Exam 7: Making Capital Investment Decisions: Further Issues

A modeling process that uses equations to show the interrelationships among key factors influencing cash flows and helps managers understand the nature of the project and the issues that need to be resolved is called

Kendle Knitting Mills is looking to purchase additional weaving looms of different sizes. One supplier has offered an appropriate configuration of machines valued at $175,000. Kendle projects incremental income from these looms before depreciation at $40,000 a year over an eight year period. Kendle can purchase similar used machines for $85,000 but the equipment is less efficient and will only last four years. Income from these is projected at $40,000, $37,000, $33,000, and $28,000 respectively. Both used and new machines will have no salvage value at the end of their useful lives. If Kendle is looking for a 14% return, determine if Kendle should buy new or used looms using common-shortest period of time approach. What should Kendle buy?

Opportunity 1 calls for a $24,000 investment which will yield income before depreciation of $18,000 the first year and $20,000 the second year. Opportunity 2 calls for an investment of $36,000 resulting, over three years, in an expected income before depreciation of $15,000, $17,000, and $28,000, respectively. The investments are mutually exclusive. The company's hurdle rate is 12%. Using the equivalent-annual-annuity approach what can be concluded about the investments?

Merton Distillers Ltd. has a discount rate of 10% and two possible projects. Both projects allow reinvestment at the end of the term. The first is three years long and has a NPV of $1.3 million. The second is four years long and has a NPV of $1.4 million. Merton Distillers Ltd. should undertake

Approximately 20,000 businesses use 350,000 cases of a particular kind of metal fastener. An average case sells for $15. If Flex Bolt Ltd. sells 200,000 cases to 8,000 businesses, what is Flex Bolt's market share?

Why are most investors risk averse?

Which of the following terms is also used to describe diversifiable risk?

A company looking for a return of 12% has capital available for projects equalling $100,000 and three projects under consideration. Each of the projects will last five years. While all the projects are divisible, if the company selects project B, it cannot do project C. Project A costs $54,000 and provides and income before amortization of $25,000, $25,000, $28,000, $26,000, and $22,000, respectively. Project B costs $63,000 and provides $12,000, $16,000, $20,000, $30,000 and $45,000 respectively. Project C costs $70,000 and provides $35,000 $24,000 $18,000 $19,000 and $10,000 respectively. The company should do

Little Air Ltd. is considering two different projects of unequal length. Which two approaches to this problem should result in the same decision?

In an effort to update its pro forma budget, Morningside Deliveries is attempting to determine the level of service, and therefore income, which will come from a new four-year contract. Morningside assigns a probability of 25% that the customer will require minimum service and provide a NPV of $28,000. The company estimates a 50% probability that medium service will be required and will generate at NPV of $32,000. There is only a likelihood of 25% that the customer will need maximum servicing and produce an NPV of $36,000. What is the standard deviation of the income from the contract?

Which of the following is a type of diversifiable risk?

Which of the following business groupings is likely to have the highest negative correlation?

A company faces a hurdle rate of 12%. It has three possible outcomes to an investment opportunity: a realistic NPV of $17,500, an optimistic NPV of $21,300 and a pessimistic NPV of $4,530. The probabilities associated with the outcomes are 55%, 22% and 23%. What is the company's ENPV?

Which of the following projects would a risk-averse investor choose?

There are three projects to consider. Project A and B both have an expected return of $1,000,000. Project C has an expected return of $800,000. Which of the following statements best describes a risk-neutral investor?

What does the expected value-standard deviation rule fail to provide?

LaVerendrye Inc. has $20 million to invest and is looking at three projects. The company's hurdle rate is 14%. Project A's initial investment is $11 million and the cash flow over four years is $1 million, $2 million, $8 million, and $10 million, respectively. Project B's initial investment is $14 million and cash flow over the same period is $10 million, $7 million, $4 million and $4 million. Project C's initial investment is $18 million and its cash flow is $2 million, $5 million, $9 million, and $11 million, respectively. The projects are divisible. Because La Verendrye cannot undertake all three projects, what is their best investment decision?

Which of the following may bias the NPV calculation upward?

The Maritime Cannery Company is considering a new machine that costs $100,000. It will last three years and management feels there are two possible cash flow possibilities each year, depending on whether the country is in recession or not. Year 1: 70% chance of $40,000 and 30% chance of $20,000; Year 2: 60% chance of $50,000 and 40% chance of $30,000; Year 3: 80% chance of $60,000 and 20% chance of $20,000. What is the expected net present value of the new machine if the company's discount rate is 6%?

An investment opportunity with identified risks and returns has been consistently rejected in competition with other opportunities. This is most likely because