## Finance -AW-Q372 Online Services

has normal cash flows, with one outflow followed by a series of inflows.

a. If a project’s NPV is less than zero, then its IRR must be less than the WACC.

b. The NPV of a relatively low-risk project should be found using a relatively high WACC.

c. A project’s NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.

d. The lower the WACC used to calculate a project’s NPV, the lower the calculated NPV will be.

e. If a project’s NPV is greater than zero, then its IRR must be less than zero.

2.Which of the following statements is CORRECT?

a. The “multiple IRR problem” can arise if a project’s cash flows are “normal.”

b. Projects with “normal” cash flows can have only one real IRR.

c. Projects with “normal” cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is “nonnormal.”

d. Projects with “nonnormal” cash flows are almost never encountered in the real world.

e. Projects with “normal” cash flows can have two or more real IRRs.

3. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

b. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.

c. The longer a project’s payback period, the more desirable the project is normally considered to be by this criterion.

d. One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money.

e. If a project’s payback is positive, then the project should be rejected because it must have a negative NPV.

4.

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

a. A project’s MIRR is unaffected by changes in the WACC.

b. A project’s discounted payback increases as the WACC declines.

c. A project’s IRR increases as the WACC declines.

d. A project’s NPV increases as the WACC declines.

e. A project’s regular payback increases as the WACC declines.

5. Which of the following statements is CORRECT?

a. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

c. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

d. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

e. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

6. Which of the following statements is CORRECT?

a. The NPV method is regarded by most academics as being the best indicator of a project’s profitability; hence, most academics recommend that firms use only this one method.

b. The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.

c. A project’s NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project’s life.

d. The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project’s profitability.

e. If the cost of capital declines, this lowers a project’s NPV.

7. Which of the following statements is CORRECT?

a. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.

b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.

c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.

d. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.

e. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.

8. Which of the following statements is NOT a disadvantage of the regular payback method?

a. Does not provide any indication regarding a project’s liquidity or risk.

b. Does not take account of differences in size among projects.

c. Does not directly account for the time value of money.

d. Ignores cash flows beyond the payback period.

e. Lacks an objective, market-determined benchmark for making decisions.

9.Which of the following statements is CORRECT?

a. A project’s MIRR can never exceed its IRR.

b. If the NPV is negative, the IRR must also be negative.

c. If Project A’s IRR exceeds Project B’s, then A must have the higher NPV.

d. If a project with normal cash flows has an IRR less than the WACC, the project must have a positive NPV.

e. If a project with normal cash flows has an IRR greater than the WACC, the project must also have a positive NPV.

10. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. A project’s MIRR is always greater than its regular IRR.

b. If a project’s IRR is greater than its WACC, then the MIRR will be greater than the IRR.

c. To find a project’s MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC.

d. A project’s MIRR is always less than its regular IRR.

e. If a project’s IRR is greater than its WACC, then the MIRR will be less than the IRR.

11.Pet World is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s IRR can be less than the WACC (and even negative), in which case it will be rejected.

Year 0 1 2 3 4 5

Cash flows $9,500 $2,000 $2,025 $2,050 $2,075 $2,100

a. 3.10%

b. 2.82%

c. 2.08%

d. 2.57%

e. 2.31%

12. Corner Jewelers, Inc. recently analyzed the project whose cash flows are shown below. However, before the company decided to accept or reject the project, the Federal Reserve changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV? Note that a project’s expected NPV can be negative, in which case it should be rejected.

Old WACC: 8.00% New WACC: 11.25%

Year 0 1 2 3

Cash flows $1,000 $410 $410 $410

a. $59.03

b. $56.08

c. $53.27

d. $48.08

e. $50.61

13. Watts Co. is considering a project that has the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less than the WACC (and even negative), in which case it will be rejected.

WACC: 10.00%

Year 0 1 2 3 4

Cash flows $850 $300 $320 $340 $360

a. 15.65%

b. 14.08%

c. 18.94%

d. 17.21%

e. 20.83%

14. Shannon Co. is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?

WACC: 10.00%

Year 0 1 2 3 4

Cash flows $950 $525 $485 $445 $405

a. 1.61 years

b. 1.79 years

c. 2.22 years

d. 2.44 years

e. 1.99 years

15.which of the following procedures best accounts for the relative risk of a proposed project?

a. Adjusting the discount rate downward if the project is judged to have above-average risk.

b. Picking a risk factor equal to the average discount rate.

c. Ignoring risk because project risk cannot be measured accurately.

d. Adjusting the discount rate upward if the project is judged to have above-average risk.

e. Reducing the NPV by 10% for risky projects.

16. Which of the following statements is CORRECT?

a. A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.

b. A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm’s existing stores.

c. A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.

d. A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.

e. Sunk costs were formerly hard to deal with but now that the NPV method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the PV of the project.

17.Which of the following statements is CORRECT?

a. A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices.

b. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.

c. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.

d. An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.

e. If sunk costs are considered and reflected in a project’s cash flows, then the project’s calculated NPV will be higher than it otherwise would be.

18. Which of the following statements is CORRECT?

a. Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project’s projected NPV.

b. Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.

c. Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.

d. Using accelerated depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV.

e. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.

19. To increase productive capacity, a company is considering a proposed new plant. Which of the following statements is CORRECT?

a. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.

b. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.

c. Capital budgeting decisions should be based on before-tax cash flows.

d. In calculating the project’s operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, “double count” it.

e. When estimating the project’s operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.

20. Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects

Project Risk Expected Return

A High 15%

B Average 12%

C High 11%

D Low 9%

E Low 6%

Which set of projects would maximize shareholder wealth?

a. A, B, and C.

b. A, B, C, D, and E.

c. A and B.

d. A, B, C, and D.

e. A, B, and D.

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21.VR Corporation has the opportunity to invest in a new project, the details of which are shown below. What is the Year 1 cash flow for the project?

Sales revenues, each year $42,500

Depreciation $10,000

Other operating costs $17,000

Interest expense $4,000

Tax rate 35.0%

a. $19,071

b. $18,118

c. $16,351

d. $17,212

e. $20,075

22. DeVault Services recently hired you as a consultant to help with its capital budgeting process. The company is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. What is the project’s NPV?

Risk-adjusted WACC 10.0%

Net investment cost (depreciable basis) $65,000

Straight-line deprec. rate 33.3333%

Sales revenues, each year $65,500

Operating costs (excl. deprec.), each year $25,000

Tax rate 35.0%

a. $17,441

b. $16,569

c. $15,740

d. $19,325

e. $18,359

23. Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other Weston’s products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%

Pre-tax cash flow reduction for other products (cannibalization) $5,000

Investment cost (depreciable basis) $80,000

Straight-line deprec. rate 33.333%

Sales revenues, each year for 3 years $67,500

Annual operating costs (excl. deprec.) $25,000

Tax rate 35.0%

a. $3,828

b. $3,636

c. $4,019

d. $4,431

e. $4,220

24. To increase productive capacity, a company is considering a proposed new plant. Which of the following statements is CORRECT?

a. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.

b. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.

c. Capital budgeting decisions should be based on before-tax cash flows.

d. In calculating the project’s operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, “double count” it.

e. When estimating the project’s operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.

25. Which of the following statements is CORRECT?

a. Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the financial forecasting process.

b. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.

c. There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases. The Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship.

d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.

e. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.

26. Last year Baron Enterprises had $225 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity last year. In millions, by how much could Baron’s sales increase before it is required to increase its fixed assets?

Select the correct answer.

a. $114.8

b. $102.0

c. $121.2

d. $108.4

e. $134.0

27. Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company’s operations next year, and he wants you to forecast the firm’s additional funds needed (AFN). The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.

Last year’s sales = S0 $350 Last year’s accounts payable $40

Sales growth rate = g 30% Last year’s notes payable $50

Last year’s total assets = A0* $440 Last year’s accruals $30

Last year’s profit margin = PM 5% Target payout ratio 60%

Select the correct answer.

a. $101.9

b. $95.7

c. $105.0

d. $98.8

e. $108.1

28. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?

a. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.

b. The spot rate equals the 90-day forward rate.

c. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.

d. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

e. The spot rate equals the 180-day forward rate.

29. If 1.64 Canadian dollars can purchase one U.S. dollar, how many U.S. dollars can you purchase for one Canadian dollar?

a. 0.61

b. 1.64

c. 1.00

d. 3.28

e. 0.37

30. Suppose that 1 British pound currently equals 1.62 U.S. dollars and 1 U.S. dollar equals 1.62 Swiss francs. What is the cross exchange rate between the pound and the franc?

a. 1 British pound equals 0.3810 Swiss francs

b. 1 British pound equals 3.2400 Swiss francs

c. 1 British pound equals 2.6244 Swiss francs

d. 1 British pound equals 1.0000 Swiss francs

e. 1 British pound equals 1.8588 Swiss francs

31.Suppose it takes 1.82 U.S. dollars today to purchase one British pound in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?

a. 1.12

b. 1.63

c. 3.64

d. 1.82

e. 2.04

32. A U.S.-based importer, Zarb Inc., makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.638 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?

a. -$243

b. -$396

c. $243

d. $638

e. $0

33. A product sells for $750 in the United States. The exchange rate is $1 to 1.65 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland?

a. 750.00 Swiss francs

b. 123.75 Swiss francs

c. 1,237.50 Swiss francs

d. 454.55 Swiss francs

e. 1,650.00 Swiss francs

34. Tashakori Trucking, a U.S.-based company, is considering expanding its operations into a foreign country. The required investment at Time = 0 is $10 million. The firm forecasts total cash inflows of $4 million per year for 2 years, $6 million for the next 2 years, and then a possible terminal value of $8 million. In addition, due to political risk factors, Tashakori believes that there is a 50% chance that the gross terminal value will be only $2 million and a 50% chance that it will be $8 million. However, the government of the host country will block 20% of all cash flows. Thus, cash flows that can be repatriated are 80% of those projected. Tashakori’s cost of capital is 15%, but it adds one percentage point to all foreign projects to account for exchange rate risk. Under these conditions, what is the project’s NPV?

a. $3.09 million

b. $1.01 million

c. $5.96 million

d. $2.77 million

e. $7.39 million

35. Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000. The exchange rate at that time was 1.420 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor?

a. -7.92%

b. 12.00%

c. 8.25%

d. 6.00%

e. -4.13%

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