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Capital Budgeting and Forecasting Models

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Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin Beagle, production manager, is considering purchasing a machine that will make the corn dogs. Austin has shopped for machines and found that the machine he wants will cost $262,000. In addition, Austin estimates that the new machine will increase the company's annual net cash inflows by $40,300. The machine will have a 12-year useful life and no salvage value.

(a) Calculate the payback period.
(b) Calculate the machine's internal rate of return.
(c) Calculate the machine's net present value using a discount rate of 10%.
(d) Assuming Corn Doggy, Inc.'s cost of capital is 10%, is the investment acceptable? Why or why not?

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Solution Preview

Please refer attached file for better understanding of formulas.

Let us study the cash flows associated with the given project

Year End Cash Flow
n Cn
0 -262000
1 40300
2 40300
3 40300
4 40300
5 40300
6 40300
7 40300
8 40300
9 40300
10 ...

Solution Summary

Solution depicts the steps to calculate the payback period, IRR and NPV parameters for the given case.

Similar Posting

26 Question Multiple Choice MANAGERIAL FINANCE

See attached file.
1. The difference between the market value of an investment and its cost is the:
Net present value
Internal rate of return
Payback Period
Profitability Index

2. The process of valuing an investment by determining the net present value of its future cash flows is called (the):
Constant dividend growth model
Discount cash flow valuation
Expected earnings model
Capital Asset Pricing Model

3. The length of time required for an investment to generate cash flow sufficient to recover its initial cost it the:
Net present value
Internal rate of return
Payback period
Profitability index

4. The discount rate that makes the net present value of an investment exactly equal to zero is the:
Payback period
Internal rate of return
Average accounting return
Profitability index

5. A situation in which taking one investment prevents the taking of another is called:
Net present value profiling
Operational ambiguity
Mutually exclusive investment decisions
Issues of scale
Multiple rates of return

6. The chnages in the firms future cash flows that are a direct consequence of accepting a project are called:
Incremental cash flows
Stand-alone cash flows
Aftertax cash flows
Net present value cash flows
Erosion cash flows

7. A cost that has alread been paid, or the liability to pay has already been incurred is a(n):
Salvage value expense
Net working capital expense
Opportunity cost
Sunk cost
Erosion cost

8. The most valuable investment given up if an alternative investment is chosen is a(n):
Salvage value expense
Net working capital expense
Sunk cost
Opportunity cost
Erosion cost

9. The possibility that errors in projected cash flows can lead to incorrect NPV estimates is called:
Forecasting risk
Projection risk
Scenario risk
Monte Carlo risk
Accounting risk

10. An analysis of what happens to NPV estimates when we ask what-if questions is called:
Forecasing analysis
Scenario analysis
Sensitivity analysis
Simualtion analysis
Break-even analysis

11. An analysis of the relation between sales volume and various measures of profitability is called:
Forecasting analysis
Scenario analysis
Sensitivity analysis
Simulation analysis
Break-evem analysis

12. The return that lender require on their loaned funds to the firm is called the:
Coupon rate
Current yield
Cost of debt
Capital gains yield
Cos of capital

13. The weighted averal of the firm's cost of equity, preferred stock, and after-tax debt is the:
Reward to risk ratio for the firm
Expected capital gains yield of the stock
Expected capital gains yield for the firm
Portfolio beta of the firm
Weighted average cost of capital (WACC)

14. The proportions of the market value of the firm's assets financed via debt, common stock, and preferred stock are called the firms ______________.
Financing costs
portfoliio weights
Beta coefficient
Capital structure weights
Cost of capital

15. The legal document describing details of the issuing corporation and its security offering to potential investors is called the _____________.
Letter of comment
Rights offering
Offering prospectus
Regulation A statement
Tombstone advertisement

16. A public offering of securities offered for sale to the general public on a direct cash basis is called a:
Best efforts offer
Firm commitment offer
General cash offer
Rights offer
Red herring offer

17. The use of personal borrowing to change the overall amount of finanical leverage to which the individual is exposed is called:
Private debt placement
Dividend recapture
Homemade leverage
A privileged subscription offer
The weighted average cost of captial

18. The equity risk derived from the firm's operating activities is called ________ risk.

19. The proposition that the cost of equity is a positive linear function of capital structure is called :
The Capital Asset Pricing Model
M&M Proposition I
M&M Propostion II
The Law of One Price
The Efficient Markets Hypothesis

20. The equity risk derived form the firm's capital structure policy is called ___________ risk.

21. Payments made out of the firm's earning to its owners in the form of cash or stock are called:
Share repurchases
Stock splits

22. Payments made by a firm to its owners from sources other than current or accumulated earings is called:
Share repurchases
Stock splits

23. A cash payment made by a firm to its owners as a result of a one-time event is called a:
Share repurchase
Liquidating dividends
Regular cash dividend
Special dividend
Extra cash dividend

24. The date by which a stockholder must be registered on the firm's roll as having share ownership in order to receive a declared dividend is called the _________.
date of ex-rights
date of ex-dividend
date of record
date of payment
date of declaration

25. The date on which the board of directors passes a resolution authorizing payment of a dividend to the sharholders if the _________ date.

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