# Cash flow, payback method, IRR, secured debt, bond yields, z

Also see attached file for problems

Text Questions and Exercises - WEEK 3

Prepare answers to the following questions and exercises from the text: Foundations of Financial Management -

Chapter 12: 1, 4, 8, 9

Chapter 16: 4, 5, 10

Chapter 12

Cash Flow

1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes ___

Depreciation ___

Earnings before taxes ___

Taxes @ 30% ___

Earnings after taxes ___

Depreciation ___

Cash flow ___

Payback Method

1. Assume a $40,000 investment and the following cash flows for two alternatives.

Year Investment X Investment Y

1 $ 6,000 $15,000

2 8,000 20,000

3 9,000 10,000

4 17,000 ?

5 20,000 ?

Which of the alternatives would you select under the payback method?

Internal Rate of return

8. You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the internal rate of return?

Internal Rate of Return

9. Warner Business Products is considering the purchase of a new machine at a cost of $11,070. The machine will provide $2,000 per year in cash flow for eight years. Warner's cost of capital is 13 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.

Chapter 16

Secured vs. unsecured debt

2. Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.

1. Security Provision 2. Yield to Maturity

a. Debenture a. 6.85%

b. Secured debt b. 8.20%

c. Subordinated debenture c. 7.76%

Bond Yields

3. The Southeast Investment Fund buys 70 bonds of the Hillary Bakery Corporation through its broker. The bonds pay 9 percent annual interest. The yield to maturity (market rate of interest) is 12 percent. The bonds have a 25-year maturity. Using an assumption of semiannual interest payments:

1. Compute the price of a bond (refer to "semiannual interest and bond prices" in Chapter 10 for review if necessary).

2. Compute the total value of the 70 bonds.

Zero coupon bond values

A 15-year, $1,000 par value zero-coupon rate bond is to be issued to yield 10 percent.

1. What should be the initial price of the bond? (Take the present value of $1,000 to be received after 15 years at 10 percent, using Appendix B at the back of the text.)

2. If immediately upon issue, interest rates dropped to 8 percent, what would be the value of the zero-coupon rate bond?

3. If immediately upon issue, interest rates increased to 12 percent, what would be the value of the zero-coupon rate bond?

https://brainmass.com/business/capital-budgeting/cash-flow-payback-method-irr-secured-debt-bond-yields-z-216471

#### Solution Preview

See attached files.

Text Questions and Exercises - WEEK 3

Prepare answers to the following questions and exercises from the text: Foundations of Financial Management -

Chapter 12: 1, 4, 8, 9

Chapter 16: 4, 5, 10

Chapter 12

Cash Flow

1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes 90,000

Depreciation 40,000

Earnings before taxes 50,000

Taxes @ 30% 15,000

Earnings after taxes 35,000

Depreciation 40,000

Cash flow 75,000

Payback Method

1. Assume a $40,000 investment and the following cash flows for two alternatives.

Year Investment X Investment Y

1 $ 6,000 $15,000

2 8,000 20,000

3 9,000 10,000

4 17,000 ?

5 20,000 ?

Which of the alternatives would you select under the payback method?

Payback method is to determine the amount of time that is used to match the amount of investment and cash inflows.

Investment X = 6,000 + 8,000 + 9,000 + 17,000 = 40,000

Payback for Investment X = 4 years

Investment Y = 15,000 + 20,000 + (5,000/10,000 amount left to make equal to 40,000 divided by the cash inflow for that year)

Payback for Investment Y = 2.5 years

I would select Investment Y due to shorter payback period.

Internal Rate of return

8. You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the ...

#### Solution Summary

This solution is comprised of a detailed explanation to compute its cash flow and answer which of the alternatives would you select under the payback method.

Financial Management

Today I need help with a 40 question multiple choice overview pre-test given by our tutor. I want to compare your results with my own and those of the tutor. Attached is a Word document with these questions and an Excel file where you put the letter answer (i.e., A, B, C, D or E). Please work the problems separately and place the appropriate letter on the Excel file sheet.

I have also attached a PPT presentation to provide some guidance as to how we approached certain subjects.

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1. What is the major complaint concerning the Sarbanes-Oxley Act of 2002 by firms?

A) the legislative maximum allowable compensation for a CEO

B) the legal requirement to disclose project information

C) the cost of compliance

D) the cost of maintaining an SEC-employed officer at the firm's premises

2. Parrino Corporation has announced that its net income for the year ended June 30, 2008, is $1,824,214. The company had an EBITDA of $ 5,174,366, and its depreciation and amortization expense was equal to $1,241,790. The company's tax rate is 34 percent. What is the amount of interest expense for the firm?

A) $2,763,961

B) $939,747

C) $1,187,720

D) $1,168,615

3. Simplex Healthcare had net income of $5,411,623 after paying taxes at 34 percent. The firm had revenues of $20,433,770. Their interest expense for the year was $1,122,376, while depreciation expense was $2,079,112. What was the firm's operating expenses excluding depreciation?

A) $8,199,429

B) $9,032,853

C) $9,321,805

D) none of the above

4. Teakap, Inc. has current assets of $ 1,456,312 and total assets of $4,812,369 for the year ending September 30, 2006. It also has current liabilities of $1,041,012, common equity of $1,500,000, and retained earnings of $1,468,347. How much long-term debt does the firm have?

A) $1,844,022

B) $2,303,010

C) $2,123,612

D) $803,010

5. Lionel, Inc. has current assets of $623,122, including inventory of $241,990, and current liabilities of 378,454. What is the quick ratio?

A) 1.65

B) 0.64

C) 1.01

D) None of the above

6. Ellicott City Manufacturers, Inc. has sales of $6,344,210, and a gross profit margin of 67.3 percent. What is the firm's cost of goods sold?

A) $2,074,557

B) $2,745,640

C) $274,560

D) None of the above

7. What will be a firm's equity multiplier given a debt ratio of 0.45?

A) 1.82

B) 1.28

C) 2.22

D) None of the above

8. Juventus Corp has total assets of $4,744,288, total debt of $2,912,000, and net sales of $7,212,465. Their net profit margin for the year is 18 percent. What is Juventus's ROA?

A) 25.6%

B) 18%

C) 27.4%

D) None of the above

9. Andrade Corp has debt of $2,834,950, total assets of $5,178,235, sales of $8,234,121, and net income of $812,355. What is the firm's return on equity?

A) 7.1%

B) 34.7%

C) 28.1%

D) 43.2%

10. Saunders, Inc. has a ROE of 18.7 percent, an equity multiplier of 2.53, sales of $2.75 million, and a total assets turnover of 2.7 times. What is the firm's net income?

A) $75,281.80

B) $514,250.00

C) $51,425.00

D) $7,528.10

11. Using higher discount rates will

A) Not affect the present value of the future cash flow.

B) Increase the present value of any future cash flow.

C) Decrease the present value of any future cash flow.

D) None of the above.

12. You are interested in investing $10,000, a gift from your grandparents, for the next four years in a mutual fund that will earn an annual return of 8 percent. What will your investment be worth at the end of four years? (Round to the nearest dollar.)

A) $10,800

B) $13,605

C) $13,200

D) None of the above

13. Your mother is trying to choose one of the following bank CDs to deposit $10,000. Which one will have the highest future value if she plans to invest for three years?

A) 3.50% compounded daily

B) 3.25% compounded monthly

C) 3.40% compounded quarterly

D) 3.50% compounded annually

14. You need to have $15,000 in five years to pay off a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years? (Round to the nearest dollar.)

A) $4,903

B) $11,275

C) $14,184

D) $12,250

15. Pedro Martinez wants to invest $25,000 in a spa that his sister is starting. He will triple his investment in six years. What is the rate of return that Pedro is being promised? (Rounded to the nearest percent.)

A) 18%

B) 20%

C) 12%

D) 25%

16. Peterson Electrical Supplies has generated a net income of $161,424 this year. The firm expects to see an annual growth of 30 percent for the next five years, followed by a growth rate of 15 percent for each of the next three years. What will be the firm's expected net income in eight years? (Round to the nearest dollar.)

A) $319,157

B) $241,329

C) $911,546

D) $689,259

17. Elegant Designers have generated sales of $625,000 for the current year. If they can grow their sales at a rate of 12 percent every year, how long will they take to triple their sales? (Round off to the nearest year.)

A) 8 years

B) 7 years

C) 10 years

D) 9 years

18. Ray Seo has $5,000 to invest in a small business venture. His partner has promised to pay him back $8,200 in five years. What is the return earned on this investment?

A) 9.3%

B) 8.7%

C) 11.1%

D) 10.4%

19. Myers, Inc., will be making lease payments of $3,895.50 for a 10-year period, starting at the end of this year. If the firm uses a 9 percent discount rate, what is the present value of this annuity? (Round to the nearest dollar.)

A) $23,250

B) $29,000

C) $25,000

D) $20,000

20. Jayadev Athreya has started on his first job. He plans to start saving for retirement early. He will invest $5,000 at the end of each year for the next 45 years in a fund that will earn a return of 10 percent. How much will Jayadev have at the end of 45 years? (Round to the nearest dollar.)

A) $2,667,904

B) $3,594,524

C) $1,745,600

D) $5,233,442

21. Ogden wants to save for a trip to Australia. She will need $12,000 at the end of four years. She can invest a certain amount at the beginning of each of the next four years in a bank account that will pay her 6.8 percent annually. How much will she have to invest annually to reach her target? (Round to the nearest dollar.)

A) $3,000

B) $2,980

C) $2,538

D) $2,711

22. A lottery winner was given a perpetual payment of $11, 444. She could invest the cash flows at 7 percent. What is the present value of this perpetuity? (Round to the nearest dollar.)

A) $112,344

B) $163,486

C) $191,708

D) $201,356

23. You plan to save $1,400 for the next four years, beginning now, to pay for a vacation. If you can invest it at 6 percent, how much will you have at the end of four years? Round to the nearest dollar.

A) $6,124

B) $5,618

C) $4,019

D) $6,492

24. Norwood Investments is putting out a new product. The product will pay out $25,000 in the first year, and after that the payouts will grow by an annual rate of 2.5 percent forever. If you can invest the cash flows at 7.5 percent, how much will you be willing to pay for this perpetuity? (Round to the nearest dollar.)

A) $312,000

B) $233,000

C) $250,000

D) $500,000

25. Largent Supplies Corp. has borrowed to invest in a project. The loan calls for a payment of $17,384 every month for three years. The lender quoted Largent a rate of 8.40 percent with monthly compounding. At what rate would you discount the payments to find amount borrowed by Largent? (Round to two decimal places.)

A) 8.40%

B) 8.73%

C) 8.95%

D) None of the above.

26. The expected return for Stock Z is 30 percent. If we know the following information about Stock Z, then what return will it produce in the Lukewarm state of the world?

Return Probability

Poor 0.2 0.25

Lukewarm ? 0.5

Dynamite! 0.4 0.25

A) 20%

B) 30%

C) 40%

D) It is impossible to determine.

27. You have invested 40 percent of your portfolio in an investment with an expected return of 12 percent and 60 percent of your portfolio in an investment with an expected return of 20 percent. What is the expected return of your portfolio?

A) 15.2%

B) 16.0%

C) 16.8%

D) 17.6%

28. Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2.

Prob Stock 1 Stock 2

0.5 0.11 0.18

0.3 0.17 0.15

0.2 0.19 0.12

A) 0.001204001

B) 0.000549003

C) -0.00027137

D) -0.3372012

E) -0.000786

29. Capital rationing implies that

A) funding resources exceed funding needs.

B) funding needs exceed funding resources.

C) funding needs equal funding resources.

D) none of the above.

30. Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.

B) Accepting a negative-NPV project has no impact on shareholder wealth.

C) Accepting a negative-NPV project decreases shareholder wealth.

D) Managers are indifferent about accepting or rejecting a zero NPV project.

31. What are the two primary drawbacks to the payback period method?

A) difficult to calculate; ignores time value of money

B) difficult to calculate; only works for long projects (e.g., 5 years or more)

C) ignores time value of money; ignores cash flows after payback is reached

D) only works for long projects; ignores cash flows after payback is reached

E) difficult to calculate; ignores cash flows after payback is reached

32. Mr. Moore is 35 years old today and is beginning to plan for his retirement. He wants to set aside an equal amount at the end of each of the next 25 years so that he can retire at age 60. He expects to live to about 80, and wants to be able to withdraw $25,000 per year from the account on his 61st through 80th birthdays. The account is expected to earn 10 percent per annum for the entire period of time. Determine the size of the annual deposits that must be made by Mr. Moore.

A) $212,850

B) $23,449

C) $2,164

D) $8,514

E) None of the above

33. Calculate the NPV of a project requiring a $3,000 investment followed by an outflow of $500 in Year 1, and inflows of $1,000 in Year 2 and $4000 in Year 3. The cost of capital is 12%. (Round to nearest $)

A) $52

B) $257

C) $198

D) $486

E) None of the above

34. The projected cash flows for two mutually exclusive projects are as follows:

Year Project A Project B

0 ($150,000) ($150,000)

1 0 50,000

2 0 50,000

3 0 50,000

4 0 50,000

5 250,000 50,000

If the cost of capital is 10%, the decidedly more favorable project is:

A) project B with an NPV of $39,539 and an IRR of 19.9%.

B) project A with an NPV of $5,230 and an IRR of 10.8%.

C) project A with an NPV of $39,539 and an IRR of 10.8%.

D) project B with an NPV of $5,230 and an IRR of 19.9%.

35. You are considering an investment that will pay you $100 in Year 1, $500 in Year 2, $0 in Year 3 and $600 in Year 4. If you require a 12% return, what is the most you should pay for this investment today? (Round to nearest $)

A) $915

B) $869

C) $734

D) $698

36. Find the present value of a payment stream of $100 per year for the first fifteen years and $200 per year for the next five years, given a 12% discount rate. (Round to nearest $)

A) $813

B) $1,402

C) $953

D) $887

E) $712

37. Modern Federal Bank is setting up a brand new branch. The cost of the project will be $1.2 million. The branch will create additional cash flows of $235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of capital is 12 percent. What is the internal rate of return on this branch expansion? (Round to the nearest percent.)

A) 20%

B) 23%

C) 25%

D) 27%

38. Capital budgeting analysis of mutually exclusive projects A and B yields the following:

Project A Project B

IRR 18% 22%

NPV $270,000 $255,000

Payback Period 2.5 yrs 2.0 yrs

Management should choose:

A) Project B because most executives prefer the IRR method.

B) Project B because two out of three methods choose it.

C) Project A because NPV is the best method.

D) either project because the results aren't consistent.

39. The Cyclone Golf Resorts is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1, 223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the firm is 13 percent, what is the NPV of this project?

A) $7,581,072

B) $2,092,432

C) $4,836,752

D) $3,112,459

40. Roswell Energy Company is installing new equipment at a cost of $10 million. Expected cash flows from this project over the next five years will be $1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's discount rate for such projects is 14 percent. What is the project's discounted payback period?

A) 4.2 years

B) 4.4 years

C) 4.8 years

D) 5.0 years