# Capital Budgeting, cash budget, effective return, Bond price

1. As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Cash Flows

A B

-$100,000 -$125,000

1 $25,000 $25,000

2 $30,000 $35,000

3 $30,000 $35,000

4 $25,000 $35,000

5 $30,000 $45,000

If Denver's cost of capital is 15 percent, defend which project would you choose.

2. Chadmark Corporation's budgeted monthly sales are $3,000. Forty percent of its customers pay in the first month and take the 2 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. Chadmark's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,500. Other payments for wages, rent, and taxes are constant at $700 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for Chadmark Corporation?

3. Which of the following bank accounts has the highest effective return and why?

A. An account which pays 10% nominal interest with monthly com-pounding.

B. An account which pays 10% nominal interest with daily com-pounding.

C. An account which pays 10% nominal interest with annual com-pounding.

D. An account which pays 9% nominal interest with daily com-pounding.

E. All of the investments above have the same effective annual return

4. Which of the following statements is most correct and why?

A. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.

B. If a bond sells at par, then its current yield will be less than its yield to maturity.

C. Assuming that both bonds are held to maturity and are of equal risk, a bond selling for more than par with ten years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par.

D. Answers A and C are correct.

E. None of the answers above is correct.

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#### Solution Preview

Please see the attached file.

1. As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Cash Flows

A B

-$100,000 -$125,000

1 $25,000 $25,000

2 $30,000 $35,000

3 $30,000 $35,000

4 $25,000 $35,000

5 $30,000 $45,000

If Denver's cost of capital is 15 percent, defend which project would you choose.

We will select the project with the higher NPV provided it is positive

Net Present Value

To calculate the NPV ( Net Present Value) we discount the cash flow at the given discount rates

A

discount rate= 15%

Year Cash flow PV factor @15.% Discounted cash flow=

0 ($100,000) 1 -100,000 =-100000*1

1 $25,000 0.869565 21,739 =25000*0.869565

2 $30,000 0.756144 22,684 =30000*0.756144

3 $30,000 0.657516 19,725 =30000*0.657516

4 $25,000 0.571753 14,294 =25000*0.571753

5 $30,000 0.497177 14,915 =30000*0.497177

NPV= -6,643

NPV = -6,643

B

discount rate= 15%

Year Cash flow PV factor @15.% Discounted cash flow=

0 ($125,000) 1 -125,000 =-125000*1

1 $25,000 0.869565 21,739 =25000*0.869565

2 $35,000 0.756144 26,465 =35000*0.756144

3 $35,000 ...

#### Solution Summary

Answers questions on:

Capital Budgeting: Compares two mutually exclusive projects.

Cash budget: Constructs a single month's cash budget

Effective return: Determines which of the bank accounts has the highest effective return

Bond price: MCQ on bond prices

Problem set on Time Value of Money, Bonds, Capital Budgeting, CAPM, breakeven analysis

The more frequent the compounding, the higher the future value, other things equal.

A) True

B) False

2. For a given amount, the lower the discount rate, the less the present value.

A) True

B) False

3. How much will accumulate in an account with an initial deposit of $100, and which earns 12% interest compounded quarterly for three years?

A) $112.00

B) $133.10

C) $140.49

D) $313.84

4. How much can be accumulated for retirement if $2,000 is deposited annually, beginning one year from today, and the account earns 11% interest compounded annually for 40 years?

A) $88,800.00

B) $675,764.89

C) $736,583.73

D) $1,163,652.13

5. Under which of the following conditions will a future value calculated with simple interest exceed a future value calculated with compound interest at the same rate?

A) The interest rate is very high.

B) The investment period is very long.

C) The compounding is annually.

D) This is not possible with positive interest rates.

6. How long must one wait (to the nearest year) for an initial investment of $2,500 to triple in value if the investment earns 8% compounded annually?

A) 9

B) 14

C) 22

D) 25

7. A credit card account that charges interest at the rate of 1.25% per month would have an annually compounded rate of _______ and an APR of _______.

A) 16.08%; 15.00%

B) 14.55%; 16.08%

C) 19.56%; 18.00%

D) 15.00%; 18.00%

8. If the effective annual rate of interest is known to be 16.08% on a debt that has quarterly payments, what is the annual percentage rate?

A) 4.02%

B) 10.02%

C) 14.50%

D) 15.19%

9. If a borrower promises to pay you $2,000 nine years from now in return for a loan of $1,000 today, what effective annual interest rate is being offered?

A) 5.26%

B) 7.39%

C) 8.01%

D) 10.00%

10. What is the present value of your trust fund if it promises to pay you $50,000 on your 30th birthday (7 years from today) and earns 12% compounded annually?

A) $22,617.46

B) $25,657.91

C) $28,223.70

D) $29,411.76

11. What is the present value of the following payment stream, discounted at 8% annually: $1,000 at the end of year 1, $2,000 at the end of year 2, and $3,000 at the end of year 3?

A) $5,022.11

B) $5,144.03

C) $5,423.87

D) $5,520.00

12. How much should you pay for a $1,000 bond with 10% coupon, annual payments, and five years to maturity if the interest rate is 12%?

A) $ 927.90

B) $ 981.40

C) $1,000.00

D) $1,075.82

13. What is the coupon rate for a bond with three years until maturity, a price of $1,053.46, and a yield to maturity of 6%?

A) 6%

B) 8%

C) 10%

D) 11%

14. What happens when a bond's expected cash flows are discounted at a rate lower than the bond's coupon rate?

A) The price of the bond increases.

B) The coupon rate of the bond increases.

C) The par value of the bond decreases.

D) The coupon payments will be adjusted to the new discount rate.

15. What is the NPV of a project that costs $100,000 and returns $45,000 annually for four years if the opportunity cost of capital is 9%?

A) $13,397.57

B) $24,473.44

C) $45,787.39

D) $75,323.81

16. The decision rule for net present value is to:

A) accept all projects with cash inflows exceeding initial cost.

B) reject all projects with rates of return exceeding the opportunity cost of capital.

C) accept all projects with positive net present values.

D) reject all projects lasting longer than 10 years.

17. Which of the following changes will increase the NPV of a project?

A) A decrease in the discount rate

B) A decrease in the size of the cash inflows

C) An increase in the initial cost of the project

D) A decrease in the number of cash inflows

18. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $40,000 annually for three years, and the cost of capital is 9%?

A) $101,251.79

B) $109,200.00

C) $117,871.97

D) $130,800.00

19. What is the approximate IRR for a project that costs $100,000 and provides cash inflows of $30,000 for 6 years?

A) 19.9%

B) 30.0%

C) 32.3%

D) 80.0%

20. If the IRR for a project is 15%, then the project's NPV would be:

A) negative at a discount rate of 10%.

B) positive at a discount rate of 20%.

C) negative at a discount rate of 20%.

D) positive at a discount rate of 15%.

21. Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: CF0 = -6,000, CF1 = +3,300, CF2 = +3,300.

A) Accept, since IRR exceeds opportunity cost.

B) Reject, since opportunity cost exceeds IRR.

C) Accept, since opportunity cost exceeds IRR.

D) Reject, since IRR exceeds opportunity cost.

22. The average of beta values for all individual stocks is:

A) greater than 1.0; most stocks are aggressive.

B) less than 1.0; most stocks are defensive.

C) unknown; betas are continually changing.

D) exactly 1.0; these stocks represent the market.

23. If a stock consistently goes down (up) by 1.6% when the market portfolio goes down (up) by 1.2% then its beta:

A) equals 1.40.

B) equals 1.24.

C) equals 1.33.

D) equals 1.40.

24. If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0, then the:

A) stock is currently under priced.

B) market risk premium is increasing.

C) stock has a significant amount of unique risk.

D) stock has a beta exceeding 1.0.

25. What is the beta of a three-stock portfolio including 25% of Stock A with a beta of .90, 40% Stock B with a beta of 1.05, and 35% Stock C with a beta of 1.73?

A) 1.05

B) 1.17

C) 1.22

D) 1.25

1. A corporate bond has a coupon rate of 9 percent, has 7 years until maturity, and sells at a yield to maturity of 7%. At what price does the bond currently sell? (Assume

annual interest payments.) ___________________

2. A company manufactures only one product. It sells the product for $20.00 per unit, The company has an annual rent expense of $75,000, annual supervisory salaries of $250,000, factory labor cost of $7.00 per unit, raw material cost of $5.50 per unit. What is its breakeven point in units for one year? ____________________

3. Another company also manufactures only one product. It sells the product for $14.25 per unit, The company has an annual rent expense of $200,000, annual supervisory salaries of $150,000, factory labor cost of $2.50 per unit, and can produce and sell 50,000 units per year. What is the most it can pay for raw material per unit and still earn a profit of $50,000 for the year? ____________________

4. You win a lottery. You have the choice of receiving $150,000 today and $50,000 per year for the next 15 years or $100,000 per year for 12 years. The annual interest rate is 7%. What is the present value of the better option? _____________________

5. A machine costs $150,000. It will increase cash flow by $20,000 per year in years one and two, and $50,000 per year in years three through five. At the end of year five the equipment can be sold for $25,000. Assuming the discount rate is 9%, what is the Net Present Value of this investment? ___________________

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