Harvard UniversityMGMT E-1000Quiz 7

Module 7 Quiz 1) Which of the following is INCORRECT in determining free cash flows? Adjust net income for interest expense This is NOT the correct answer because it is true; you do adjust net income for interest exp ...

Module 7 Quiz 1) Which of the following is INCORRECT in determining free cash flows? Adjust net income for interest expense This is NOT the correct answer because it is true; you do adjust net income for interest expense in determining free cash flows. Subtract capital expenditures This is NOT the correct answer because it is true; you do subtract capital expenditures in determining free cash flows. Subtract depreciation correct This is the correct answer! It is NOT true. You ADD BACK depreciation in determining free cash flows. Subtract change in working capital This is NOT the correct answer because it is true; you do subtract the change in net working capital in determining free cash flows. 2) A project has an initial cost of $44,000. Expected cash flows as a result of this project are projected as indicated below. Calculate the payback period for this project. Assume a discount rate of 9%.The correct answer is 3.5 years. At the end of year 3 the project has returned $35,000 ($10,000 + $10,000 + $15,000). This leaves $9,000 to be returned to hit payback. Assuming that the $18,000 projected for year 4 comes in a steady stream, this would mean it would take half of that year. =3+(44000-(B4+B5+B6))/18000 3) The founders of a business are interested in investing in a project in the coming year. The two projects are mutually exclusive. The estimated cash flows of the two projects are shown below. The company's Weighted Average Cost of Capital (WACC) is 9%. The table below shows the data from the previous spreadsheet exercise and the correct IRR calculation. PROJECT 1 PROJECT 2 t Cash Flows t Cash Flows 0 ($300,000) 0 ($120,000) 1 $30,000 1 $40,000 2 $45,000 2 $40,000 3 $60,000 3 $25,000 4 $60,000 4 $20,000 5 $60,000 5 $10,000 6 $60,000 6 $10,000 7 $120,000 7 $10,000 IRR: 8.55% IRR: 9.60% Which project should the company undertake? Project 1 Project 2 correct The correct answer is Project 2. Project 2 has the higher IRR and the IRR for Project 1 is below the WACC of 9%.4) What is free cash flow? It is “free” money, which means it is available at a 0% interest rate. It is the amount of cash that a business could be expected to generate from its normal operations. correct Free Cash Flow is another name for Net Income. It is the total amount of money being transferred into and out of a business. Free cash flow is the amount of cash that a business could be expected to generate from its normal operations. 5) Which of the following cash flows should be used in an NPV calculation to determine which project to pursue? (Select all that apply.) The cash inflows expected as a result of the project correct This is correct! It is an incremental cash flow that would only be received if the project were undertaken. Recurring cash flows from ongoing current operations This is not a relevant cash flow because it would be recurring regardless of which project is pursued. Investment needed to be made by the company to undertake the project correct This is correct! It is an incremental cash flow that would only be incurred if the project is undertaken. Capital expenditures related to upkeep of existing equipment This is not a relevant cash flow because it would be incurred regardless of which project is pursued. 6) A CFO of a start-up company is evaluating the timing of a significant capital expenditure. He was previously at a mature company that used a discount rate of8% so he used the same rate at the start-up company. Which of the following would be impacted if the discount rate were raised to reflect the risk of the startup company? Internal rate of return This would not be impacted by a change in the discount rate. Payback period This would not be impacted by a change in the discount rate. Return on investment This would not be impacted by a change in the discount rate. Net present value correct NPV is the only one of the answer choices that is impacted by the discount rate. 7) A project has the estimated cash flows shown as indicated below. The discount rate is 8% and the NPV is $17,924. Calculate the IRR of this project. The correct answer is 18.97%. The correct answer formula, which should be entered into cell E6, is the following:=IRR(B2:B7) 8) Which of the following statements is NOT true in relation to the Gordon Growth Model? Terminal value is the present value of infinite cash flows expected in the future. This statement is true. A higher discount rate results in a higher terminal value. correct This statement is not true. A higher discount rate results in a lower terminal value. The Gordon Growth Model assumes that the growth rate will remain fixed. This statement is true. A higher growth rate results in a higher terminal value. This statement is true. 9) When projecting financial statements, which of the following accounts is difficult to forecast using the percent of sales method? Accounts Receivable Accounts Receivable will normally trend with sales. Accounts Payable Accounts Payable will normally trend with sales. Interest Expense correct Normally, Accounts Receivable, Accounts Payable, and Cost of Sales will trend in a direct relationship with sales. However, Interest Expense is more dependent upon the level of borrowings which does not necessarily track with sales. Cost of Sales Cost of Sales will normally trend with sales. 10)A company is considering buying a diagnostic piece of equipment for $250,000. The machine will be depreciated on a straight-line basis for 10 years with a salvage value of $40,000. The company expects the machine to be able to generate after-tax revenues of $33,000 in each of the 10 years, and then it will sell the machine for $40,000 at the end of 10 years. The sum of the undiscounted