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CHEAT SHEET FIN442 EXAM 2

- Capital Budgeting Cash Flow is $500. You paid $200 of interest and repaid $360 of debt. You also bought $150 of new fixed assets.
Actual Cash Flow is: ACF = 500-[200(1-.3)]-360 = 0
- NPV without growth is $-45 at a 10% discount rate. The IRR with growth is 16%. The growth rate is at least 6%
- You are indifferent between a large project and a smaller mutually exclusive project when: IRR of delta is equal to the required
rate
- Which event would have the greatest effect on the standard deviation? Deviation from mean of +30 and probability of 8%
- X costs $4,000 and has a 16% IRR. The cost of capital is 10% for the first $1,000 then 20% for addition funds. Do not invest in X
because 16% < 17.5%
- A costs $1,000 and returns $1,400 in 1 year. B costs $4,000 and returns $4,800 in 1 year. The required rate of return is 12%. A and B
are mutually exclusive. Invest in: B
- A costs $1,000 and returns $1,400 in 1 year. B costs $3,000 and returns $3,600 in 1 year. The required rate of return is 9% on the first
$1,000 and 11% on additional funds. A and B are mutually exclusive. Invest in: A
- Big ICO A has a 20% IRR and small ICO B has a 30% IRR. The rate of return on Delta (B-A) is 14% and the cost of capital for delta is
12%. A and B are mutually exclusive. Invest in: A
- A and B have unequal lives and are of equal risk. A has a $50 NPV and IRR = 11% while B has a $60 NPV and IRR = 12%. They are not
mutually exclusive. Invest in: BOTH
- A project has a DOL of 3.5 and you expect a 5% increase in sales. EBIT should increase by: 3.5*5= 17.5
- What is most important at the time you decide to invest? Financial Breakeven
- The economy is in recession. All around you businesses are failing and you are losing money. But you have faith in the future. What
measure best tells you if you can survive in the next few months? Cash breakeven
- Two mutually exclusive projects, both of which you would replace and both have positive NPVs, have unequal lives. They are of equal
risk. To minimize work, but ensure making the correct choice, you should choose the project with the higher equivalent annuity.
- X has a $1,000 NPV, life of 5 years and 5% required rate of return. The Fair Value of an infinite series of Project X is: NPV/PVIFA =
1000/4.3295 = 230.98
- A has an Equivalent annuity of $5 and a Fair Value of $65. B has an equivalent annuity of $4 and Fair Value of $52. Which is riskier?
K=EA/FV K=5/65 = 7.68 K=4/52 = 7.68they are equally risky
- Which is the best? DOL= +5
- If the coefficient of variation is negative: the probability of loss is greater than 50%
- The coefficient variation = .68 the probability of loss is: 1/.68 = 1.47 (math table) 42.92 = 50 42.92 = 7.08%
- Which would resolve risk the fastest? Serial correlation
- A company that is negatively affected by both extremely high and low interest rates would be most concerned about which of the
following characteristics of the distribution of interest rates? Kurtosis
- A project with independent cash flows has a 25% probability of negative NPV at time zero. If the cash flows have perfect serial
correlation, the probability of negative NPV at time zero would be greater than 25%
- Can an increase in standard deviation of returns ever reduce your probability of loss? yes, if the expected return is negative
- The option to abandon is most valuable when: cash flows are serially correlated
- The cost of new common stock is never less than the cost of new retained earnings. TRUE
- NPAT = $30 and you pay $60 of dividends. Debt ratio = 40% there is a break in WACC schedule at: $33.33
- You have book debt of $100 and market debt of $110. You have book equity of $100 and marketing equity of $90. The weight of debt
in WACC is: 110/200 = 55%
- As a result of an investment decision you give up the chance to sell an old machine for $100. The machine is three years old with an
original cost of $1,000 and was being depreciated via MACRS as a 5-year asset. The ICO will: increase
- Increase NWC by $34 at time zero and by $17 at time one. The ICO will: increase by $34
- Expected NPV = $10 Stand. Dev, of NPV =$25. Probability of a negative NPV? Z= 10-0/25 =.4 (math table) 50-15.54 = 34.46% (SAME
WITH IRR)
- Expected return = -.5% standard deviation = 25% probability of returns less than 10%: 105/25=.6 (table) 50+22.57
- Coefficient of variation = 10 probability of negative return: 1/10 = .1 (table) 50 3.98 46.02%
- As the coefficient of variation decreases, the probability of a negative return decreases
- As serial correlation increases, the risk of loss increases/////// as serial correlation increases, the rate of uncertainty resolution
increases
ACCOUNTING BREAKEVEN: FC-DEP/P-VC *if VC % then 1-%
CASH BREAKEVEN: FC/P-VC
DOL: EBIT+ (F+D)/EBIT
*FBEP > BEP > CBEP
According to the Normal Distribution:
EBIT = Rev-FC-Depreciation
8.
Events above the mean are more likely than events below the mean F That would be skewness
9.
The mean is the single most likely event
T because it is also the mode
10.
The farther you are from the mean the less likely the event
T tails are smaller
11.
All events have an equal probability of happening
F mode is more likely than tails
12.
The distribution in #7 has skewness
F same on both sides of mean
*DOL can NEVER be equal to one. No DOL at breakevenit would be UNDEFINED ---- at BE, EBIT is zero
P = 100 V=60 F=1000 D=3000 V/P=60%
BEP= (3000+1000)/(1-6) CBEP=100/(1-.6)
As the reinvestment rate increases. MIRR increases If the reinvestment rate RR is lower than the IRR, the MIRR will be lower than the
IRR but higher than RR
RR<MIRR<IRR
OR RR>MIRR>IRR
MIRR= FV/PV = FV/ICO = FIVF = 1+MIRR
Project
A
IRR1221/500 = 2.44 = 11%
ICO
1221
Reinvestment rate = 8%, MIRR?
ACBCF
Year 2
2 Year 1
800 933.12
N=1, I%=8, PV=-500, PMT=0, FV=?=540
1 Year 2
500 540
Year 1
0 Year 3
200 200
N=2, I%=8, PV=-800, PMT=0, FV=?=933.12
-1673.12
MIRR= N=3, I%=?=11.07, PV=1221, PMT=0, FV=1673.12
-IRR with a positive growth will always be greater than the IRR without growth.
Projects A and B both have a 10% cost of funds, life of 5 years, and 4% growth.
Project A costs 3696 and would have cash inflows of 1000/year if no growth occurs.

NPV w/o growth= 3.7908*1000-3696 = 94.8 NPV w/ growth= (.1-.04)=.06=4.2124*1000-3696=516.40


IRR w/o growth=
3696/1000=3.696=11%
IRR w/ growth= 11+4
Project B costs 16000 and would have cash inflows of 4000/year if no growth occurs
NPV w/o growth= 3.7908*4000-160000=-836.80
NPV w/growth=4.2124*4000-160000=849.60
IRR w/o
growth=160000/4000=4=8%
IRR
IRR w/ growth = 8+4
**You would be indifferent between A and B at a discount rate of 7%. (10000-3696)/(4000-1000)=4.101
**At a 10% cost of funds, you be indifferent between A and B at a 3% growth rate. 10-7

when I > O then RR < IRR = good

when I < O then RR >IRR = good

IRR=COST/PMT = PVIFA

NPV = -COST + (CASH FLOW X PVIFA)


1. Equivalent Annuity = $100 Required rate of return = 5% Fair Value of an infinite series = $2000 = $100 / .05
2. Project life = 5 years Required rate of return = 10% NPV = $10,000 Equivalent annuity = $10,000 / PVIFA(10%,5) = $10,000 /
3.7908 = $2,637.97
Fair value of an infinite series = $2,637.97 / .1 = $26,379.7
3. A has a $4,000 equivalent annuity and 5% required rate. B has a $8,000 equivalent annuity and 10% required rate. Both will
operate forever.
Fair Value $4,000 / .05 = $80,000 = $8,000 / .1
Which is better at creating value? Equally good
X costs $5,000, annual benefits = $1,000, 10% required rate of return and life of 10 years.
Z costs $60,000, annual benefits = $10,000, 14% required rate of return and life of 15 years.
You must choose between these two mutually exclusive projects and plan to run this operation forever.
X
Z
NPV N=10, I% = 10, PV=? 6144.57, PMT=-1000
6144.57-5000=1144.57
61421-60000=1421
EQUVALENT ANNUITY
1144.57/6.1446=186.28
1421/6.1422 = 231.35
FAIR VALUE
186.28/.1 = 1862.8
231.35/.14 = 1652.5
PERFER PROJEXT X
5. A and B are mutually exclusive. You do not plan to replace either at the end of its life.
A NPV
6. A and B are mutually exclusive and of unequal risk. You do plan to replace either project.
C Fair Value
7. A and B are not mutually exclusive. You do not plan to replace either at the end of its life
D Both
8. A and B are mutually exclusive and of equal risk. You do plan to replace either project.
B Equivalent Annuity

SHORTER PAYBACK PERIODS = HIGHER IRR = BETTER THE PROJECT = BUT HAVE HIGHER RISK

MIRR = IF REINVESTMENT RATE IS HIGHER THAN THE IRR, THEN MIRR IS GREATER THAN IRR

PP AND IRR ARE NOT AFFECTED BY THE DISCOUNT RATE

HIGH NPV = THE MORE VALUE THE PROJECT ADDS


o
RR > MIRR > IRR

EARLY CASH FLOWS = LONGER RR

LATER CASH FLOWS = LOWER IRR