Calculate the initial cash flow and net cash flows

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Reference no: EM132368636

Business Finance Questions -

Question One: Multiple Choice Questions - Choose the best answer

1. When we are comparing projects with cash outflows and unequal lives, we can use the:

(a) IRR

(b) Present value

(d) Annual equivalent cost

(e) None of the above

2. Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation?

(a) The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent.

(b) The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent.

(c) To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information.

(d) Project L should be selected at any cost of capital, because it has a higher IRR.

(e) Project S should be selected at any cost of capital, because it has a higher IRR.

3. A cost that has been incurred and cannot be removed, and hence should not be considered in an investment decision is known as:

(a) opportunity cost

(b) erosion

(d) irrelevant cost

(e) none of the above

4. The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:

(a) debt is more risky than equity.

(b) bankruptcy is a disadvantage to debt.

(d) Both debt is more risky than equity; and bankruptcy is a disadvantage to debt.

(e) Both bankruptcy is a disadvantage to debt; and firms will incur large agency costs of short term debt by issuing long term debt.

5. Indirect costs of financial distress:

(a) effectively limit the amount of equity a firm issues.

(b) serve as an incentive to increase the financial leverage of a firm.

(d) tend to increase as the debt-equity ratio decreases.

(e) include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection.

6. Given realistic estimates of the probability and cost of bankruptcy, the future costs of a possible bankruptcy are borne by:

(a) all investors in the firm.

(b) debtholders only because if default occurs interest and principal payments are not made.

(d) management because if the firm defaults they will lose their jobs.

e) None of these.

Question Two - The DAC Co. has recently completed a $200,000, two-year marketing study. Based on the results of the study, DAC has estimated that 6,000 units of its new electro-optical data scanner could be sold annually over the next 8 years, at a price of $8,000 each. Variable costs per unit are $4,400, and fixed costs total $5.4 million per year.

Start-up costs include $17.6 million to build production facilities, $1.5 million for land, and $4 million in net working capital. The $17.6 million facility will be depreciated on a straight-line basis to a value of zero over the eight-year life of the project. At the end of the project's life, the facilities (including the land) will be sold for an estimated $4.7 million. The value of the land is not expected to change during the eight year period.

DAC is an ongoing, profitable business and pays taxes at a 30% rate on all income and capital gains. Cost of capital for this project is 20%. Calculate the followings:

(a) The initial cash flow at year 0.

(b) The net cash flows in years 1 to 7.

(d) The NPV.

Question Three - Explain the implications of MM (1963) propositions I, II and III in tax world using appropriate diagrams.

Reference no: EM132368636

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