BUAD 306 Business Finance Fall 2014 Practice Exam 3 This practice exam has 16 questions The actual exam has 28 questions 1 The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following a b c d e Salvage value Wasted value Sunk cost Opportunity cost Erosion 2 JL Plastic Corp spent 1 200 last week repairing a machine This week the company is trying to decide if the machine should be sold or whether it should be kept for manufacturing purposes When analyzing this decision the 1 200 should be treated as which type of cost a Opportunity b Fixed c Incremental d Erosion e Sunk 3 Gateway Communications is considering a project with an initial fixed asset cost of 2 46 million which will be depreciated straight line to a zero book value over the 10 year life of the project At the end of the project the equipment will be sold for an estimated 300 000 The project will not directly produce any sales but will reduce operating costs by 725 000 a year The tax rate is 35 percent The project will require 45 000 of inventory which will be recouped when the project ends Should this project be implemented if the firm requires a 14 percent rate of return Why or why not a No The NPV is 172 937 49 b No The NPV is 87 820 48 c Yes The NPV is 251 860 34 d Yes The NPV is 387 516 67 e Yes The NPV is 466 940 57 4 Silver Petroleum Inc just purchased some equipment at a cost of 67 000 What is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5 year property for MACRS a b c d e 67 000 x 1 0 20 x 0 32 67 000 1 0 20 0 32 67 000 x 1 0 32 67 000 x 1 0 32 67 000 x 0 32 5 You own some equipment that you purchased 4 years ago at a cost of 225 000 The equipment is 5 year property for MACRS You are considering selling the equipment today for 87 000 Which one of the following statements is correct if your tax rate is 35 a b c d e The tax due on the sale is 26 425 The book value today is 186 120 The accumulated depreciation to date is 38 880 The taxable amount on the sale is 38 880 The aftertax salvage value is 70 158 6 A 4 year project has an initial asset investment of 306 600 and initial net working capital investment of 29 200 and an annual operating cash flow of 46 720 The fixed asset is fully depreciated over the life of the project and has no salvage value The net working capital will be recovered when the project ends The required return is 15 percent What is the project s equivalent annual cost or EAC a 158 491 b 152 309 c 147 884 d 145 509 e 142 212 7 A 4 year project has an initial asset investment of 306 600 and initial net working capital investment of 29 200 and an annual operating cash flow of 46 720 The fixed asset is fully depreciated over the life of the project and has no salvage value The net working capital will be recovered when the project ends The required return is 15 percent What is the project s equivalent annual cost or EAC a 158 491 b 152 309 c 147 884 d 145 509 e 142 212 8 Consider an asset that costs 176 000 and is depreciated straight line to zero over its 11year tax life The asset is to be used in a 7 year project at the end of the project the asset can be sold for 22 000 The relevant tax rate is 30 percent What is the aftertax cash flow from the sale of this asset a 31 800 b 32 600 c 33 300 d 34 100 e 34 600 9 Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities Which one of the following terms best defines that market a Riskless market b Evenly distributed market c Zero volatility market d Blume s market e Efficient capital market 10 Which one of the following categories of securities had the highest average return for the period 1926 2010 a US Treasury bills b Large company stocks c Small company stocks d Long term corporate bonds e Long term government bonds 11 You own a portfolio that has 2 000 invested in Stock A and 3 500 invested in Stock B The expected returns on these stocks are 14 percent and 9 percent respectively What is the expected return on the portfolio a 10 06 b 10 50 c 10 82 d 11 13 e 11 41 12 The expected return on JK stock is 15 78 percent while the expected return on the market is 11 34 percent The stock s beta is 1 51 What is the risk free rate of return a 2 22 b 2 31 c 2 42 d 2 50 e 2 63 13 The common stock of Jensen Shipping has an expected return of 14 7 percent The return on the market is 10 8 percent and the risk free rate of return is 3 8 percent What is the beta of this stock a 92 b 1 23 c 1 33 d 1 41 e 1 56 14 You would like to combine a risky stock with a beta of 1 68 with U S Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market What percentage of the portfolio should be invested in the risky stock a 32 b 40 c 54 d 60 e 68 15 What is the expected return on a portfolio that is equally weighted between stocks K and L given the following information a b c d e 11 13 11 86 12 25 13 32 14 40 16 Which one of the following should earn the most risk premium based on CAPM a Diversified portfolio with returns similar to the overall market b Stock with a beta of 1 38 c Stock with a beta of 0 74 d US Treasury bill e Portfolio with a beta of 1 01