Exam 13: Pricing Decisions

Martin Corporation has the following equity structure: Market Value Pretax Cost After-Tax Cost Long-term debt \ 300,000 10\% 6\% Preferred stock 500,000 10 10 Common stock 200,000 15 15 Martin's weighted average cost of capital is:

Allen Co. invested in a machine that has a 3-year useful life. The company's discount rate is 12%, and the net present value of the investment is $(573). Annual cost savings are: year 1 $3,000; year 2 $4,000; and year 3 $5,000. Determine the original cost of the machine. Ignore income taxes.

Net Present Value analysis is: I. A long-term decision-making method II. Incorporates the time value of money III. Used frequently in Canada.

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: Cost of new machine \ 100,000 Annual cost savings in cash expenses 45,000 Terminal value 8,000 Maintenance required in the 4th year 5,000 Book value of the old machine 20,000 The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded. The present value of the total savings (excluding the maintenance in year 4) in annual cash operating costs is:

The Conroy Co. wants to purchase a machine for a new product line that costs $138,750. The company's engineering department estimates the machine will last 10 years and provide an annual contribution margin of $25,000. Ignore income taxes. The internal rate of return to the nearest tenth of a percent is:

Apex Co. has $100,000 available for long-term investment. Which projects should be selected from the list below? Proiect Cost IRR NPV Profitability Index 1 \ 60,000 16\% \ 3,413 1.057 2 40,000 20\% 7,563 1.190 3 40,000 24\% 8,036 1.201 4 20,000 14\% 1,313 1.066 5 60,000 18\% 14,583 1.243 .243

The process that managers use when they evaluate multi-year investments is called

Capital Invest, Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year: Initial capital outlay \ 200,000 \ 298,000 \ 248,000 \ 272,000 Annual cash inflows: Year 1 \ 65,000 \ 100,000 \ 880,000 \ 95,000 Year 2 70,000 135,000 95,000 125,000 Year 3 80,000 90,000 90,000 90,000 Year 4 40,000 65,000 80,000 60,000 Net present value (3,789) 4,276 14,064 14,662 Profitability Index 0.98 1.01 1.06 1.05 Internal rate of return 11\% 13\% 14\% 15\% Which project(s) should Capital Invest, Inc. undertake during the upcoming year if it has only $600,000 of funds available?

Which of the following is not a step in the process for addressing capital budgeting decisions?

The time value of money means:

Internal rate of return:

As the number of periods increases for a project having uniform cash flows, the present value of each future discounted cash flow becomes:

Benjamin Company invested in a 3-year project and expects a 15% rate of return. Annual cash inflows from the project are: year 1 $8,000; year 2 $8,500; and year 3 $9,500. The net present value is $4,000. What was the amount of the original investment? Ignore income taxes.

DBR Corporation is considering the purchase and implementation of an enterprise-wide information system. Which of the following would be the least biased source of qualitative information about the project?

The nominal method is preferred to the real method for NPV analysis because: I. Cash flows can be inflated at different rates II. It includes a risk premium III. It includes the risk-free rate

The effect of a strategic investment decision on a company's reputation is often difficult to quantify.

An amortizable asset's taxable basis is calculated as its:

Managers responsible for proposing a project are likely to be favourably biased in their estimates of future project cash flows.

In capital budgeting decisions, amortization shields part of operating income from the effect of income taxes.

In general, the initial project investment does not require discounting in a net present value analysis.