Question

1.

A corporation is evaluating the relevant cash flows for a capital budgeting project involving expansion of the firm’s activities and must estimate the terminal cash flow for the project. The project will involve purchasing a machine for $120,000. The machine has a usable life of 6 years but would be disposed of after 5 years at an estimated sale price of $10,000. The machine will be depreciated under the prime cost (straight-line) method supposing a 6-year life. Net working capital is expected to decline by $6,000 at the end of the 5 years of the project. The firm has a 40 per cent tax rate on ordinary income and long-term capital gains. The terminal cash flow is:

	a.	$12,000
	b.	$8,000
	c.	$20,000
	d.	$0

2.

In the Gordon model, the value of ordinary shares is the

	a.	actual amount each ordinary shareholder would expect to receive if the firm's assets are sold, creditors and preference shareholders are repaid, and any remaining money is divided among the ordinary shareholders.
	b.	present value of a non-growing dividend stream.
	c.	net value of all assets which are liquidated for their exact accounting value.
	d.	present value of a constant, growing dividend stream.

3.

QBC system has an outstanding issue of $1000 par-value bonds with a 9% coupon interest rate. The issue pays interest annually and has 12 years remaining to its maturity date. If the bond of similar risk earning 10% rate of return, the selling price of the QBC system bond today is:

	a.	$931.86
	b.	$930.01
	c.	$318.63
	d.	$613.23

4.

Which of the following statements concerning the NPV is not true?

	a.	If two competing projects are being considered, the one expected to yield the lowest NPV should be selected.
	b.	The NPV of a project is the sum of all the discounted cash flows associated with a project.
	c.	The NPV technique takes account of all the cash flows associated with a project.
	d.	The NPV technique takes account of the time value of money.

Answer 1

1-	option is C		20000
	Accumulated depreciation	(120000/6)*5	100000
	Book value of machine at the end of year 5	120000-100000	20000
	Loss on disposal of machine	20000-10000	10000
	tax credit on disposal of machine	10000*40%	4000
	sale proceeds with tax credit on loss on disposal of machine	10000+4000	14000
	terminal cash flow	sale proceeds with tax credit+recovery of working capital	14000+6000	20000
2-	option is D	present value of a constant, growing dividend stream.	because value of stock is found by discounting the future expected cash flow at a rate equal to cost of equity
3-	option is A	931.86
	Year	cash flow	present value factor at 10% =1/(1+r)^n r =10%	present value of cash flow= cash flow*present value factor
	1	90	0.909091	81.81818
	2	90	0.826446	74.38017
	3	90	0.751315	67.61833
	4	90	0.683013	61.47121
	5	90	0.620921	55.88292
	6	90	0.564474	50.80265
	7	90	0.513158	46.18423
	8	90	0.466507	41.98566
	9	90	0.424098	38.16879
	10	90	0.385543	34.6989
	11	90	0.350494	31.54445
	12	1090	0.318631	347.3076
	Value of debt =sum of present value of cash flow			931.86
4-	option is A	If two competing projects are being considered, the one expected to yield the lowest NPV should be selected.	because a project with highest NPV is always selected and rest of statements like NPV is a sum of all the discounted cash flow associated with the projects, it takes into account all the cash inflow and outflows and it consider the concept of time value of money.