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Finance 3003Chapter 8

 International Rate of Return The discount rate at which NPV equals zero The discount rate used to value capital investments is often referred to as ________. Opportunity Cost of Capital A positive NPV investment _______________ which a negative NPV investment ____________________ builds shareholder value; destroys shareholder value Since a risky dollar is worth less than a safe one, returns for risky projects must be ____________ than those of a risk-free investment. higher What is the NPV of a project with an initial investment of \$95, a cash flow in one year of \$107, and a discount rate of 6%? (Be sure to record initial investment as a negative number.) \$5.94 If two projects (investments) A and B are said to be mutually exclusive then we know that the firm ______________ must choose to invest in either A or B, but not both When choosing mutually exclusive projects, choose the one that offers the ____________________ highest NPV A project has an initial investment of \$125,000 and cash flows of \$50,000 per year for 3 years. What is the project’s internal rate of return (IRR)? 9.7% A projects IRR measures the _________ whereas the opportunity cost of capital is equal to the _________________. profitability of a project; return offered by equivalent-risk investment in the capital market. Under which situations should the IRR decision rule be avoided? Mutually Exclusive ProjectsMultiple Rates of ReturnA project NPV does not decline smoothly as discount rate increases The NPV rule states that managers increase shareholder wealth by: accepting all projects with a positive NPV A project with an initial investment of \$5 million and cash flows for 6 years of \$1.5 million per year. What is the project’s internal rate of return (IRR)? 19.9% Profitability Index (PI) Formula NPV/Initial Investment When the firm’s budget is limited, then the firm should select the project with the ______________ highest PI ratio The limit set on the amount of funds available for investment is referred to as: capital rationing Capital rationing that is imposed by top management of a firm is called ___________ rationing. _____________ rationing occurs when a firm cannot raise the money it needs from outside sources. Soft, Hard In simple cases of capital rationing, the _____________ can tell a firm which projects to accept Profitability index (PI) What are problems that managers may encounter when deciding between mutually exclusive projects? When equipment should be replacedThe choice between short and long-lived equipmentThe timing of investments Making the choice to invest today or to postpone that investment to a future date is a choice between mutually exclusive projects. When making this choice, what is the correct criterion to use? Choose the investment date that produces the highest NPV today The cash flow per period with the same present value as the cost of buying and operating a machine is called the: Equivalent annual annuity Equivalent annual annuity formula (PV of costs)/(# of years annuity factor) When comparing investments in assets with different lives you should: select the project with the lowest equivalent annual annuity of costs A machine that costs \$20,000 today has annual operating costs of \$1,500, \$1,600, \$1,700, and \$1,800 in each of the next four years. The discount rate is 10 percent. The PV of costs is _________ and the equivalent annual annuity is __________. \$25,192.61; \$7,947.53 what are the Investment criterion methods most used by firms NPVIRR The IRR rule specifies that a firm should select any project whose IRR is ___________ the firm’s ____________ higher than; opportunity cost of capital What are three limitations of the Payback Rule for accepting projects? Gives equal weight to all cash flows arriving before the cutoff period Biases the firm against long-term projects in favor of short-term onesDoes not consider cash flows after the payback period What capital budgeting decision method finds the present value of each cash flow before calculating a payback period? Discounted payback period True or False: the payback rule states that a project should be accepted if its payback period is greater than a specified cutoff period False: payback period is LESS than a specified cutoff period The payback period for a project can best be defined as: the length of time before you can recover you initial investment The rate of return rule states that a firm should invest in any project offering a rate of return that is higher than the: opportunity cost of capital Which of the following is the capital investment decision criterion that will always lead management to make the value-maximizing choice? NPV True or false: when choosing among mutually exclusive projects, choose the one that offers the highest NPV True When evaluating a single project for acceptance, the NPV and IRR decision rules will give the same result when ______________ the graph of NPV versus discount rate declines smoothly as discount rate increases
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Personal Finance-Chapter 11

 Emergency Fund an amt of money you can obtain quickly in case of immediate need Line of Credit a short term loan that is approved before the money is actually needed Seven steps to survive a financial crisis/make sure financial affairs are in order Establish a larger than usual emergency fundKnow what you oweReduce SpendingPay off credit cardsApply for a line of credit at your bank, credit union, or financial institutionNotify credit card companies and lenders if you are unable tomake paymentsMonitor the value of your investments and retirement accts how long can a bankruptcy or going bankrupt remain on your credit report? Up to ten years What are the employer sponsored retirement accounts? 401(k) or 403(b) What does safety in an investment mean? Minimal risk or loss Speculative investment high-risk investment made in the hope of earning a relatively large profit in a short amount of time how should risk and investment be related? The potential return on any investment should be directly related to the risk the investor assumes inflation rise in the general level of prices If values of investments decrease overall interest rates increase pg 258 Interest rate risk is associated with preferred stocks or government/corporate bonds resulting in changes in the interest rates in the economy how does the govt reduce interest rate risk inflation protected bonds most conservative investments passbook savings, accounts, certificates of deposit, securities by u.s. govt Liquidity ability to buy or sell an investment quickly w/o substantially affecting the investments value Asset allocation process of spreading your assets amoung several different types of investments to lessen risk government bond written pledge of a government or a municipality to repay a specified sum of money, along with interest municipal bond debt security issued by a state or local government general obligation bond bond backed by the full faith, credit, and unlimited taxing power of the government that issued it revenue bond bond that is repaid from the income generated by the project it is designed to finance Corporate bond corporations written pledge to repay a specified amt of money with interest maturity date for a corporate bond, the date on which the corporation is to repay the borrowed money bond indenture a legal document that details all of the conditions relating to a bond issue trustee financially independent firm that acts as the bondholders representative debenture bond that is backed only by the reputation of the issuing corporation mortgage bond corporate bond secured by various assets of the issuing firm convertible bond a bond that can be exchanged, at the owner’s option, for a specified numver of shares of the corporations common stock call feature feature that allows the corporation to call in, or buy, outstanding bonds from current bondholders before the maturity date sinking fund fund to which annual or semiannual deposits are made for the purpose of redeemng a bond issue serial bonds bonds of a single issue that mature on different dates
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Finance Ch. 4 True/False

 Starting to invest early for retirement increases the benefits of compound interest. True Starting to invest early for retirement reduces the benefits of compound interest. False A time line is meaningful even if all cash flows do not occur annually. True A time line is not meaningful unless all cash flows occur annually. False Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly. True Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. False Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. True Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods. False Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts. True Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts False If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series. False If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series. True Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value. True Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value. False If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate. False If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate. True A “growing annuity” is a cash flow stream that grows at a constant rate for a specified number of periods. True A “growing annuity” is any cash flow stream that grows over time. False The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. False The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date. True Suppose Sally Smith plans to invest \$1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) True Suppose Randy Jones plans to invest \$1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) False The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant. True The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant False All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases. True All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases. False If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year. True If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year. False As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan). True As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan). False When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage declines in the loan’s later years. False When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage increases in the loan’s later years. True The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan’s life, the greater the percentage of the payment that will be a repayment of principal. True The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan’s life, the smaller the percentage of the payment that will be a repayment of principal. False Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest rate on the loan. False Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate. True
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FINANCE

 The tax savings generated as a result of a firm’s depreciation expense is called the: depreciation tax shield You are considering the purchase of new equipment. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. You should select the machine which has the: lowest equivalent annual cost Wiley Electric just purchased some MACRS 5-year property at a cost of \$118,000. Which one of the following will correctly give you the book value of this equipment at the end of year 3?MACRS 5-year propertyYear Rate1 20.00%2 32.00%3 19.20%4 11.52%5 11.52%6 5.76% \$118,000 x (1 – .20 – .32 – .192) A project’s operating cash flow will increase when: depreciation expense increases Shelly’s Boutique is evaluating a project which will increase annual sales by \$70,000 and annual costs by \$40,000. The project will initially require \$100,000 in fixed assets which will be depreciated straight-line to a zero book value over the 5-year life of the project. The applicable tax rate is 34 percent. What are the operating cash flows for this project from years 1-5 and what is the NPV of the entire project if the WACC is 7%? … Superior Manufacturers is considering a 3-year project with an initial cost of \$846,000. The project will not directly produce any sales but will reduce operating costs by \$295,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated \$30,000. The tax rate is 34 percent. The project will require \$31,000 in extra inventory for spare parts and accessories. Should this project be implemented if Superior Manufacturing requires an 8 percent rate of return? Why or why not? No; The NPV is -\$87,820.48. A project is expected to create operating cash flows of \$35,000 a year for four years. The initial cost of the fixed assets is \$100,000. These assets will be worthless at the end of the project. An initial \$5,000 of net working capital will be required at the project’s start. What is the project’s net present value if the required rate of return is 11 percent? \$6,879.25 The Furniture Makers purchased some fixed assets three years ago for \$52,000. The assets are classified as 5-year property for MACRS. The company is considering selling these assets now so they can buy some newer fixed assets which utilize the latest in technology. The company has been offered \$15,500 for these old assets. What is the net cash flow from the salvage value if the tax rate is 34 percent?MACRS 5-year propertyYear Rate1 20.00%2 32.00%3 19.20%4 11.52%5 11.52%6 5.76% \$15,321.84 Allied Partners just purchased some fixed assets that are classified as 3-year property for MACRS. The assets cost \$2,400. What is the amount of the depreciation expense in year 4?MACRS 3-year propertyYear Rate1 33.33%2 44.44%3 14.82%4 7.41% \$177.84 A firm is considering a project that will increase sales by \$135,000 and cash expenses by \$105,000. The project will cost \$120,000 and be depreciated using the straight-line method to a zero book value over the 4-year life of the project. The company has a marginal tax rate of 34 percent. What is the value of the depreciation tax shield? \$10,200 The Clothing Co. is looking at a project that will require and initial increase of \$40,000 in net working capital and \$100,000 in fixed assets. The project is expected to produce annual sales of \$90,000 with associated costs of \$60,000. The project has a 10-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 35 percent. What are the operating cash flows for this project and what is the IRR for this entire project? \$23,000; 12.45%
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