your Name __________________________

1. Assume that you calculated an NPV of a normal project and the answer was less than $0 (i.e., NPV was negative). Which of the following is true?
a. The PI is greater than one. b.The project is not acceptable using the daub and wattle method.
c. The IRR is less than the discount rate. d. The project is not acceptable using the payback rule.
e. We do not have enough information to know which of the above statements is true.

2. NYT Corporations is considering a project that will pay nothing for the first five years, $40,000 in the sixth year, $80,000 in the seventh year, $120,000 in the eighth year, $160,000 in the ninth year, and $200,000 in the tenth year. The appropriate discount rate is 8.8% and the project requires an investment tomorrow of $250,000 if we accept the project. The NPV of this project is closest to:
a. $10,000 b. $20,000 c. $30,000 d. $40,000
e. None of the above answers are within $5,000 of the actual NPV.

USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 4,5, AND 6

You have been asked to analyze the following project for Wally's Widgets, Inc. You were given the following information which may or may not be relevant in your analysis. A. Wally's cost of capital/discount rate is 11% and Wally's income tax rate is 30%. B. Production of the product will continue for twenty years. C. Last year, we paid a design expert $300 to design the production line. We also received a federal government grant of $550 to pay for the design our new production line. D. It will cost us $3,100 to build our new production line. According to the IRS, we must use straight line depreciation and depreciate the line over the next 10 years to $0 value. E. The product we will manufacture is the Wally Wonder Widget. We will produce 100 of these widgets which have a selling price of $5 each. F. This new product will reduce Fred's Fancy Widgets (a competitor of our firm) sales by 20 Widgets. His price per widget is also $5 each and his variable costs are the same as our firm. G. Our two variable expenses are; Cost of Good Sold percentage = 40%, and Labor Cost =10%. H. Our Fixed Cost will increase by $60 due to this project. The accountants have allocated Wally's useless son to the project with his annual salary of $30. This son always does nothing and can be expected to do nothing in the future. I. In order to build the new line, we must close the cafeteria. The cafeteria owner pays us $50 in rent per year. J. The production line will be worthless (value=$0) in twenty years. K. Two current accounts are affected by the project. Inventory will be reduced by $200 if we accept the project and accounts payable will increase by $300 if we accept the project. Both will return to normal levels when the project ends.

4. Wally's Widgets cash flows in year zero associated with this project is closest to:
a. -$2,600 b. -$2,850 c. -$3,100 d. -$3,350
e. None of the above answers are within $125 of the correct answer.

5. The Net Cash Flows in Year 3 are closest to:
a. -$100 b. $100 c. $150 d. $200
e. None of the answers are within $50 of the correct answer.

6. The Total Cash Flows in Year 20 are closest to:
a. -$400 b. -$200 c. $100 d. $300
e. None of the above answers are within $100 of the correct answer.

7. Consider the following mutually exclusive projects, for a firm using a discount rate of 10%:
Project Ini. Investment NPV IRR PI Payback
A $1,000,000 $100,000 10.2% 1.04 3 years
B $100 $1 11% 1.11 1/2 year
C $50,000 $70,000 23% 1.32 1 year
D $200,000 $24,000 13% 1.44 5 years

Which project should the firm accept?
a. Accept all of the projects. b. Project D c. Project C. d. Project B. e. Project A.

8. Which of the following statements is most correct?
a. Sunk costs must be included in the project's cash flow.
b. R&D expenditures cannot be a part of the initial cost of a project.
c. Opportunity costs are sunk costs and therefore should not be included in the cost of the project.
d. Depreciation is not a cash expense.
e. All of the above statements are false.
ANSWERS

1. Assume that you calculated an NPV of a normal project and the answer was less than $0 (i.e., NPV was negative). Which of the following is true?
c. The IRR is less than the discount rate.

2. NYT Corporations is considering a project that will pay nothing for the first five years, $40,000 in the sixth year, $80,000 in the seventh year, $120,000 in the eighth year, $160,000 in the ninth year, and $200,000 in the tenth year. The appropriate discount rate is 8.8% and the project requires an investment tomorrow of $250,000 if we accept the project. The NPV of this project is closest to:
d. $40,000
actual NPV = $40,503.37

USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 4,5, AND 6

You have been asked to analyze the following project for Wally's Widgets, Inc. You were given the following information which may or may not be relevant in your analysis. A. Wally's cost of capital/discount rate is 11% and Wally's income tax rate is 30%. B. Production of the product will continue for twenty years. C. Last year, we paid a design expert $300 to design the production line. We also received a federal government grant of $550 to pay for the design our new production line. D. It will cost us $3,100 to build our new production line. According to the IRS, we must use straight line depreciation and depreciate the line over the next 10 years to $0 value. E. The product we will manufacture is the Wally Wonder Widget. We will produce 100 of these widgets which have a selling price of $5 each. F. This new product will reduce Fred's Fancy Widgets (a competitor of our firm) sales by 20 Widgets. His price per widget is also $5 each and his variable costs are the same as our firm. G. Our two variable expenses are; Cost of Good Sold percentage = 40%, and Labor Cost =10%. H. Our Fixed Cost will increase by $60 due to this project. The accountants have allocated Wally's useless son to the project with his annual salary of $30. This son always does nothing and can be expected to do nothing in the future. I. In order to build the new line, we must close the cafeteria. The cafeteria owner pays us $50 in rent per year. J. The production line will be worthless (value=$0) in twenty years. K. Two current accounts are affected by the project. Inventory will be reduced by $200 if we accept the project and accounts payable will increase by $300 if we accept the project. Both will return to normal levels when the project ends.

4. Wally's Widgets cash flows in year zero associated with this project is closest to:
a. -$2,600
-3100 (cost of line) + (+200 + 300) (working capital change) =- 2600

5. The Net Cash Flows in Year 3 are closest to:
d. $200

+500 revenue
-250 variable costs
-60 fixed costs
-310 depreciation
-50 rent opportunity cost
=-170 ebit
- -51 tax
=-119 NOPAT
+310 depreciation
= +191 operating cash flow


6. The Total Cash Flows in Year 20 are closest to:
a. -$400

+500 revenue
-250 variable costs
-60 fixed costs
-50 rent opportunity cost
=+140 ebit
- 42 tax
=+98 NOPAT
+0 depreciation
= +98 operating cash flow

0 salvage
0 tax
-500 reversal of working capital

-402 is total cash flows in year 20

7. Consider the following mutually exclusive projects, for a firm using a discount rate of 10%:
Project Ini. Investment NPV IRR PI Payback
A $1,000,000 $100,000 10.2% 1.04 3 years
B $100 $1 11% 1.11 1/2 year
C $50,000 $70,000 23% 1.32 1 year
D $200,000 $24,000 13% 1.44 5 years

e. Project A.
If mutually exclusive, choose the best good project.

8. Which of the following statements is most correct?
d. Depreciation is not a cash expense.
Note, there was some truth in statements A and B, but D is always true.

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