1.

 Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the
discount rate is 11 percent? Why or why not?

    

2. You are analyzing the following two mutually exclusive projects and have developed the following
information. What is the crossover rate?

    
3. A project is expected to create operating cash flows of $35,000 a year for four years. The initial cost of the
fixed assets is $100,000. These assets will be worthless at the end of the project. An additional $5,000 of net
working capital will be required throughout the life of the project. What is the project's net present value if the
required rate of return is 11 percent? 

4. A project will produce an operating cash flow of $10,100 a year for five years. The initial cash investment in
the project will be $32,500. The net after-tax salvage value is estimated at $6,000 and will be received during
the last year of the project's life. What is the net present value of the project if the required rate of return is 10
percent? 

5. The Quick Producers Co. is analyzing a proposed project. The company expects to sell 10,000 units, give or
take 5 percent. The expected variable cost per unit is $6 and the expected fixed cost is $29,000. The fixed and
variable cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation
expense is $25,000. The tax rate is 34 percent. The sale price is estimated at $13 a unit, give or take 6 percent.
What is the operating cash flow for a sensitivity analysis using total fixed costs of $26,000? 

 
6. Madeline's Specialty Goods is considering a project with total sales of $19,000, total variable costs of
$10,400, total fixed costs of $4,500, and estimated production of 500 units. The depreciation expense is $2,600
a year. What is the contribution margin per unit? 
 

Q7-9: The Franklin Co. is analyzing a proposed project. The company expects to sell 3,500 units, give or take
15 percent. The expected variable cost per unit is $6 and the expected fixed costs are $15,500. Cost estimates
are considered accurate within a plus or minus 5 percent range. The depreciation expense is $6,000. The sales
price is estimated at $21 a unit, give or take 3 percent. The company bases their sensitivity analysis on the base
case scenario.

7. What is the sales revenue under the worst case scenario? 

8. What is the earnings before interest and taxes under the worst case scenario? 

9. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $23. What
are the earnings before interest and taxes? 

 
10. Top Notch, Inc. is expanding and needs $5 million to help fund this growth. Top Notch estimates they can
sell new shares of stock for $25 a share. They also estimate that it will cost an additional $200,000 for filing and
legal fees related to the stock issue. The underwriters have agreed to an 8 percent spread. How many shares of
stock must Top Notch sell if they are going to have $5 million available for their expansion needs? 

11. Hamilton, Inc. is issuing a rights offering wherein every shareholder will receive one right for every share of
stock they own. The new shares in this offering are priced at $30 plus 2 rights. The current market price of
Hamilton, Inc. stock is $34.50 a share. What is the value of one right? 

12. You have a $9,000 portfolio which is invested in stocks A, B, and a risk-free asset. $4,000 is invested in
stock A. Stock A has a beta of 1.84 and stock B has a beta of 0.68. How much needs to be invested in stock B if
you want a portfolio beta of .95? 

 
13. Bertelli's is analyzing a project with an initial cost of $55,000 and cash inflows of $33,000 a year for two
years. This project is an extension of the firm's current operations and thus is equally as risky as the current
firm. The firm uses only debt and common stock to finance their operations and maintains a debt-equity ratio
of .35. The aftertax cost of debt is 6 percent and the cost of equity is 11 percent. The tax rate is 34 percent. What
is the projected net present value of this project? 

14. Bridgewater Fountains is considering expanding its current line of business and has developed the following
expected cash flows for the project. Should this project be accepted based on the discounting approach to the
modified internal rate of return if the discount rate is 9.6 percent? Why or why not?

    

15. Jeff is considering a project which will produce cash inflows of $1,500 a year for 6 years. The project has a
10 percent required rate of return and an initial cost of $6,200. What is the discounted payback period? 
16. Elderkin & Martin is considering an investment which will cost $259,000. The investment produces no cash
flows for the first year. In the second year, the cash inflow is $58,000. This inflow will increase to $150,000 and
then $200,000 for the following two years before ceasing permanently. The firm requires a 14 percent rate of
return and has a required discounted payback period of three years. The firm should _____ the project because
the discounted payback period is _____ years. Accept or reject this project? Why? 

 17. You are considering the following two mutually exclusive projects. Both projects will be depreciated using
straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value.

   

What should you do based on NPV analysis? 

18. Superior Manufacturers is considering a 3-year project with an initial cost of $846,000. The project will not
directly produce any sales but will reduce operating costs by $295,000 a year. The equipment is depreciated
straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold
for an estimated $30,000. The tax rate is 34 percent. The project will require $31,000 in extra inventory for
spare parts and accessories. Should this project be implemented if Superior Manufacturing requires an 8 percent
rate of return? Why or why not? 

19. You are working on a bid to build four small apartment buildings a year for the next three years for a local
community. This project requires the purchase of $900,000 of equipment which will be depreciated using
straight-line depreciation to a zero book value over the three years. The equipment can be sold at the end of the
project for $400,000. You will also need $200,000 in net working capital over the life of the project. The fixed
costs will be $475,000 a year and the variable costs will be $140,000 per building. Your required rate of return
is 12 percent for this project and your tax rate is 34 percent. What is the minimal amount, rounded to the nearest
$500, that you should bid per building? 

20. Winning Sportswear wants to raise $3 million through a rights offering to renovate their current facilities.
The subscription price for the offering is set at $20 a share. Currently, the company has 120,000 shares of stock
outstanding at a market price of $25 a share. Each shareholder will receive one right for each share of stock they
own. How many rights will be needed to purchase one new share of stock in this offering? 

 
Answer Key

1. Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the
discount rate is 11 percent? Why or why not?

    
a. Yes; The PI is .91.
b. Yes; The PI is 1.01.
c. Yes; The PI is 1.10.
D. No; The PI is .91.
e. No; The PI is 1.10.

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #71
SECTION: 9.6
TOPIC: PROFITABILITY INDEX
TYPE: PROBLEMS
 
2. You are analyzing the following two mutually exclusive projects and have developed the following
information. What is the crossover rate?

    
a. 6.02 percent
b. 7.23 percent
c. 10.92 percent
d. 12.21 percent
E. 14.47 percent

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #87
SECTION: 9.5
TOPIC: CROSSOVER RATE
TYPE: PROBLEMS
 
3. A project is expected to create operating cash flows of $35,000 a year for four years. The initial cost of the
fixed assets is $100,000. These assets will be worthless at the end of the project. An additional $5,000 of net
working capital will be required throughout the life of the project. What is the project's net present value if the
required rate of return is 11 percent? 
a. $1,879.25
b. $3,585.60
C. $6,879.25
d. $8,585.60
e. $11,879.25

AACSB TOPIC: ANALYTIC

Ross - Chapter 010 #70
SECTION: 10.3 AND 10.4
TOPIC: PROJECT NPV
TYPE: PROBLEMS
 
4. A project will produce an operating cash flow of $10,100 a year for five years. The initial cash investment in
the project will be $32,500. The net after-tax salvage value is estimated at $6,000 and will be received during
the last year of the project's life. What is the net present value of the project if the required rate of return is 10
percent? 
a. $3,613.72
b. $5,515.64
c. $5,786.95
D. $9,512.47
e. $11,786.95

AACSB TOPIC: ANALYTIC

Ross - Chapter 010 #72
SECTION: 10.3, 10.4 AND 10.5
TOPIC: PROJECT NPV
TYPE: PROBLEMS
 

 The Quick Producers Co. is analyzing a proposed project. The company expects to sell 10,000 units, give or
take 5 percent. The expected variable cost per unit is $6 and the expected fixed cost is $29,000. The fixed and
variable cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation
expense is $25,000. The tax rate is 34 percent. The sale price is estimated at $13 a unit, give or take 6 percent.

Ross - Chapter 011

 
5. What is the operating cash flow for a sensitivity analysis using total fixed costs of $26,000? 
a. $19,000
b. $22,960
c. $29,040
d. $31,460
E. $37,540

EBIT = [(10,000 ($13 $6)] $26,000 $25,000 = $19,000

Tax = $19,000 .34 = $6,460
OCF = $19,000 + $25,000 $6,460 = $37,540

AACSB TOPIC: ANALYTIC

Ross - Chapter 011 #66
SECTION: 11.2
TOPIC: SENSITIVITY ANALYSIS
TYPE: PROBLEMS
 

6. Madeline's Specialty Goods is considering a project with total sales of $19,000, total variable costs of
$10,400, total fixed costs of $4,500, and estimated production of 500 units. The depreciation expense is $2,600
a year. What is the contribution margin per unit? 
a. $12.00
B. $17.20
c. $23.80
d. $29.00
e. $34.00

Contribution margin = ($19,000 $10,400) / 500 = $17.20

AACSB TOPIC: ANALYTIC

Ross - Chapter 011 #74
SECTION: 11.3
TOPIC: CONTRIBUTION MARGIN
TYPE: PROBLEMS
 

 The Franklin Co. is analyzing a proposed project. The company expects to sell 3,500 units, give or take 15
percent. The expected variable cost per unit is $6 and the expected fixed costs are $15,500. Cost estimates are
considered accurate within a plus or minus 5 percent range. The depreciation expense is $6,000. The sales price
is estimated at $21 a unit, give or take 3 percent. The company bases their sensitivity analysis on the base case
scenario.

Ross - Chapter 011

 
7. What is the sales revenue under the worst case scenario? 
A. $60,600.75
b. $62,474.00
c. $73,500.00
d. $84,525.00
e. $87,060.75

Sales revenue for the worst case = 3,500 .85 $21 .97 = $60,600.75

AACSB TOPIC: ANALYTIC

Ross - Chapter 011 #58
SECTION: 11.2
TOPIC: SCENARIO ANALYSIS
TYPE: PROBLEMS
 

8. What is the earnings before interest and taxes under the worst case scenario? 
a. $840
B. $1,650
c. $2,810
d. $5,090
e. $8,530

EBIT for worst case = (10,000 .95) [($13 .94) ($6 1.04)] ($29,000 1.04) $25,000 = $1,650

AACSB TOPIC: ANALYTIC

Ross - Chapter 011 #64
SECTION: 11.2
TOPIC: SCENARIO ANALYSIS
TYPE: PROBLEMS
 

9. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $23. What
are the earnings before interest and taxes? 
A. $38,000
b. $44,000
c. $50,000
d. $59,500
e. $65,000

EBIT = [($23 $6) 3,500] $15,500 $6,000 = $38,000

AACSB TOPIC: ANALYTIC

Ross - Chapter 011 #61
SECTION: 11.2
TOPIC: SENSITIVITY ANALYSIS
TYPE: PROBLEMS
 
10. Top Notch, Inc. is expanding and needs $5 million to help fund this growth. Top Notch estimates they can
sell new shares of stock for $25 a share. They also estimate that it will cost an additional $200,000 for filing and
legal fees related to the stock issue. The underwriters have agreed to an 8 percent spread. How many shares of
stock must Top Notch sell if they are going to have $5 million available for their expansion needs? 
a. 207,360 shares
b. 208,696 shares
c. 217,391 shares
d. 224,640 shares
E. 226,087 shares

Total value of issue = ($5,000,000 + $200,000) / (1 .08) = $5,652,173.91; Number of shares needed =
$5,652,173.91 / $25 = 226,086.96 = 226,087 shares

AACSB TOPIC: ANALYTIC

Ross - Chapter 016 #61
SECTION: 16.4 AND 16.7
TOPIC: FLOTATION COSTS
TYPE: PROBLEMS
 

11. Hamilton, Inc. is issuing a rights offering wherein every shareholder will receive one right for every share of
stock they own. The new shares in this offering are priced at $30 plus 2 rights. The current market price of
Hamilton, Inc. stock is $34.50 a share. What is the value of one right? 
a. $1.00
B. $1.50
c. $2.25
d. $3.00
e. $4.50

Value per share excluding right = [$30 + (2 $34.50)] / (1 + 2) = $99 / 3 = $33

Value of one right = $34.50 $33 = $1.50

AACSB TOPIC: ANALYTIC

Ross - Chapter 016 #69
SECTION: 16.8
TOPIC: VALUE OF A RIGHT
TYPE: PROBLEMS
 
12. You have a $9,000 portfolio which is invested in stocks A, B, and a risk-free asset. $4,000 is invested in
stock A. Stock A has a beta of 1.84 and stock B has a beta of 0.68. How much needs to be invested in stock B if
you want a portfolio beta of .95? 
a. $0
B. $1,750
c. $3,279
d. $5,000
e. $7,279

BetaPortfolio = .95 = ($4,000 / $9,000 1.84) + (x / $9,000 .68) + [($9,000 $4,000 x) / $9,000 0)]; .95
= .817777778 + .000075556x + 0; .00007556x = .132222222; x = $1,750

AACSB TOPIC: ANALYTIC

Ross - Chapter 013 #59
SECTION: 13.2 AND 13.6
TOPIC: ANALYZING A PORTFOLIO
TYPE: PROBLEMS
 

13. Bertelli's is analyzing a project with an initial cost of $55,000 and cash inflows of $33,000 a year for two
years. This project is an extension of the firm's current operations and thus is equally as risky as the current
firm. The firm uses only debt and common stock to finance their operations and maintains a debt-equity ratio
of .35. The aftertax cost of debt is 6 percent and the cost of equity is 11 percent. The tax rate is 34 percent. What
is the projected net present value of this project? 
A. $2,501
b. $2,854
c. $2,913
d. $3,011
e. $3,418

AACSB TOPIC: ANALYTIC

Ross - Chapter 015 #72
SECTION: 15.4
TOPIC: CAPITAL BUDGETING PROBLEM
TYPE: PROBLEMS
 
14. Bridgewater Fountains is considering expanding its current line of business and has developed the following
expected cash flows for the project. Should this project be accepted based on the discounting approach to the
modified internal rate of return if the discount rate is 9.6 percent? Why or why not?

    
a. Yes; The IRR is 9.11 percent.
B. Yes; The IRR is 11.87 percent.
c. Yes; The IRR is 11.99 percent.
d. No; The IRR is 11.87 percent.
e. No; The IRR is 11.99 percent.

The modified cash flows will be:

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #67
SECTION: 9.5
TOPIC: MODIFIED INTERNAL RATE OF RETURN
TYPE: PROBLEMS
 
15. Jeff is considering a project which will produce cash inflows of $1,500 a year for 6 years. The project has a
10 percent required rate of return and an initial cost of $6,200. What is the discounted payback period? 
a. 4.55 years
b. 4.61 years
c. 5.55 years
D. 5.61 years
e. never

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #79
SECTION: 9.3
TOPIC: DISCOUNTED PAYBACK PERIOD
TYPE: PROBLEMS
 

16. Elderkin & Martin is considering an investment which will cost $259,000. The investment produces no cash
flows for the first year. In the second year, the cash inflow is $58,000. This inflow will increase to $150,000 and
then $200,000 for the following two years before ceasing permanently. The firm requires a 14 percent rate of
return and has a required discounted payback period of three years. The firm should _____ the project because
the discounted payback period is _____ years. Accept or reject this project? Why? 
a. accept; 2.26
b. accept; 2.49
c. accept; 3.96
d. reject; 3.26
E. reject; 3.96

Elderkin & Martin should reject the project since the payback period of 3.96 years exceeds the required 3 years.

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #80
SECTION: 9.3
TOPIC: DISCOUNTED PAYBACK PERIOD
TYPE: PROBLEMS
 
 You are considering the following two mutually exclusive projects. Both projects will be depreciated using
straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value.

   

Ross - Chapter 009

 

17. What should you do based on NPV analysis? 

A. accept project B and reject project A
b. reject both project A and project B
c. accept both project A and project B
d. accept project A and reject project B
e. It does not matter which project you accept as the projects have equal and positive net present values.

Project B should be accepted and project A should be rejected.

AACSB TOPIC: ANALYTIC

Ross - Chapter 009 #93
SECTION: 9.1
TOPIC: NET PRESENT VALUE
TYPE: PROBLEMS
 
18. Superior Manufacturers is considering a 3-year project with an initial cost of $846,000. The project will not
directly produce any sales but will reduce operating costs by $295,000 a year. The equipment is depreciated
straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold
for an estimated $30,000. The tax rate is 34 percent. The project will require $31,000 in extra inventory for
spare parts and accessories. Should this project be implemented if Superior Manufacturing requires an 8 percent
rate of return? Why or why not? 
a. No; The NPV is $128,147.16.
B. No; The NPV is $87,820.48.
c. No; The NPV is $81,429.28.
d. Yes; The NPV is $33,769.37.
e. Yes; The NPV is $153,777.33.

AACSB TOPIC: ANALYTIC

Ross - Chapter 010 #75
SECTION: 10.3 AND 10.6
TOPIC: COST-CUTTING
TYPE: PROBLEMS
 
19. You are working on a bid to build four small apartment buildings a year for the next three years for a local
community. This project requires the purchase of $900,000 of equipment which will be depreciated using
straight-line depreciation to a zero book value over the three years. The equipment can be sold at the end of the
project for $400,000. You will also need $200,000 in net working capital over the life of the project. The fixed
costs will be $475,000 a year and the variable costs will be $140,000 per building. Your required rate of return
is 12 percent for this project and your tax rate is 34 percent. What is the minimal amount, rounded to the nearest
$500, that you should bid per building? 
a. $292,500
b. $316,500
c. $330,500
D. $341,500
e. $365,000

NI = $320,477.95 $300,000 = $20,477.95; EBT = $20,477.95 / (1 .34) = $31,027.20

Sales = $31,027.20 + ($900,000 / 3) + $475,000 + ($140,000 4) = $1,366,027.20
Bid per building = $1,366,027.20 / 4 = $341,506.80
When rounded to the nearest $500, the bid price is $341,500.

AACSB TOPIC: ANALYTIC

Ross - Chapter 010 #77
SECTION: 10.6
TOPIC: BID PRICE
TYPE: PROBLEMS
 

20. Winning Sportswear wants to raise $3 million through a rights offering to renovate their current facilities.
The subscription price for the offering is set at $20 a share. Currently, the company has 120,000 shares of stock
outstanding at a market price of $25 a share. Each shareholder will receive one right for each share of stock they
own. How many rights will be needed to purchase one new share of stock in this offering? 
A. 0.8 rights
b. 1.0 rights
c. 1.2 rights
d. 1.4 rights
e. 1.6 rights

Number of rights issued = 1 120,000 = 120,000; Number of shares needed = $3m / $20 = 150,000; Rights
needed for each new share = 120,000 / 150,000 = .80 rights

AACSB TOPIC: ANALYTIC

Ross - Chapter 016 #67
SECTION: 16.8
TOPIC: NUMBER OF RIGHTS
TYPE: PROBLEMS
 
Homework Summary

Category #  of  Question

s
AACSB TOPIC: ANALYTIC 20
Ross - Chapter 009 7
Ross - Chapter 010 4
Ross - Chapter 011 7
Ross - Chapter 013 1
Ross - Chapter 015 1
Ross - Chapter 016 3
SECTION: 10.3 AND 10.4 1
SECTION: 10.3 AND 10.6 1
SECTION: 10.3, 10.4 AND 10.5 1
SECTION: 10.6 1
SECTION: 11.2 4
SECTION: 11.3 1
SECTION: 13.2 AND 13.6 1
SECTION: 15.4 1
SECTION: 16.4 AND 16.7 1
SECTION: 16.8 2
SECTION: 9.1 1
SECTION: 9.3 2
SECTION: 9.5 2
SECTION: 9.6 1
TOPIC: ANALYZING A PORTFOLIO 1
TOPIC: BID PRICE 1
TOPIC: CAPITAL BUDGETING PROBLEM 1
TOPIC: CONTRIBUTION MARGIN 1
TOPIC: COST-CUTTING 1
TOPIC: CROSSOVER RATE 1
TOPIC: DISCOUNTED PAYBACK PERIOD 2
TOPIC: FLOTATION COSTS 1
TOPIC: MODIFIED INTERNAL RATE OF RETURN 1
TOPIC: NET PRESENT VALUE 1
TOPIC: NUMBER OF RIGHTS 1
TOPIC: PROFITABILITY INDEX 1
TOPIC: PROJECT NPV 2
TOPIC: SCENARIO ANALYSIS 2
TOPIC: SENSITIVITY ANALYSIS 2
TOPIC: VALUE OF A RIGHT 1
TYPE: PROBLEMS 20