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Reading 44: Capital Budgeting - LOS f ~ Q1-3

Q1. Mollette Industries uses the payback period as its primary means for ranking capital projects. Which of the following most likely describes Mollette Industries with regard to location and management education?

          Location                                         Management education

 

A)  U.S. based firm                     Undergraduate degree or lower

B)  European-based firm          MBA degree or higher

C)  European-based firm          Undergraduate degree or lower

Q2. Garner Corporation is investing $30 million in new capital equipment. The present value of future after-tax cash flows generated by the equipment is estimated to be $50 million. Currently, Garner has a stock price of $28.00 per share with 8 million shares outstanding. Assuming that this project represents new information and is independent of other expectations about the company, what should the effect of the project be on the firm’s stock price?

A)   The stock price will increase to $30.50.

B)   The stock price will increase to $34.25.

C)   The stock price will remain unchanged.

Q3. Osborn Manufacturing uses the NPV and IRR methods as its primary tools for evaluating capital projects. Which of the following most likely describes Osborn Manufacturing with regard to firm ownership and company size?

          Firm ownership                 Company size

 

A)      Public                              Small

B)      Private                             Large

C)      Public                              Large

 

答案和详解如下:

Q1. Mollette Industries uses the payback period as its primary means for ranking capital projects. Which of the following most likely describes Mollette Industries with regard to location and management education?

          Location                                         Management education

 

A)  U.S. based firm                     Undergraduate degree or lower

B)  European-based firm          MBA degree or higher

C)  European-based firm          Undergraduate degree or lower

Correct answer is C)

Despite the theoretical superiority of the NPV and IRR methods for determining and ranking project profitability, surveys of corporate managers show that a variety of methods are used. Firms that were most likely to use the payback period method were European firms and management teams with less education.

Q2. Garner Corporation is investing $30 million in new capital equipment. The present value of future after-tax cash flows generated by the equipment is estimated to be $50 million. Currently, Garner has a stock price of $28.00 per share with 8 million shares outstanding. Assuming that this project represents new information and is independent of other expectations about the company, what should the effect of the project be on the firm’s stock price?

A)   The stock price will increase to $30.50.

B)   The stock price will increase to $34.25.

C)   The stock price will remain unchanged.

Correct answer is A)

In theory, a positive NPV project should provide an increase in the value of a firm's shares.

NPV of new capital equipment = $50 million - $30 million = $20 million
Value of company prior to equipment purchase = 8,000,000 × $28.00 = $224,000,000
Value of company after new equipment project = $224 million + $20 million = $244 million
Price per share after new equipment project = $244 million / 8 million = $30.50

Note that in reality, changes in stock prices result from changes in expectations more than changes in NPV.

Q3. Osborn Manufacturing uses the NPV and IRR methods as its primary tools for evaluating capital projects. Which of the following most likely describes Osborn Manufacturing with regard to firm ownership and company size?

          Firm ownership                 Company size

 

A)      Public                              Small

B)      Private                             Large

C)      Public                              Large

Correct answer is C)

Despite the theoretical superiority of the NPV and IRR methods for determining and ranking project profitability, surveys of corporate managers show that a variety of methods are used. Firms that use the NPV and IRR methods tend to be larger, publicly-traded, companies.

 

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