FIN 3610: SAMPLE QUESTIONS (With solutions)

Use the following information to answer questions #1 through #3.

Wintergreen, Inc
Income Statement for the Present Year

Net sales $14,650

Costs 12,103
Taxable income $ 2,547
Taxes 866
Net income $ 1,681

Wintergreen, Inc.
Balance Sheet for the Present Year

Cash $ 525 Accounts payable $ 1,963

Accounts receivable 3,135 Notes payable 2,618
Inventory 976 Total $ 4,581
Total $ 4,636 Long-term debt 6,600
Net fixed assets 23,770 Common stock 7,500
Retained earnings 9,725
Total assets $28,406 Total liabilities and equity $28,406

Assets, accounts payable and costs are proportional to sales. Debt and equity are not.

1. Sales of Wintergreen, Inc. are expected to increase by 7% next year. Wintergreen is

currently operating at maximum capacity. Wintergreen does not pay a dividend. Given
this projection, which one of the following statements is correct concerning next year’s
pro forma statement for Wintergreen Inc. if the percentage of sales approach is used?
a. Costs are projected to be $11,311.
b. Net income is projected to be $1,986.
c. The projected retained earnings is $11,406.
d. The long-term debt is projected to be $7,062.
e. The EFN is projected to be $52.

e) Increase in Retained earnings = ($1,681)(1 + .07) = $1,798.67

Increase in Total Assets = ($28,406)(.07) = $1,988.32
Increase in Accounts Payable = ($1,963)(.07) = $137.41
EFN = $1,988.32 - $1,798.67 - $137.41 = $52.24

2. Sales of Wintergreen, Inc are expected to increase by 6% next year. Wintergreen is

currently operating at maximum capacity. Wintergreen has a 20% dividend payout
ratio. What is the external financing need?
a. -$196
b. -$161
c. $161
d $196
e. $279

c) Increase in Retained Earnings = (1,681)(1 + .06)(1 - .20) = $1,425.49

Increase in Total Assets = ($28,406)(.06) = $1,704.36
 Increase in Accounts Payable = ($1,963)(.06) = $117.78
EFN = $1,704.36 - $1,425.49 - $117.78 = $161.09

3. Sales of Wintergreen, Inc. are expected to increase by 12% next year. Wintergreen is
currently operating at 85% of capacity. The plowback ratio is 60%. What is the external
financing need?
a. -$809
b. -$433
c. $1,290
d. $1,563
e. $2,043

a) Current maximum capacity = $14,650 / .85 = $17,235.29;

Projected sales = ($14,650)(1 + .12) = $16,408;
Additional fixed assets required = $0 as projected sales are less than the current
maximum capacity;
Increase in current assets = ($4,636)(.12) = $556.32;
Increase in AP = ($1,963)(.12) = $235.56;
Increase in RE = ($1,681)(1 + .12)(.60) = $1,129.63
EFN = $556.32 - $235.56 - $1,129.63 = -$808.87

4. Assuming the following ratios are constant, what is the sustainable growth rate?
Total asset turnover = 2.00
Profit margin = 8.0%
Equity multiplier = 1.50
Payout ratio = 60%
a. 8.00%
b. 10.62%
c. 14.40%
e. 16.82%
e. 24.00%

b) ROE = (.08)(2)(1.5) = 0.24; SGR = (.24)(1-.6) / 1 – (.24)(1-.6) = .1062 = 10.62%

5. Which one of the following statements is correct concerning the external financing
need (EFN) and the dividend payout ratio? Assume EFN is a positive number.
a. The dividend payout ratio has no effect on the EFN.
b. An increase in the dividend payout ratio will decrease the EFN.
c. An increase in the dividend payout ratio will increase the EFN.
d. The effect on EFN caused by an increase in the dividend payout ratio can not be
predicted.
e. An increase in EFN causes the dividend payout ratio to decrease.

6. The external financing need tends to ______ as the projected growth rate in sales
increases.
a. decrease
b. increase
c. remain constant
d. vary in an unpredictable manner
e. increase and then decrease
7. Which of the following statements is (are) true concerning the internal rate of return
(IRR)?
I. The IRR is a widely used capital budgeting technique.
II. The IRR method can produce multiple rates of return if the cash flows are
nonconventional.
III. If the IRR rate is used as the discount rate, then the resulting profitability index must
equal 1.0.
IV. The crossover point occurs where the IRR of two projects are equal.
a. II only
b. II and III only
c. II and IV only
d. I, II, and III only
e. I, II, and IV only
8. The internal rate of return on a project is 11.24%. Which of the following (is) are true if
the project is assigned a 9.5% discount rate?
I. The project will have a negative net present value.
II. The profitability index will be greater than 1.0.
III. The initial investment is less than the market value of the project.
IV.The project will have a positive effect on shareholders if it is accepted.
a. I only
b. II and IV only
c. I and III only
d. II and III only
e. II, III, and IV only

9. Atlantic, Inc. is considering a project that is expected to produce the following cash
flows over the next five years: $22,500, $27,900, $41,800, $33,000, and $15,000
respectively. Atlantic has $98,000 available, which is the amount needed to initiate the
project. Should Atlantic accept this project if the required rate of return is 12%? Why or
why not?
a. No; Atlantic would lose $2,407 in today’s dollars if they accept the project.
b. No; The IRR is 13.47%, which is greater than the required return.
c. No; The PI is 1.04, which is considered a reject signal.
d. Yes; Atlantic will make $3,567 in today’s dollars if they accept the project.
e. Yes; The PI is .96, which is considered an acceptance signal.

d). NPV = -$98,000 + $22,500 / 1.12 + $27,900 / (1.12)2 + $41,800 / (1.12)3 + $33,000 /
(1.12)4 + $15,000 / (1.12)5 = $3,567

Use the following information for questions #10 and #11.

Kim Lee is analyzing two projects. Project A requires a $1,200 initial investment and
returns $600 a year for four years. Project B requires a $1,500 initial investment and
returns $700 a year for four years.

10. At what discount rate would Kim Lee be indifferent between the two projects?
a. 4.25%
b. 6.37%
c. 8.14%
d. 12.59%
e. The crossover point cannot be computed based on the information provided.

d) Find the crossover point by equating the NPV formula of Cash flows of Project A and
Project B. After some manipulations:
($1,500 – 1,200) = {700 – 600}{1 - [1 / (1 + r)4]} / r; r = 12.59%
On the calculator, put in the CF’s and then find the IRR key. [Note this is the crossover
return where the NPV[Project A] = NPV[Project B].

11. At what range of discount rates should Kim choose Project A and Project B?
a. Project B: 0 to 6.37%; Project A: 6.37% to infinity
b. Project B: 0 to 6.37%; Project A: 6.37% to 30.65%
c. Project B: 0 to 12.59%; Project A: 12.59% to 34.9%
d. Project B: 0 to 30.65%; Project A: 0 to 34.9%
e. Project B: 0 to 30.65%; Project A: 30.65% to infinity
 12. Nathan’s is considering offering boots for sale along with their current lines of shoes
and slippers. The projected annual sales for the company, with and without boots, are as
follows:
Product Without boots With boots
Shoes $289,400 $271,850
Slippers $54,950 $53,900
Boots $0 $46,800
What amount should be used as the annual sales figure when evaluating the addition of
boots to the product line?
a. $28,200
b. $46,800
c. $344,350
d. $372,550
e. $400,750

a) Sales = $271,850 - $289,400 + $53,900 - $54,950 + $46,800 = $28,200

13. A furniture manufacturer is planning on buying a new industrial sander costing

$118,000. The sander has projected maintenance costs of $16,000 annually over the
three-year life of the sander. At the end of the three years, the sander will be worthless
and will be scrapped. The company has a 34% tax rate, a 16% discount rate, and uses
straight-line depreciation over the life of a project. What is the equivalent annual cost?
a. $36,520
b. $49,727
c. $51,311
d. $55,333
e. $68,540

b) Depreciation tax shield = Dt = (118000/3)(0.34) = 13,373

OCF = (0-16,000)(1-0.34) + 13,373.33 = $2,813
NPV = - $118,000 + ($2,813 / 1.16) + ($2,813 / (1.16)2 + ($2,813 / (1.16)3 = -$111,682.31;
-$111.682.31 = {EAC}{[1 – 1 / (1 +.16)3] / .16}; EAC = $49,727.43

14. Your company wants to bid on the sale of 10 customized machines per year for five
years. The initial costs for the project are $1.6 million with a salvage value of $800,000
after five years. The machine will be depreciated straight-line to zero over the five
years. Annual fixed costs are estimated at $700,000. Variable cost per machine is
$81,500. The project requires net working capital of $120,000. The company has a 34%
tax rate and desires a 15% return on the project. What is the minimum price that the
company should bid per single machine?
a. $198,196
b. $212,028
c. $219,887
d. $221,009
e. $223,619

a) Non-OCF cash flows at year 5 = ($800,000)(1-.34) + $120,000

= $648,000; $648,000 / (1.15)5 = $322,171;
Non-OCF cash flows = -$1,600,000 - $120,000 + $322,171 = $1,397,829;
$1,397,829 = {OCF}{[1 -1 / (1.15)5] / .15};
OCF = $416,994;
Depreciation = $1,600,000 / 5 = $320,000;
Depreciation tax shield = Dt = (320,000)(0.34) = 108,800
$416,994 = [Sales – 700,000 – (81,500*10)] (1-0.34) + 108,800;
Sales = $1,981,961;
Bid per machine = $1,981,961 / 10 = $198,196

15. Which one of the following statements is true concerning project analysis?
a. Net present value is the best method to use when analyzing cost saving projects
involving equipment that will be replaced at the end of the project and the options
available have different project lives.
b. The internal rate of return is the best method of analysis when the projects under
consideration are cost cutting projects with negative cash flows for all time periods.
c. The internal rate of return is the best method of analysis when two or more cost cutting
projects, with differing initial costs, are being compared because the method
incorporates the time value of money concept.
d. For cost cutting proposals where a decision is being made between two or more
pieces of equipment with differing lives, the equivalent annual cost method is
considered superior to the net present value method if the equipment is to be
replaced at the end of its life.
e. All the above.

16. A company is considering a new venture. This venture will require the purchase of
$321,000 of equipment (which will be depreciated straight-line to zero over the life of
the project and have no salvage value), $45,000 in inventory, and will increase accounts
payable by $73,000. Expected sales are $625,000 with costs of $480,000. The project
will last for five years, be taxed at 35% and have a required rate of return of 14%. What
is the net present value of this project?
a. $22,995
b. $38,291
c. $66,316
d. $93,167
e. $107,709

d) Initial cash outlay = -$321,000 - $45,000 + $73,000 = -$293,000;

Depreciation = $321,000 / 5 = $64,200;
Depreciation tax shield = Dt = (64,200)(0.35) = 22,470

OCF = [625,000 – 480,000] (1-0.35) + ($22,470) = $116,720;

Cash flows in years 1 through 4 = $116,720;
Cash flow in year 5 = $116,720 - $73,000 + $45,000 = $88,720; NPV = $93,167