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business
fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

Why might it be rational for a small firm that does not have access to the capital markets to use the payback method rather than the NPV method?AppendixlLO1
Project X is very risky and has an NPV of $3 million. Project Y is very safe and has an NPV of $2 5 million. They are mutually exclusive, and project risk has been properly considered in the NPV
What reinvestment rate assumptions are built into the NPV, IRR, and MIRR methods? Give an explanation for your answer.AppendixlLO1
A firm has a $100 million capital budget. It is considering two projects, each costing $100 million. ProjectAhas an IRR of 20% and anNPV of $9million; itwill be terminated after 1 year at a profit of
NPV Project K costs $52,125, its expected cash inflows are $12,000 per year for 8 years, and its WACC is 12%. What is the project’s NPV?AppendixlLO1
IRR Refer to Problem 11-1. What is the project’s IRR?AppendixlLO1
MIRR Refer to Problem 11-1. What is the project’s MIRR?AppendixlLO1
PAYBACK PERIOD Refer to Problem 11-1. What is the project’s payback?AppendixlLO1
DISCOUNTED PAYBACK Refer to Problem 11-1. What is the project’s discounted payback?AppendixlLO1
NPV Your division is considering two projects with the following cash flows (in millions):0 2$17$6$10$9$5$10 2$25 2$20 Project A Project B 1 3a. What are the projects’ NPVs assuming the WACC is 5%?
CAPITAL BUDGETING CRITERIA A firm with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation, are as follows:0 2
CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS A mining company is considering a new project. Because the mine has received a permit, the project would be legal;but it would cause significant
CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS An electric utility is considering a new power plant in northern Arizona. Power from the plant would be sold in the Phoenix area, where it is badly
CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a WACC of 10% is considering the following mutually exclusive projects:0 2 3$225$49$225$50$55$50$55$300$55$300 2$400 2$600 Project
CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS Project S costs $15,000, and its expected cash flows would be $4,500 per year for 5 years.Mutually exclusive Project L costs $37,500, and its
IRR AND NPV A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:0 2$10$800$250$250$900$0 2$1,000 2$1,000 Project S Project L 3 4$10$400 1The company’s
MIRR A firm is considering two mutually exclusive projects, X and Y, with the following cash flows:0 2$700$50$300$100$100$1,000 2$1,000 2$1,000 Project X Project Y 3 4$400$50 1The projects are
CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units;otherwise, the highly
NPV PROFILES: TIMING DIFFERENCES An oil-drilling company must choose between two mutually exclusive extraction projects, and each costs $12 million. Under Plan A, all the oil would be extracted in 1
NPV PROFILES: SCALE DIFFERENCES A company is considering two mutually exclusive expansion plans. Plan A requires a $40 million expenditure on a large-scale integrated plant that would provide
CAPITAL BUDGETING CRITERIA A company has a 12% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following cash flows:0 2 3 2$180$0$850$134 2$100$134
NPV AND IRR A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month, 60 payments remain, and the next payment is due in 1 month. The mall’s owner plans to sell the property
MULTIPLE IRRS AND MIRR A mining company is deciding whether to open a strip mine, which costs $2 million. Cash inflows of $13 million would occur at the end of Year 1.The land must be returned to its
NPV A project has annual cash flows of $7,500 for the next 10 years and then $10,000 each year for the following 10 years. The IRR of this 20-year project is 10 98%. If the firm’s WACC is 9%, what
MIRR Project X costs $1,000, and its cash flows are the same in Years 1 through 10. Its IRR is 12%, and its WACC is 10%. What is the project’s MIRR?AppendixlLO1
MIRR A project has the following cash flows:0 2 3 2$500 $202 2$X $196 $350 $451 1 4 5 This project requires two outflows at Years 0 and 2, but the remaining cash flows are positive. Its WACC is 10%,
CAPITAL BUDGETING CRITERIA Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows:0 2$20$6$10$10$5$20 2$30
BASICS OF CAPITAL BUDGETING You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other
Why should companies use a project’s free cash flows rather than accounting income when determining a project’s NPV?AppendixLO1
Explain the following terms: incremental cash flow, sunk cost, opportunity cost, externality, and cannibalization.AppendixLO1
Provide an example of a “good” externality, that is, one that increases a project’s true NPV.AppendixLO1
In what ways is the setup for finding a project’s cash flows similar to the projected income statements for a new single-product firm? In what ways would the two statements be different?AppendixLO1
Would a project’s NPV for a typical firm be higher or lower if the firm used accelerated rather than straight-line depreciation? Explain.AppendixLO1
How could the analysis in Table 12.1 be modified to consider cannibalization, opportunity costs, and sunk costs?AppendixLO1
Why does net operating working capital (NOWC) appear as both a negative and a positive number in Table 12.1?AppendixLO1
What role do incremental cash flows play in a replacement analysis?AppendixLO1
If you were analyzing a replacement project and you suddenly learned that the old equipment could be sold for $1,000 rather than $100, would this new information make the replacement look better or
In Table 12.2, we assumed that output would not change if the old machine was replaced. Suppose output would actually double. How would this change be dealt with in the framework of Table
Which type is theoretically the most relevant? Why?AppendixLO1
What is one classification scheme that firms often use to obtain risk-adjusted costs of capital?AppendixLO1
Explain briefly how a sensitivity analysis is done and what the analysis is designed to show.AppendixLO1
What is a scenario analysis, what is it designed to show, and how does it differ from a sensitivity analysis?AppendixLO1
What is Monte Carlo simulation? How does a simulation analysis differ from a regular scenario analysis?AppendixLO1
Is it easier to measure the stand-alone, within-firm, or beta risk for projects such as a new delivery truck or a Home Depot warehouse?AppendixLO1
If a firm cannot measure a potential project’s risk with precision, should it abandon the project? Explain your answer.AppendixLO1
Why might DCF techniques not always lead to proper capital budgeting decisions?AppendixLO1
What is a real option?AppendixLO1
What are some types of real options? Briefly explain each one.AppendixLO1
Would you expect an abandonment option to increase or decrease a project’s NPV and its risk as measured by the coefficient of variation? Why?AppendixLO1
How can the value of an option be estimated?AppendixLO1
Explain how a financial manager might estimate his or her firm’s optimal capital budget.AppendixLO1
What is capital rationing?AppendixLO1
Is a firm’s optimal capital budget dynamic or static over time? Explain.AppendixLO1
What factors must be considered when a firm is developing its optimal capital budget?AppendixLO1
How does a firm’s annual capital budget reflect market conditions?AppendixLO1
Identify several benefits of the post-audit.AppendixLO1
What are some factors that complicate the post-audit process?AppendixLO1
KEY TERMS Define the following terms:a. Incremental cash flow; sunk cost; opportunity cost; externality; cannibalizationb. Stand-alone risk; corporate (within-firm) risk; market (beta) riskc.
PROJECT AND RISK ANALYSIS As a financial analyst, you must evaluate a proposed project to produce printer cartridges. The equipment would cost $55,000, plus $10,000 for installation. Annual sales
Operating cash flows rather than accounting income are listed in Table 12.1. Why do we focus on cash flows as opposed to net income in capital budgeting?AppendixLO1
Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs and externalities should be included. Give an example of each.AppendixLO1
Explain why net operating working capital is included in a capital budgeting analysis and how it is recovered at the end of a project’s life.AppendixLO1
Why are interest charges not deducted when a project’s cash flows for use in a capital budgeting analysis are calculated?AppendixLO1
Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the
What are some differences in the analysis for a replacement project versus that for a new expansion project?AppendixLO1
Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in the capital budget.AppendixLO1
In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone
Define (a) sensitivity analysis, (b) scenario analysis, and (c) simulation analysis. If GE were considering two projects (one for $500 million to develop a satellite communications system and the
If you were the CFO of a company that had to decide on hundreds of potential projects every year, would you want to use sensitivity analysis and scenario analysis as described in the chapter, or
REQUIRED INVESTMENT Truman Industries is considering an expansion. The necessary equipment would be purchased for $9 million, and the expansion would require an additional $3 million investment in
PROJECT CASH FLOW Eisenhower Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the
AFTER-TAX SALVAGE VALUE Kennedy Air Services is now in the final year of a project.The equipment originally cost $20 million, of which 80% has been depreciated. Kennedy can sell the used equipment
REPLACEMENT ANALYSIS The Chang Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero.
OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its
DEPRECIATION METHODS Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her
SCENARIO ANALYSIS Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be “average.”However, the CFO realizes
NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for
NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine.The base price is $108,000, and shipping and installation costs would add another $12,500.The machine falls into the
REPLACEMENT ANALYSIS The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6
REPLACEMENT ANALYSIS Mississippi River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to
PROJECT RISK ANALYSIS The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,750 and has an expected life of 3 years. Annual project cash flows begin 1
SCENARIO ANALYSIS Your firm, Agrico Products, is considering a tractor that would have a cost of $36,000, would increase pretax operating cash flows before taking account of depreciation by $12,000
NEW PROJECT ANALYSIS Holmes Manufacturing is considering a new machine that costs$250,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to
REPLACEMENT ANALYSIS The Erley Equipment Company purchased a machine 5 years ago at a cost of $90,000. The machine had an expected life of 10 years at the time of purchase, and it is being
REPLACEMENT ANALYSIS The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and
ABANDONMENT OPTION The Scampini Supplies Company recently purchased a new delivery truck. The new truck costs $22,500; and it is expected to generate after-tax cash flows, including depreciation, of
OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its WACC is 12 5%.The company is considering the following seven investment projects:Project Size IRR A $ 750,000 14.0%B 1,250,000 13.5 C
NEW PROJECT ANALYSIS You must analyze a potential new product—a caulking compound that Cory Materials’ R&D people developed for use in the residential construction industry. Cory’s marketing
CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as
What are the four main issuers of bonds?AppendixLO1
Why are U.S. Treasury bonds not completely riskless?AppendixLO1
In addition to default risk, what key risk do investors in foreign bonds face?Explain.AppendixLO1
Define floating-rate bonds, zero coupon bonds, callable bonds, putable bonds, income bonds, convertible bonds, and inflation-indexed bonds (TIPS).AppendixLO1
Which is riskier to an investor, other things held constant—a callable bond or a putable bond? Explain.AppendixLO1
In general, how is the rate on a floating-rate bond determined?AppendixLO1
What are the two ways sinking funds can be handled? Which alternative will be used if interest rates have risen? If interest rates have fallen?AppendixLO1
A bond that matures in 8 years has a par value of $1,000 and an annual coupon payment of $70; its market interest rate is 9%. What is its price? ($889.30)AppendixLO1
A bond thatmatures in 12 years has a par value of $1,000 and an annual coupon rate of 10%; the market interest rate is 8%. What is its price? ($1,150.72)AppendixLO1
Which of those two bonds is a discount bond, and which is a premium bond?Explain.AppendixLO1
Explain the difference between yield to maturity (YTM) and yield to call (YTC).AppendixLO1

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