Intermediate Finance – Exam II
Multiple choice (3 points each.)
1. How much would you be willing to pay for a share of ABC Corp. stock if it just paid
an annual dividend of $2.00 per share and has a long-term growth rate of 5%? Your
required rate of return on the stock is 15%.
a. $20.00
b. $10.00
c. $10.50
d. $21.00
e. no solution
2. What is the return on equity of O&J Corp. if they just paid an annual dividend of
$1.50, have a long-term growth rate of 10%, and their current stock price is $12.
a.
23.75%
b. 22.50%
c.
21.60%
d. 15.125%
e.
10%
3. The investment opportunity schedule shows:
a. the marginal cost of capital for every project in descending order
b. the weighted cost of capital for every project in ascending order
c. the weighted cost of capital at every breakpoint
d. the IRR of every project in descending order
e. the NPV profile of a project and its IRR
4. The retained earnings breakpoint shows:
a. the point at which the NPV crosses the horizontal axis
b. the amount of accumulated depreciation expensed on an old piece of equipment
c. the amount of money that can be spent on capital projects before retained earnings
are used up
d. the total capital budget for a company with no retained earnings
e. the capital expenditures at which a company’s cost of capital will decrease
5. Increased depreciation expense from a new piece of equipment results in a cash inflow
because:
a. the new equipment increases revenue
b. the tax break from increased depreciation causes an inflow
c. the new equipment’s depreciation is offset by the net operating cash flow
d. depreciation doesn’t affect cash inflow only changes in revenues and operating
expenses do
e. increased depreciation expense doesn’t result in a cash inflow, it causes a cash
outflow
Problems.
1. (15 points) Comodo Industries can issue new bonds for 9%. Their earnings per share
has been as follows:
Year
EPS
1995
$1.35
1996
1.50
1997
1.85
1998
2.05
1999
2.28
Their payout ratio is 30% and their common stock currently sells for $35. Comodo’s tax
rate is 40%. Their capital structure is as follows:
Debt
Equity (100,000 shares)
$750,000
250,000
$1,000,000
Calculate the company’s cost of capital. Show all work. (Remember when calculating g,
the PV # goes into the calculator as negative.)
Calculate the company’s retained earnings breakpoint.
2. (20 points) A project has the following cash flows:
year
0
1
2
3
Cash Flow
$- 43,000
19,000
20,000
12,000
The discount rate is 12%. Calculate the following (Show work for MIRR.)
a. Payback = _____________________
b. NPV = _______________________
c. IRR = ________________________
d. MIRR = ________________________
3. (Replacement problem – 35 points) Terry’s Hamburgers is considering replacing their
old Frosty Ice Cream machine with a new Softee Ice Cream machine that can make five
different flavors of softees. The old machine was purchased 3 years ago for $29,000 and
has an expected life of 6 years and salvage value of $5,000. The old machine was
depreciated using the straight-line method and has three years of depreciation left. The
old machine could be sold today for $12,500.
The new Softee Ice Cream machine has a purchase price of $45,000 and will cost $2,000
to install. It has an expected life of 3 years and will be depreciated using 5 year MACRs
(20%, 32%, 19%, 12%, 11%, 6%). If the new machine is purchased, cleaning materials
and spare parts totaling $1,400 will have to be purchased. At the end of 3 years, the
machine has an expected salvage value of $10,000. The new machine is expected to
increase revenues by $14,000 per year and decrease operating expenses by $5,600 per
year.
Terry’s current tax rate is 40%. The company’s cost of capital is 10%. Clearly show the
incremental cash flows that result from purchasing the new machine. What is the NPV?
Should Terry purchase the new Softee machine?
4. (15 points) When analyzing two mutually exclusive projects, the NPV and IRR
methods can recommend different projects. Graphically show and explain how this can
happen. In what cases is this likely to occur? If a conflict occurs, which method is
preferable and why?