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Multiple Choice

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:

Project: A Project: B

Initial End-of-Year Initial End-of-Year
Investment Cash Flows Investment Cash Flows
$40,000 Year1- $20,000 $90,000 $40,000
Year 2- 20,000 40,000
Year 3- 20,000 80,000

You are a financial analyst in the firm and you don't like the payback approach. Your recommendation would be to (Suppose the firm's required rate of return is 15%)

a- accept projects A and B.
b- accept project A and reject B
c- reject project A and accept B.
d- reject both.

A company's fixed operating costs are $500,000, its variable costs are $3.00 per unit, and the product's sales price is $4.00. What is the company's breakeven point, i.e., at what unit sales volume would its income equal its costs?

a) 500,000

b) 600,000

c) 700,000

d) 800,000

e) 900,000

A stock just paid a dividend of $1. The required rate of return is rs = 11%, and the constant growth rate is 5%. What is the current stock price?

a. $15.00
b. $17.50
c. $20.00
d. $22.50
e. $25.00

Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm's after tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period?

a- 2 years
b- 4 years
c- 6 years
d 8 years
e- 10 years

Solution Preview

1. Since the payback period is not to be used, we calculate the NPV of the project and accept the project if the NPV is positive.
NPV of Project A is -40,000+20,000/1.15 + 20,000/1.15^2 + 20,000/1.15^3 = $5,664.50
NPV of Project B is -90,000 + 40,000/1.15 + 40,000/1.15^2 + 80,000/1.15^3 = $27,629.65
Since the projects are mutually exclusive we can select only 1 and so ...

Solution Summary

The solution explains some multiple choice questions relating to capital budgeting