FINC330 BUSINESS FINANCE
FALL 2012 – Section 5165 (Atherton)
Final Exam (December 2012)
Due Date: Sunday, December 16, 2012 by 11:59pm
The exam is an individual effort.
Do not work, consult, or collaborate with others.
Submit via Assignment folder in WebTycho (email if any trouble with WebTycho)
PART 1 – MULTIPLE CHOICE (CIRCLE THE CORRECT ANSWER FOR 1 POINT EACH) 1. The four basic sources of long-term funds for the business firm are
A) current liabilities, long-term debt, common stock, and preferred stock.
B) current liabilities, long-term debt, common stock, and retained earnings.
C) long-term debt, paid-in capital in excess of par, common stock, and retained earnings.
D) long-term debt, common stock,
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A.) One defect of the IRR method is that it does not take account of cash flows over a project's full life.
B.) One defect of the IRR method is that it does not take account of the time value of money.
C.) One defect of the IRR method is that it does not take account of the cost of capital.
D.) One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
21. The analyst should be careful when conducting ratio analysis to ensure that
A) the overall performance of the firm is not judged on a single ratio.
B) the dates of the financial statements being compared are the same.
C) the same accounting procedures were used.
D) all of the above.
22. Given the financial data for New Electronic World, Inc. (NEW), compute the Operating Cash Flow for the NEW for the year ended December 31, 2005
For the year ended December 31,
A) $28,000.
B) $33,000.
C) $35,000. D) $43,000.
23. The higher an asset's beta,
A) the more responsive it is to changing market returns.
B) the less responsive it is to changing market returns.
C) the higher the expected return will be in a down market.
D) the lower the expected return will be in an up market.
24. Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently
IRR uses all cash flows and incorporates the time value of money. When evaluating independent projects, IRR will always lead to the same decision as NPV. Because IRR assumes that cash flows will be reinvested at the internal rate of return, which is not always or even usually the case, it can rank mutually exclusive projects incorrectly. With certain patterns of cash flows, the IRR equation has more than one solution, which confuses the decision rule. IRR is slightly more
Internal Rate of Return is a discount rate in which the net present value of an investment becomes zero. The investment should be accepted if the IRR is not less than the cost of capital. The IRR measures risk, by showing what the discounted rate would have to reach to lose all present value. Futronics Inc. investment would have an IRR of 14.79%. The investment should be accepted since it is greater than the 8% cost of capital. The 14.79% IRR shows the growth expected from the
Operating cash flow was not enough to cover capital investments (this firm does not to appear to pay dividends as it does not show in the prior 3 years). The firm is financing it operations from the issuance of common stock. $23,082 was raised during the period, which is covering its investments in capital expenditures.
The payback’s reciprocal would be more useful for projects with very long lives. The payback reciprocal is best used when the useful life of an investment is twice the payback period. The IRR rises when the useful life of an investment increase which would then get closer to the higher reciprocal.
The assumptions of discount rate and depreciation method are acceptable. However, the other two assumptions described as below are considered to be inappropriate.
period a 10% stock dividend was declared and distributed. The market value was $25 a
Thus, by year three the company will be making a profit off the investment as year three is 86.73 million profit by 55.35 cost giving the company a 31.38 million dollar surplus. Generally, a period of payback of three year or less is acceptable (Reference Entry) causing this project to be viable based off the payback analysis. Although, these calculations are flawed. The reason for this is because the time value of money is not taken into effect when calculating payback periods which is where IRR can further assist in a more realistic financial picture (Reference Entry).
A project may have more than one IRR, especially when returns of an investment yield negative cash flows following positive cash flows.
Question 1 – Methods Used to evaluate the investment using the payback, discounted payback, ARR, NPV, PI, IRR, MIRR and equivalent annual annuity methods.
The ARR also fails to consider the timing of profit as a 22% ARR in 12 years may be better than a 18% rate of return for 8 years, ignoring that the longer the term of the project, the greater the risk involved.
The use of an accounting rate of return also underscores a project 's true future profitability because returns are calculated from accounting statements that list items at book or historical values and are, thus, backward-looking. According to the ARR, cash flows are positive due to the way the return has been tabulated with regard to returns on funds employed. The Payback Period technique also reflects that the project is positive and that initial expenses will be retrieved in approximately 7 years. However, the Payback method treats all cash flows as if they are received in the same period, i.e. cash flows in period 2 are treated the same as cash flows received in period 8. Clearly, it ignores the time value of money and is not the best method employed. Conversely, the IRR and NPV methods reflect that The Super Project is unattractive. IRR calculated is less then the 10% cost of capital (tax tabulated was 48%). NPV calculations were also negative. We accept the NPV method as the optimal capital budgeting technique and use its outcome to provide the overall evidence for our final decision on The Super Project. In this case IRR provided the same rejection result; therefore, it too proved its usefulness. Despite that, IRR is not the most favorable method because it can provide false results in the case where multiple negative
1. What is the appropriate required rate of return against which to evaluate the prospective IRR 's from the B ANSWER:The appropriate rate of return against which to evaluate the IRR is the risk-free rate, plus the market risk
Internal rate of return (IRR) and Payback period “IRR of a project provides useful information regarding the sensitivity of the project’s NPV to errors in the estimate of its cost of capital” (Pierson et al.2011, pp.157).This proposal also shows the project is profitable by using Excel to get the IRR of 18.9%, which is
NPV and IRR: When examining the NPV and the IRR of the Merseyside project, the numbers were very attractive. It had a positive net present value and an IRR above 10 percent. By these numbers, along with others,
Importantly, IRR is a method for determining value that does not depend on the determination of a discount rate. This method requires the calculation of a discount rate such that the discounted value of future cost-benefit flows exactly equals the initial investment. Dean (1951 in Smith, 1986:8) recommends that the company make investment decisions by "looking to the capital markets for the firm 's cost of capital, accepting each project with an internal rate of return and exceeds this market-determined cost of capital". As such, to apply the IRR reference must be made to the discount rate in order to arrive at a decision.