# 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