# BUSI 320 Corporate Finance Online Exam

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1. award: 1.00 point

2. award: 1.00 point

Assume a corporation has earnings before depreciation and taxes of $102,000, depreciation of $40,000, and that it has a 35 percent tax bracket.

a. Compute its cash flow using the following format. (Input all answers as positive values.)

Earnings before depreciation and taxes $ Depreciation Earnings before taxes $ Taxes Earnings after taxes $ Depreciation Cash flow $

b. How much would cash flow be if there were only $12,000 in depreciation? All other factors are the same.

Cash flow $

c. How much cash flow is lost due to the reduced depreciation from $40,000 to $12,000?

Cash flow lost $

View Hint #1

Worksheet Difficulty: Basic Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

The Short-Line Railroad is considering a $120,000 investment in either of two companies. The cash flows are as follows:

Year Electric Co. Water Works

1 $ 60,000 $ 30,000 2 30,000 30,000 3 30,000 60,000

4 – 10 20,000 20,000javascript:doHint(‘13252700675547003′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Fb7da6927%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);

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3. award: 2.00 points

a. Compute the payback period for both companies. (Round your answers to 1 decimal place.)

Payback Period Electric Co. years Water Works years

b. Which of the investments is superior from the information provided?

Water Works Electric Co.

rev: 04_16_2014_QC_48106

Worksheet Difficulty: Basic

Learning Objective: 12-03 The payback method considers the importance of liquidity, but fails to consider the time value of money.

X-treme Vitamin Company is considering two investments, both of which cost $44,000. The cash flows are as follows:

Year Project A Project B

1 $46,000 $38,000 2 17,000 18,000 3 13,000 15,000

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal

places.)

Payback Period Project A year(s) Project B year(s)

a-2. Which of the two projects should be chosen based on the payback method?

Project A Project B

b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do

not round intermediate calculations and round your final answers to 2 decimal places.)

Net Present Value Project A $ Project B $

b-2. Which of the two projects should be chosen based on the net present value method? Project A

Project Bhttp://lectures.mhhe.com/connect/0077861612/appendix_b.jpg

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5. award: 1.00 point

c. Should a firm normally have more confidence in the payback method or the net present value

method?

Net present value method Payback method

View Hint #1

Worksheet

Learning Objective: 12-03 The payback method considers the importance of liquidity, but fails to consider the time value of money.

Difficulty: Basic

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

You buy a new piece of equipment for $30,204, and you receive a cash inflow of $4,100 per year for 14 years. Use Appendix D for an approximate answer but calculate your final answer using the financial calculator method.

What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Internal rate of return %

View Hint #1

Worksheet Difficulty: Basic

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $95,000. The annual cash inflows for the next three years will be:

Year Cash Flow

1 $ 48,000 2 46,000 3 41,000

Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the financial calculator method.

a. Determine the internal rate of return. (Do not round intermediate calculations. Enter your answer

as a percent rounded to 2 decimal places.)

Internal rate of return %javascript:doHint(‘13252700675040058′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F3bd6dc8a%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/appendix_d.jpgjavascript:doHint(‘13252700675040176′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Ff1d2dab%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/appendix_b.jpghttp://lectures.mhhe.com/connect/0077861612/appendix_d.jpg

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6. award: 2.00 points

7. award: 1.00 point

b. With a cost of capital of 15 percent, should the equipment be purchased?

Yes No

Worksheet Difficulty: Basic

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $69,000. The annual cash flows have the following projections. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year Cash Flow 1 $ 29,000 2 29,000

3 29,000 4 34,000 5 20,000

a. If the cost of capital is 13 percent, what is the net present value of selecting a new machine? (Do not

round intermediate calculations and round your final answer to 2 decimal places.)

Net present value $ b. What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a

percent rounded to 2 decimal places.)

Internal rate of return % c. Should the project be accepted?

Yes No

rev: 04_08_2014_48104

View Hint #1

Worksheet Difficulty: Intermediate

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Turner Video will invest $84,500 in a project. The firm’s cost of capital is 6 percent. The investment will provide the following inflows. Use Appendix A for an approximate answer but calculate your final answerhttp://lectures.mhhe.com/connect/0077861612/appendix_b.jpghttp://lectures.mhhe.com/connect/0077861612/appendix_d.jpgjavascript:doHint(‘13252700675557680′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F1aed9dd1%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/appendix_a.jpg

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8. award: 2.00 points

using the formula and financial calculator methods.

Year Inflow

1 $ 28,000 2 30,000 3 34,000 4 38,000 5 42,000

The internal rate of return is 12 percent.

a. If the reinvestment assumption of the net present value method is used, what will be the total value of

the inflows after five years? (Assume the inflows come at the end of each year.) (Do not round intermediate calculations and round your answer to 2 decimal places.)

Total value of inflows $

b. If the reinvestment assumption of the internal rate of return method is used, what will be the total value

of the inflows after five years? (Use the given internal rate of return. Do not round intermediate calculations and round your answer to 2 decimal places.)

Total value of inflows $

c. Which investment assumption is better?

Reinvestment assumption of IRR Reinvestment assumption of NPV

View Hint #1

Worksheet Difficulty: Intermediate

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows: Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Project E Project H ($52,000 investment) ($47,000 investment) Year Cash Flow Year Cash Flow

1 $ 10,000 1 $ 27,000 2 14,000 2 19,000 3 24,000 3 15,000 4 31,000

a. Determine the net present value of the projects based on a zero percent discount rate.

Net Present Value Project E $ Project H $javascript:doHint(‘13252700675559015′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Fcd73a720%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/appendix_b.jpg

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9. award: 4.00 points

10. award: 2.00 points

b. Determine the net present value of the projects based on a discount rate of 9 percent. (Do not round

intermediate calculations and round your answers to 2 decimal places.)

Net Present Value Project E $

Project H $ c. If the projects are not mutually exclusive, which project(s) would you accept if the discount rate is 9

percent? Project E

Project H Both H and E

Worksheet Difficulty: Challenge

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Telstar Communications is going to purchase an asset for $620,000 that will produce $300,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three- year MACRS depreciation schedule in Table 12–12. (This represents four years of depreciation based on the half-year convention.) The firm is in a 30 percent tax bracket.

Fill in the schedule below for the next four years. (Input all amounts as positive values. Round your answers to the nearest whole dollar amount.)

Year 1 Year 2 Year 3 Year 4

Earnings before depreciation and taxes $ $ $ $ Depreciation Earnings before taxes $ $ $ $ Taxes Earnings after taxes $ $ $ $ Depreciation Cash flow $ $ $ $

View Hint #1

Worksheet Difficulty: Challenge Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

The Summitt Petroleum Corporation will purchase an asset that qualifies for three-year MACRShttp://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpgjavascript:doHint(‘13252700675043755′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F69d4c870%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);

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11. award: 2.00 points

depreciation. The cost is $160,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-12.

Year 1 $ 90,000

Year 2 101,000 Year 3 46,000 Year 4 44,000

The firm is in a 30 percent tax bracket and has a cost of capital of 16 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not

round intermediate calculations and round your answer to 2 decimal places.)

Net present value $

b. Under the net present value method, should Summitt Petroleum Corporation purchase the asset?

Yes No

View Hint #1

Worksheet Difficulty: Challenge

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

An asset was purchased three years ago for $200,000. It falls into the five-year category for MACRS depreciation. The firm is in a 40 percent tax bracket. Use Table 12–12.

a. Compute the tax loss on the sale and the related tax benefit if the asset is sold now for $23,060. (Input

all amounts as positive values. Do not round intermediate calculations and round your answers to whole dollars.)

Tax loss on the sale $ Tax benefit $

b. Compute the gain and related tax on the sale if the asset is sold now for $72,060. (Input all amounts as

positive values. Do not round intermediate calculations and round your answers to whole dollars.)

Taxable gain $ Tax obligation $

View Hint #1http://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpghttp://lectures.mhhe.com/connect/0077861612/Appendix_B.jpgjavascript:doHint(‘13252700674994353′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Faa20222e%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpgjavascript:doHint(‘13252700675089554′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Febd4a7a9%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);

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12. award: 3.00 points

Worksheet Difficulty: Challenge Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

DataPoint Engineering is considering the purchase of a new piece of equipment for $400,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $220,000 in nondepreciable working capital. Seventy-five thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12–11, Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year Amount

1 $ 233,000 2 192,000 3 162,000 4 147,000 5 111,000 6 101,000

The tax rate is 30 percent. The cost of capital must be computed based on the following:

Cost(aftertax) Weights Debt Kd 8.20% 25% Preferred stock Kp 12.80 15 Common equity (retained earnings) Ke 17.00 60

a. Determine the annual depreciation schedule. (Do not round intermediate calculations. Round your

depreciation base and annual depreciation answers to the nearest whole dollar. Round your percentage depreciation answers to 3 decimal places.)

Year Depreciation

Base Percentage Depreciation

Annual Depreciation

1 $ $ 2 3 4 5 6 $

b. Determine the annual cash flow for each year. Be sure to include the recovered working capital in Year

6. (Do not round intermediate calculations and round your answers to 2 decimal places.)

Year Cash Flow

1 $ 2 3javascript:doHint(‘13252700675089554′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Febd4a7a9%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/ch12/Table_12_11.jpghttp://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpghttp://lectures.mhhe.com/connect/0077861612/appendix_b.jpg

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13. award: 5.00 points

4 5 6

c. Determine the weighted average cost of capital. (Do not round intermediate calculations. Enter

your answer as a percent rounded to 2 decimal places.)

Weighted average cost of capital %

d-1. Determine the net present value. (Use the WACC from part c rounded to 2 decimal places as a

percent as the cost of capital (e.g., 12.34%). Do not round any other intermediate calculations. Round your answer to 2 decimal places.)

Net present value $

d-2. Should DataPoint purchase the new equipment?

No Yes

View Hint #1

Worksheet Difficulty: Challenge Learning Objective: 12-05 The discount orcutoff rate is normally the cost of capital.

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $64,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $27,800. A new piece of equipment will cost $154,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year Cash Savings

1 $65,000 2 57,000 3 55,000 4 53,000 5 50,000 6 39,000

The firm’s tax rate is 35 percent and the cost of capital is 8 percent.

a. What is the book value of the old equipment? (Do not round intermediate calculations and round

your answer to the nearest whole dollar.)

Book value $javascript:doHint(‘13252700675562799′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Fc7db69%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpghttp://lectures.mhhe.com/connect/0077861612/appendix_b.jpg

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b. What is the tax loss on the sale of the old equipment? (Do not round intermediate calculations and

round your answer to the nearest whole dollar.)

Tax loss $

c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your

answer to the nearest whole dollar.)

Tax benefit $

d. What is the cash inflow from the sale of the old equipment? (Do not round intermediate

calculations and round your answer to the nearest whole dollar.)

Cash inflow $

e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)

(Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Net cost $

f. Determine the depreciation schedule for the new equipment. (Round the depreciation base and

annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)

Year Depreciation

Base Percentage Depreciation

Annual Depreciation

1 $ $ 2 3 4 5 6 $

g. Determine the depreciation schedule for the remaining years of the old equipment. (Round the

depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)

Year Depreciation

Base Percentage Depreciation

Annual Depreciation

1 $ $ 2 3 4

h. Determine the incremental depreciation between the old and new equipment and the related tax shield

benefits. (Enter the tax rate as a decimal rounded to 2 decimal places. Round all other answers

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to the nearest whole dollar.)

Year

Depreciation on New

Equipment

Depreciation on Old

Equipment Incremental Depreciation Tax Rate

Tax Shield Benefits

1 $ $ $ $ 2 3 4

5

6

i. Compute the aftertax benefits of the cost savings. (Enter the aftertax factor as a decimal rounded

to 2 decimal places. Round all other answers to the nearest whole dollar.)

Year Savings (1 – Tax Rate) Aftertax Savings

1 $65,000 $ 2 57,000 3 55,000 4 53,000 5 50,000 6 39,000

j-1. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual

benefits. (Do not round intermediate calculations and round your answers to the nearest whole dollar.)

Year

Tax Shield Benefits from Depreciation

Aftertax Cost Savings

Total Annual Benefits

1 $ $ 2 3 4 5 6

j-2. Compute the present value of the total annual benefits. (Do not round intermediate calculations

and round your answer to the nearest whole dollar.)

Total annual benefits $

k-1. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e).

(Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to the nearest whole dollar.)

Net present value $

k-2. Should the replacement be undertaken?

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14. award: 2.00 points

15. award: 2.00 points

Yes No

View Hint #1

Worksheet Difficulty: Challenge

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Assume you are risk-averse and have the following three choices.

Expected

Value Standard Deviation

A $1,830 $ 970 B 2,760 1,850 C 1,680 1,330

a. Compute the coefficient of variation for each. (Round your answers to 3 decimal places.)

Projects Coefficient of

Variation A B C

b. Which project will you select? Project B

Project C Project A

View Hint #1

Worksheet Difficulty: Basic Learning Objective: 13-02 Most investors are risk-averse, which means they dislike uncertainty.

Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:

Possible

Market Reaction Sales in

Units Probabilities Low response 30 .30 Moderate response 45 .20 High response 50 .30 Very high response 75 .20javascript:doHint(‘13252700674953568′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F2e6ea06d%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%26nbsp%3B%3C%2Fa%3E’);javascript:doHint(‘13252700675566185′,%20”,%20’%3Cp%3E%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Fee6e9277%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E%3C%2Fp%3E’);

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16. award: 3.00 points

17. award: 2.00 points

a. What is the expected value of unit sales for the new product? (Do not round intermediate calculations and round your answer to the nearest whole unit.)

Expected value units

b. What is the standard deviation of unit sales? (Do not round intermediate calculations. Round your

answer to 2 decimal places.)

Standard deviation units

View Hint #1

Worksheet Difficulty: Basic

Learning Objective: 13-01 The concept of risk is based on uncertainty about future outcomes. It requires the computation of quantitative measures as well as qualitative considerations.

Shack Homebuilders Limited is evaluating a new promotional campaign that could increase home sales. Possible outcomes and probabilities of the outcomes are shown next.

Possible Outcomes Additional

Sales in Units Probabilities Ineffective campaign 50 .30 Normal response 110 .30 Extremely effective 130 .40 Compute the coefficient of variation. (Do not round intermediate calculations. Round your answer to 3 decimal places.) Coefficient of variation

View Hint #1

Worksheet Difficulty: Basic

Learning Objective: 13-01 The concept of risk is based on uncertainty about future outcomes. It requires the computation of quantitative measures as well as qualitative considerations.

Five investment alternatives have the following returns and standard deviations of returns.

Alternatives Returns:

Expected Value Standard Deviation

A $ 1,820 $ 550 B 860 1,030 C 5,900 1,200 D 1,980 540 E 61,000 22,100javascript:doHint(‘13252700675567763′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Ff509b959%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);javascript:doHint(‘13252700675569734′,%20”,%20’%3Cp%3E%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Fcdbc3dd7%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E%3C%2Fp%3E’);

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18. award: 2.00 points

Calculate the coefficient of variation and rank the five alternatives from lowest risk to the highest risk by using the coefficient of variation. (Round your answers to 3 decimal places.)

Alternatives Coefficient of

Variation Rank A (Click to select)

B (Click to select)

C (Click to select)

D (Click to select)

E (Click to select)

Worksheet Difficulty: Basic

Learning Objective: 13-01 The concept of risk is based on uncertainty about future outcomes. It requires the computation of quantitative measures as well as qualitative considerations.

Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.

Investments Returns:

Expected Value Standard Deviation

Buy stocks $ 8,880 $ 6,030 Buy bonds 7,720 2,050 Buy commodity futures 17,200 23,200 Buy options 18,700 12,900

a-1. Compute the coefficients of variation. (Round your answers to 3 decimal places.)

Coefficient ofVariation Buy stocks Buy bonds Buy commodity futures Buy options

a-2. Which one of the following four investments should Tim choose?

Buy bonds Buy stocks Buy commodity futures Buy options

b. Which one of the four investments should Mike choose?

Buy bonds Buy stocks Buy commodity futures Buy options

View Hint #1javascript:doHint(‘13252700675572032′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F9ad325cc%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);

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19. award: 2.00 points

20. award: 2.00 points

Worksheet Difficulty: Basic Learning Objective: 13-02 Most investors are risk-averse, which means they dislike uncertainty.

Mountain Ski Corp. was set up to take large risks and is willing to take the greatest risk possible. Lakeway Train Co. is more typical of the average corporation and is risk-averse.

Projects Returns:

Expected Value Standard Deviation

A $269,000 $143,000 B 734,000 462,000 C 153,000 120,000 D 163,000 298,000

a-1. Compute the coefficients of variation. (Round your answers to 3 decimal places.)

Coefficient ofVariation Project A Project B Project C Project D

a-2. Which projects should Mountain Ski Corp. choose? Project A

Project B Project D Project C

b. Which one of the four projects should Lakeway Train Co. choose based on the same criteria of using

the coefficient of variation?

Project B Project A Project C Project D

View Hint #1

Worksheet Difficulty: Basic Learning Objective: 13-02 Most investors are risk-averse, which means they dislike uncertainty.

Waste Industries is evaluating a $53,800 project with the following cash flows. Years Cash Flows

1 $ 9,240 2 15,900 3 22,600 4 21,300 5 33,000javascript:doHint(‘13252700675572032′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F9ad325cc%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);javascript:doHint(‘13252700675572034′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2Ffe427b66%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);

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21. award: 2.00 points

The coefficient of variation for the project is .975. Coefficient of

Variation Discount Rate 0 − .25 4%

.26 − .50 9%

.51 − .75 10%

.76 − 1.00 12% 1.01 − 1.25 18%

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Select the appropriate discount rate.

4% 9% 10% 12% 18%

b. Compute the net present value. (Negative amount should be indicated by a minus sign. Do not

round intermediate calculations and round your answer to 2 decimal places.)

Net present value $

c. Based on the net present value should the project be undertaken? No

Yes

View Hint #1

Worksheet Difficulty: Intermediate

Learning Objective: 13-03 Because investors dislike uncertainty, they will require higher rates of return from risky projects.

Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 11 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 16 percent. Either method will require an initial capital outlay of $102,000. The inflows from projected business over the next five years are given next.

Years Method 1 Method 2 1 $32,100 $17,600 2 38,500 25,500 3 47,800 40,400 4 35,100 37,000 5 20,600 72,200http://lectures.mhhe.com/connect/0077861612/appendix_b.jpgjavascript:doHint(‘13252700675572055′,%20”,%20’%3Cp%3E%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F280aaffd%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E%3C%2Fp%3E’);

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22. award: 2.00 points

Use Appendix B for an approximate answer but calculate your final answers using the formula and financial calculator methods. a. Calculate net present value for Method 1 and Method 2. (Do not round intermediate calculations and

round your answers to 2 decimal places.)

Net Present Value Method 1 $

Method 2 $

b. Which method should be selected using net present value analysis?

Method 1 Method 2 Neither of these

View Hint #1

Worksheet Difficulty: Intermediate

Learning Objective: 13-03 Because investors dislike uncertainty, they will require higher rates of return from risky projects.

Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $26,300. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby’s cost of capital is 12 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods.

Cash Flow Probability

$ 3,890 .2 5,190 .3 7,550 .4 9,800 .1 a. What is the expected value of the cash flow? The value you compute will apply to each of the five years.

Expected Cash Flow $

b. What is the expected net present value? (Negative amount should be indicated by a minus sign. Do

not round intermediate calculations and round your answer to 2 decimal places. )

Net Present Value $

c. Should Debby buy the new equipment? Yes

No

View Hint #1http://lectures.mhhe.com/connect/0077861612/appendix_b.jpgjavascript:doHint(‘13252700675573546′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F5867bb59%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);http://lectures.mhhe.com/connect/0077861612/appendix_d.jpgjavascript:doHint(‘13252700675574555′,%20”,%20’%3Ca+target%3D%22_blank%22+href%3D%22http%3A%2F%2Fwww.viddler.com%2Fembed%2F4d50c523%2F%3Ff%3D1%26amp%3Bautoplay%3D0%26amp%3Bplayer%3Dsimple%26amp%3Bdisablebranding%3D0%22%3EGuided+Example%3C%2Fa%3E’);

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23. award: 2.00 points

Worksheet Difficulty: Intermediate

Learning Objective: 13-01 The concept of risk is based on uncertainty about future outcomes. It requires the computation of quantitative measures as well as qualitative considerations.

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,694,000 and will produce $359,000 per year in years 5 through 15 and $532,000 per year in years 16 through 25. The U.S. gold mine will cost $2,085,000 and will produce $295,000 per year for the next 25 years. The cost of capital is 11 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.) a-1. Calculate the net present value for each project. (Do not round intermediate calculations and

round your answers to 2 decimal places.)

Net Present Value The Australian mine $ The U.S. mine $

a-2. Which investment should be made? Australian mine

U.S. mine b-1. Assume the Australian mine justifies an extra 5 percent premium over the normal cost of capital

because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)

Net Present Value The Australian mine $

b-2. Does the new assumption change the investment decision?

Yes No

View Hint #1

Worksheet Difficulty: Challenge

Learning Objective: 13-01 The concept of risk is based on uncertainty about future outcomes. It requires the computation of quantitative measures as well as qualitative considerations.

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