PRACTICE TEST

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Texas A&M University, Corpus Christi *

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5315

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Finance

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Apr 3, 2024

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docx

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PRACTICE TEST #1  Section 2.5 Cash Flow of the Firm  McSherry Interiors has beginning net fixed assets of $ 234,100 and ending net fixed assets of $ 243,600 . Assets valued at $42,500 were sold during the year. Depreciation was $62,500 . What is the amount of net capital spending? Explanation Net capital spending = $243,600 − 234,100 + 62,500 Net capital spending = $72,000  Section 2.5 Cash Flow of the Firm   Zhao Pediatrics has operating cash flow of $11,618 . Depreciation is $2,345 and interest paid is $395. A net total of $485 was paid on long-term debt. The firm spent $6,180 on fixed assets and decreased net working capital by $420 . What is the cash flow of the firm? Explanation CF( A ) = $11,618 − 6,180 − (−$420) CF( A ) = $5,858  Section 2.5 Cash Flow of the Firm   Grimaldi, Incorporated, has total revenue of $ 4,116 , depreciation of $319, selling and administrative expenses of $554 , interest expense of $162, dividends of $75, cost of goods sold of $2,354 , and taxes of $186 . What is the operating cash flow? OCF = $4,116 − 2,354 − 554 − 186 OCF = $1,022  Section 5.2 The Payback Period Method   You are considering a project with an initial cost of $10,140. What is the payback period for this project if the cash inflows are $2,300, $4,500, $9,100, and $13,000 for Years 1 to 4, respectively? Explanation Payback = 2 + ($10,140 − 2,300 − 4,500)/$9,100 Payback = 2.37 years  Section 5.3 The Discounted Payback Period Method 

 A project has an initial cost of $10,600 and produces cash inflows of $ 3,700 , $ 4,900 , and $ 2,500 for Years 1 to 3, respectively. What is the discounted payback period if the required rate of return is 7.5 percent? Explanation PV = $3,700/1.075 + $4,900/1.075 2 + $2,500/1.075 3 PV = $9,694.39 The project will never pay back on a discounted basis.  Section 5.5 Problems with the IRR Approach  An analyst is considering two mutually exclusive projects that have been assigned the same discount rate of 10.5 percent. Project A has an initial cost of $54,500 , and should produce cash inflows of $16,400 , $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $79,400 , and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. What is the incremental IRR? Explanation 0 = [−$79,400 − (−$54,500)] + ($0 − 16,400)/(1 + IRR) + ($48,300 − 28,900)/(1 + IRR) 2 + ($42,100 − 31,700)/(1 + IRR) 3 IRR = −15.40% Calculation of incremental internal rate of return Formula: A B C D 1 Difference 2 Years A B 3 0 -54500 -79400=B3-C3 4 1 16400 0=B4-C4 5 2 28900 48300=B5-C5 6 3 31700 42100=B6-C6 7 IRR =IRR(B3:B6) =IRR(C3:C6) =IRR(D3:D6)

Computation: A B C D 1 Differen ce 2Years A B 3 0 -54500 -79400 24900 4 1 16400 0 16400 5 2 28900 48300 -19400 6 3 31700 42100 -10400 7IRR 17.43% 5.42% -15.40% Explanation: The incremental IRR is calculated by equating the present value of the incremental cash flows to the incremental initial investment. The incremental cash flow is the difference between the annual cashflows of the two projects.  Section 5.5 Problems with the IRR Approach  Project A has an initial cost of $75,000 and annual cash flows of $33,000 for three years. Project B costs $60,000 and has cash flows of $25,000, $30,000, and $25,000 for Years 1 to 3, respectively. Projects A and B are mutually exclusive. The incremental IRR is _______ percent and if the required rate is higher than the crossover rate then Project _______ should be accepted. Explanation 0 = [−$75,000 − (−$60,000)] + ($33,000 − 25,000)/(1 + IRR) + ($33,000 − 30,000)/(1 + IRR) 2 + ($33,000 − 25,000)/(1 + IRR) 3 IRR = 12.89% Using a discount rate of 15 percent: NPV A = −$75,000 + $33,000{1 − [1/(1 + .15) 3 ]}/.15 NPV A = $346.43 NPV B = −$60,000 + $25,000/1.15 + $30,000/1.15 2 + $25,000/1.15 3 NPV B = $861.35

 Section 8.1 Bonds and Bond Valuation   Consider a bond with an annual coupon rate of 7 percent that pays semiannual interest and matures in ten years. The market rate of return on bonds of this risk is currently 3.5 percent. What is the current value of a $1,000 face value bond? Explanation Bond value = [.07($1,000)/2]{[1 − 1/(1 + .035/2) 10(2) ]/(.035/2)} + $1,000/(1 + .035/2) 10(2) Bond value = $1,293.18 Look for an excel  Consider a bond with a coupon rate of 8 percent that pays semiannual interest and matures in eight years. The market rate of return on bonds of this risk is currently 11 percent. What is the current value of a $1,000 face value bond? ???? ??? https://www.omnicalculator.com/finance/pvifa Face Value = $1,000 Annual Coupon = 8%*$1,000 = $80 Semi-annual Coupon = $80 / 2 = $40 Annaul Market rate = 11% Semi-annual Market rate = 5.5% Maturity in 8 years Price = $40*PVIFA(5.5%, 16) + 1,000*PVIF(5.5%, 16) Price = $40*(1-(1/1.055)^16)/0.055 + 1,000/1.055^16 Price = $843.07 So, current price of bond is $843.07

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