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Finance Practice Questions

1) If a project IRR (internal rate of return) is 5% and the project is expected to provide incremental cash flows of \$10,000 annually for 3 years, approximately how much will the project’s initial investment be ?

a) \$30,000

b) \$31,500

c) \$27,232

d) \$57,232

e) Not enough information

2) A company is considering an investment costing \$102,500 with cash flows of \$9,800 in Year 2, \$48,700 in Year 3, and \$82,900 in Year 4. If the discount rate is 9 percent, what is the discounted payback period? If the required discounted payback period is 3.5 years, should this project be accepted or rejected?

a) 2.82 years; accepted

b) 3.96 years; accepted

c) 3.09 yearsl accepted

d) 2.82 years; rejected

e) 3.96 years; rejected

3) Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

a) The new project is expected to reduce sales of one of the company’s existing products by 5%.

b) Since the firm’s director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project’s initial cost.

c) The company has spent and expensed \$1million on R&D associated with the new project.

d) A and B

e) A, B, and C

4)  All else equal a project’s operating cash flow will decrease when the

a) Net working capital requirement decreases

b) Sales projections are increased

c) Interest expense is increased

d) Depreciation expense decreases

e) C and D

5) Farris Industrial purchased a machine 5 years ago at a cost of \$229,380. The machine is being depreciated using the straight-line method over 8 years. The tax rate is 35 percent and the discount rate is 16 percent. If the machine is sold today for \$74,500, what will be the after-tax salvage value?

a) \$74,500.00

b) \$67,625.09

c) \$78,531.13

d) \$37,389.69

e) \$115,454.05

6) A new 5-year project will require \$194,000 for fixed assets, \$58,000 for inventory, and \$42,000 for accounts receivable. Short-term debt is expected to increase by \$46,000. The fixed assets will be depreciated straight-line to zero over the project’s life and have an expected after-tax salvage value of \$2,900. The net working capital returns to its original level at the end of the project. The tax rate is 34 percent, and the required return is 13 percent. What is the cash flow recovery from net working capital at the end of this project?

a) \$54,000

b) \$35,000

c) \$146,000

d) \$108,000

e) \$63,000

7) Wilson’s is an all-equity firm that is reviewing a project with an internal rate of return of 13.09 percent and a beta of 1.21. The market risk premium is 8.1 percent, the tax rate is 35 percent, and the risk-free rate is 2.9 percent. The firm’s beta is 1.42. Should the project be accepted according to the CAPM? Why or why not?

a) Yes, since the CAPM rate is 12.70 percent

b) No, since the CAPM rate is 12.70 percent

c) Yes, since the CAPM rate is 9.19 percent

d) No, since the CAPM rate is 14.40 percent

e) Yes, since the CAPM rate is 14.40 percent

8) Assuming a company’s cost of equity exceeds its pretax cost of debt. Given this assumption and assuming all else is held constant, the company’s WACC must increase if the

a) Tax rate increases

b) Company’s beta increases

c) Pretax cost of debt decreases

d) Debt-to-equity ratio decreases

e) Market risk premium decreases

9) XYZ Inc. has a weighted average cost of capital of 11.5 percent. Its target capital structure is 55 percent common equity and 45 percent debt (the firm has no preferred stock). The before-tax cost of debt is 9 percent and the company tax rate is 30 percent. If the expected dividend next period (D1) is \$5 and the current stock price is \$45, what is the stock’s dividend growth rate?

a) 2.68%

b) 3.44%

c) 4.64%

d) 5.83%

e) 6.75%

10) According to the pecking order theory, firms prefer to issue debt than equity if internal return is sufficient.

a) True

b) False