Financial Modelling 2555A/B Study Guide - Midterm Guide: Sunk Costs, Standard Deviation, Accounts Payable
You purchased land 3 years ago for $60000 and believe its market value is now $90000. You are considering building a hotel on this land instead of selling it. To build the hotel, it will initially cost you $150000, an expense that you plan to depreciate straight line over the next three years. Wells Fargo offered you a loan for $60,000 at an 8% interest rate to be repaid over the next 4 years. You anticipate that the hotel will earn revenues of $165000 each year, while expenses will be a mere $30000 each year. The initial working capital requirement will be $7000 which will be recovered in the last year. The tax rate is 35%. Your estimated cost of capital is 10%. What is the net present value of this project?
The NPV rule states that you should accept an investment if the NPV:
is less than or equal to zero.
is less than the investment's initial cost.
exceeds the investment's initial cost.
The payback period is the period of time it takes an investment to generate sufficient cash flows to:
earn the required rate of return.
produce the required net income.
produce a yield equal to or greater than the market rate on similar investments.
have a cash inflow, rather than an outflow, for the year.
recover the investment's initial cost.
A proposed project will increase a firm's accounts payables. This increase:
should be ignored when conducting scenario analysis.
is a cash outflow at time zero.
is an initial cash inflow only.
is a sunk cost and should be ignored.
is a cash inflow at time zero and a cash outflow at the end of the project.
What is the net present value of a project with the following cash flows if the discount rate is 7 percent?
Year 0: $-3500
Year 1: $1200
Year 2: $1000
Year 3: $900
Year 4: $0
The change in a firm's future cash flows that results from adding a new project are referred to as _____ cash flows.
1. A discount factor:
A. Is the same as compounding future cash flow B. performs the reverse function of a compounding interest rate C. allows investors to quantify a figure which will assist them in comparing alternative investments D. b and c E. a, b and c
2. As the interest rate used to discount future cash flows is decreased present value of the future cash in-flows: A. increases B. decreases C. stays the same
3. Most bonds pay interest: A. monthly B. quarterly C. semi-annually D. annually E. none of the above
4. How much money will Jane have in 3 years if the money compounds at the annual rate of 10% and she sets aside $1000: A. $1300 B. $1331 C. $1406 D. $1420 E. None of the above
5. When performing sensitivity analysis:
A statistical methods should not be employed B. electronic spreadsheets make the job more manageable C. assumptions should be changed one at a time D. all of the above E. B and C
6. A differential analysis: A. can be used to compare an alternative to the status quo B. can be used to compare any set of alternative C. is easier to comprehend if a consistent frame of reference is employed D. B and C E. A, B, C
7. When projected assets are less than projected liabilities and equity the firm will have:
A a need for debt B. need for equity C. excess cash D. none of the above
8. If the bonds coupon rate is less than the general interest rate in the market the bond will sell at:
A premium B. discount C. neither A or B
9. Present value calculations: A. can help the creation of value B. can provide managers with a means of identifying the investment choices C. do not help the creation of value D. A and B E. B and C
10. When projected assets are more than projected liabilities and equity the plug will be:
A notes payable B. notes receivable C. cash D. none of the above
11. Earl is saving for a pair of jet skis, how much money must Earl put aside now to receive $14,000 six years from now if the money is compounding at an 8% annual compound rate:
A $8847 B. $8800 C. $8822 D. $8810 E. none of the above
12. Which of the following methods helps to size the investments: a. payback b. present value payback c. present value index d. irr e. none of the above
13. Jones company acquires the Mathis company. Jones is in a totally unrelated business to mathis. This is an example of: a. vertical integration b. horizontal integration c. diversification d. none of the above
14. The bondâs yield to maturity calculation is similar to a __________ calculation
a. NPV b. IRR c. payback d. discounted payback e. none of the above
15. If the bonds coupon rate is equal to the general interest rates in the market, the bond will sell at a: a. premium b. discount c. neither A nor B
16. synergy may result from: a. enhanced cash flow b. diversification c.excess cash d. all of the above
17. profit margin and asset turnover are combined to yield: a. EPS b.Payout c. ROA d.ROE e. none of the above
18. the ______matches revenues with expense for the entire accounting period: a, balance sheet b. cash flow statement c. statement of retained earnings d. income statement e. none of the above
19. which of the following would be included amoung the investment numbers of a capital budget? A. purchase price of the asset b. trade-in value of and asset being replaced c. investment tax credit from acquisition d. installation costs of the machinery e. all of the above
20. economic value is the same as: a. book value/net asset value b. owners equity c. none of the above
The discounted dividend model can be used to value divisions and firms that do not pay dividends.
For the discounted dividend model, a firm's weighted average cost of capital is used as the discount rate.
For the corporate valuation model, a firm's cost of equity is used as the discount rate.
For the constant growth model to hold, a firm's cost of equity needs to be greater than its constant dividend growth rate (i.e., rs > g).
From the constant growth model, if the constant dividend growth rate is equal to zero, a firm's share price is equal to the constant dividend divided by the cost of equity (i.e., g=0).
If a company's constant dividend growth rate is negative, the formula for the constant growth model cannot be applied.
The internal rate of return method (IRR) assumes that cash flows are reinvested at the internal rate of return.
The modified internal rate of return method (MIRR) assumes that cash flows are reinvested at the weighted average cost of cpaital.
For mutually exclusive projects, if there is a conflict between NPV and IRR, the project with the highest IRR is chosen.
The IRR is independent of a firm's weighted average cost of capital.
The WACC only represents the "hurdle rate" for a typical project with average risk. Therefore, the project's WACC should be adjusted to reflect the project's risk.
Firms with riskier projects generally have a lower WACC.
Holding all else constant, an increase in the target debt ratio tends to lower the WACC.
Short-term bond prices are less sensitive than long-term bond prices to interest rate changes.
Companies are not likely to call bonds unless interest rates have declined significantly. Thus, the call provision is valuable to firms but detrimental to long term investors.
On balance, bonds that have a sinking fund are regarded as being safer than those without such a provision.
If beta < 1.0, the security is less risky than average.
According to the Security Market Line (SML), in general, a companyâs expected return will double when its beta doubles.
According to the Security Market Line (SML), if a portfolio of real world stocks has a beta of zero, the required rate of return for the portfolio is equal to the risk-free rate.
It ignores cash flows occurring after the payback period.
It ignores the time value of money, that is, dollars received in different years are all given the same weight.