FIN 571 Wk 3 Practice Wk 3 Practice Questions
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FIN 571 Wk 3 Practice Wk 3 Practice Questions

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What happens over time to the real cost of purchasing a home if the mortgage payments are fixed in nominal terms and inflation is in existence? Multiple Choice • The real cost is constant. • The real cost is increasing. • The real cost is decreasing. • The price index must be known to answer this question. How much more would you be willing to pay today for an investment offering $10,000 in 4 years rather than in 5 years? Your discount rate is 8%. Multiple Choice • $544.47 • $681.48 • $740.74 • $800.00 3 What is the annually compounded rate of interest on an account with an APR of 10% and monthly compounding? Multiple Choice • 10.00% • 10.47% • 10.52% • 11.05% Explanation EAR = [1 + (0.10 / 12)] 12 − 1 = 0.1047, or 10.47% 4 An amortizing loan is one in which: Multiple Choice • the principal remains unchanged with each payment. • accrued interest is paid regularly. • the maturity of the loan is variable. • the principal balance is reduced with each payment. 5 Suppose you take out a 30-year mortgage for $100,000 with annual payments. The interest rate on the mortgage is 8%. When you have paid off half the mortgage, so that the value of the remaining payments is reduced to $50,000, how many more payments need to be made? Multiple Choice • Approximately 15 payments • Approximately 12 payments • Approximately 8 payments • Approximately 20 payments Explanation Solve first for the annual payment: $100,000 = PMT(1 / 0.08 − 0.08 × 1.0830). PMT = $8,882.74 PV = PMT [(1 / r) − 1 / r(1 + r)t] $50,000 = 8,882.74{1 / 0.08−1 / (0.08 × 1.08t} Either use logs or trial and error to find t ≈ 8 6 Eighteen years from now, 4 years of college are expected to cost $150,000. How much more must be deposited into an account today to fund this expense if you can earn only 8% on your savings rather than the 11% you hope to earn? Multiple Choice • $12,211.18 • $13,609.21 • $14,006.41 • $14,614.03 Explanation Additional deposit = $150,000 / 1.0818 − $150,000 / 1.1118 Additional deposit = $14,614.03 7 Projects A and B are mutually exclusive lending projects. Project A has an IRR of 20% while Project B has an IRR of 30%. You would be more likely to choose B unless: Multiple Choice • Project B has a longer life than Project A. • Project A has more risk than Project B. • Project A is twice the size of Project B. • Project B has a larger cash inflow in Year 1 than Project A. 8 If the IRR for a project is 15%, then the project's NPV would be: Multiple Choice • negative at a discount rate of 10%. • positive at a discount rate of 20%. • negative at a discount rate of 20%. • positive at a discount rate of 15%. 9 A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years, followed by cash outflows of $1,000 annually for 2 years. At most, this project has ________ different IRR(s). Multiple Choice • one • two • three • five 10 You can continue to use your less efficient machine at a cost of $8,000 annually. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. If the new machine lasts 5 years and the cost of capital is 15%, you should: Multiple Choice • buy the new machine and save $600 in equivalent annual costs. • buy the new machine and save $388 in equivalent annual costs. • keep the old machine and save $388 in equivalent annual costs. • keep the old machine and save $580 in equivalent annual costs. Explanation NPV = −$12,000 − $5,000[(1 / 0.15) − 1 / 0.15(1.15)5] = −$28,760.78 Using a financial calculator: N = 5; I = 15%; PV = −$28,760.78; FV = 0; CPT PMT = $8,579.79 Change in annual cost = $8,579.79 − 8,000 = $579.79 11 What is the minimum cash flow that could be received at the end of year 3 to make the following project "acceptable"? Initial cost = $100,000; cash flows at end of years 1 and 2 = $35,000; opportunity cost of capital = 10%. Multiple Choice • $29,494 • $30,000 • $39,256 • $52,250 Explanation NPV = 0 − $100,000 + ($35,000 / 1.1) + $35,000 / 1.12 + $x / 1.13; x = $52,250 A cash flow of $52,250 received in year 3, and discounted at 10%, would increase the NPV to zero. 12 Soft capital rationing: Multiple Choice • is costly to shareholders. • is used to evaluate mutually exclusive projects. • should be costless to the shareholders of the firm. • solves the problem of investment timing. 13 If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR? Multiple Choice • 8.98% • 7.39% • 8.50% • 7.67% Explanation Using a financial calculator: n = 5; PV = −$72,000; PMT = $18,500; FV = 0; CPT i = 8.98% 14 When calculating cash flow from operations, one should: Multiple Choice • subtract depreciation since it represents the cost of replacing worn-out equipment. • deduct the depreciation tax shield from after-tax profit. • use after-tax profit and ignore depreciation. • add depreciation to after-tax profit. 15 Corporate income statements are designed primarily to show: Multiple Choice • cash flows during a period. • account balances at the end of a period. • performance during a period. • market values of assets and liabilities. 16 The NPV of an investment proposal becomes negative solely as a result of allocating a portion of the corporation president's salary. It is most likely the case that: Multiple Choice • the project should be accepted. • rejecting the project is the decision. • the allocation should be postponed until the project is accepted. • the salary should be considered an opportunity cost of the project. 17 If inflation is forecast to increase, which of the company’s following cash flows is most likely to change? Multiple Choice • The depreciation tax shield. • Labor costs. • Costs of raw materials purchased on a fixed price contract. • Interest payments on its long-term debt. 18 Which of the following ly adjusts for depreciation when calculating a project’s operating cash flow? Multiple Choice • (revenues − cash expenses) × (1 − tax rate) + (tax rate × depreciation). • pretax profit + depreciation tax shield. • after-tax profit − depreciation. • ignore depreciation since it is not a cash flow. 19 A proposed project requires an initial investment of $8,500 in current assets, 75% of which will be financed with accounts payable. The project will have: Multiple Choice • an initial cash outflow of $8,500 at time zero for net working capital. • a cash outflow for net working capital at the end of the project. • a cash inflow at the end of the project from net working capital. • a cash outflow for net working capital every year of the project's life. 20 New projects or products can provide positive indirect effects as well as negative effects. Which one of the following appears to be a negative indirect effect? Multiple Choice • The new machine required for the project uses less electricity than the existing machine. • Orders for your complementary products are expected to increase. • Customer orders of supplies for the firm’s existing products are expected to decrease. • Variable costs are expected to decrease since the firm can order larger quantities.

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