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Accounting & MIS 3300
Exam IV
Autumn 2014
Instructions:
1.
Read each question carefully and answer fully. Some problems have
limited or no partial credit.
2.
Problems not supported by relevant and readable computations are
subject to point loss. Where appropriate, terms like “unfavorable,”
“favorable,” “better off,” “worse off,” etc. must be included with number
answers. Dollar amounts should include a dollar sign; unit amount
should include an indication of the unit.
3.
Budget your time carefully. It is generally better to finish half of each
problem than to complete all of half the problems. Students who start
early or continue to work on exams after instructed to stop will receive
penalties as outlined in the syllabus.
4.
It is the student's responsibility to verify that all the listed problems
and pages are contained is this booklet. Unanswered questions
receive zero points regardless of reason.
Problem
Pages
Approximate
Points
I
2
5+5+5+5=20
9 – 11 minutes
II
3
12+8=20
9 – 11 minutes
III
4
12+10=22
10 – 12 minutes
IV
5
6+6+6=18
8 – 10 minutes
V
6
8+6+6=20
9 – 11 minutes
100
45 – 55 minutes
Total
Approximate
Time
Page 2 of 7
PROBLEM I
Part A. The Aaron Company has $800,000 in debt and $600,000 in equity. They pay a
before-tax rate of 12% on debt and 18% on equity. Their tax rate is 40%.
REQUIRED: Compute weighted-average cost of capital.
Weighted-Average Cost of Capital
%
Part B. The Arnold Company has net operating income of $86,000 and has $420,000 in
average assets. Sales were $2,000,000. Ignore income taxes.
REQUIRED: Compute Return on Investment (ROI):
ROI
%
Part C. The Axe Company desires a minimum return of 9%. It has a project that will
require an investment of $325,000 and will earn $44,000. Sales will be $1,600,000. Ignore
income taxes.
REQUIRED: Compute Residual Income (RI):
Residual Income
$
Part D. The Ames Company has a weighted-average cost of capital of 10.6%. They have
total assets of $400,000 and liabilities of $300,000 (of which $80,000 is current). They
earned $50,000 before taxes. The tax rate is 30%.
REQUIRED: Compute the Economic Value Added (EVA):
Economic Value Added
$
Page 3 of 7
PROBLEM II
The Baxter Company is considering an investment in a new project. The following are
before-tax amounts. The project will cost $80,000 and will generate positive cash flows of
$23,000 per year for four years. The project will have a salvage value of $5,000 at the end
of its four-year life. It will also require a working capital investment of $4,000.
Part A. REQUIRED: Compute the net present value of this project at 9%, ignoring taxes.
Part B. REQUIRED: Compute the after-tax net present value of this project at 9%. The
tax rate is 40% and the firm will use zero salvage and straight-line for tax depreciation
purposes.
Page 4 of 7
PROBLEM III
You are the CFO of Carter Enterprises. A few months ago, you ordered a machine, the
XJ196, to increase production. It cost you $200,000, has a four-year life, and a salvage
value of $40,000. Just before you are to take delivery, another firm offers to sell you their
machine, the YJ197, an exact replacement for the XJ196 you are about to receive. The
YJ197 costs $400,000, has a four-year life, and a salvage value of $50,000. The YJ197 has
annual operating costs of $90,000 compared to $200,000 for XJ196. You discover you
cannot cancel the order for the XJ196. However, if you decide to use the YJ197, it can be
ready to use when the XJ196 would have been ready (essentially immediately). The XJ196
would still be delivered and paid for, and you have found a broker willing to pick it up and
give you $65,000 for it. All the above numbers are before considering taxes.
Part A. You have two choices: go ahead and use the XJ196, or replace it and use the
YJ197. REQUIRED: Determine which you should do by computing the net present value
of replacing the XJ196 with the YJ197 at 11%, ignoring taxes.
Part B. REQUIRED: Redo the above computing the after-tax net present value at 11%.
The tax rate is 30% and the firm uses zero salvage and straight-line for tax depreciation
purposes.
Page 5 of 7
PROBLEM IV
Draftner sells one product at the same price per unit. In 20x1 and 20x2, the results were:
Sales Units
Sales
CGS
Gross Margin
Operating Expenses
Operating Income
20x2
50,000
$ 2,750,000
2,375,000
$
375,000
205,000
$
170,000
Per Unit
$ 55.00
47.50
$ 7.50
4.10
$ 3.40
20x1
42,000
$ 2,310,000
2,123,000
$
187,000
188,200
$
(1,200)
Per Unit
$ 55.00
50.55
$ 4.45
4.48
$ (0.03)
This year, 20x3, is expected to have the same cost structure as in both 20x1 and
20x2 and the same units sales as in 20x2, absent any special orders or transfers. For each
part, make your answer stand out.
Part A. Assume Draftner receives a special order for 18,000 units at $45 each from Dogton.
Draftner has a capacity of 60,000 units. Dogton requires a less elaborate unit that will cost
Draftner $1 less to produce. How much better or worse off will Draftner be if they accept
this take-it-or-leave-it special order?
Part B. Assume the facts in Part A. Assume Draftner and Dogton are divisions of Danger
Enterprises. Draftner has a capacity of 60,000 units. Draftner is required to quote a single
price to Dogton for the 18,000 units requested. Dogton can buy these units for $40 from an
outside supplier. What transfer price per unit should Draftner submit to make Danger as
well off as possible?
Part C. Redo Part B, without the constraint to issue a single price for all 18,000 units.
Page 6 of 7
PROBLEM V
The Easton Company is considering taking on a one-time project. The profitability of the
project depends upon the weather—which has a 60% chance of good and a 40% chance of
bad—and the contract they sign—either A or B. The profit from the project in each case is:
Weather:
Good
Bad
Contract A Contract B
$ 100,000 $ 75,000
$ (10,000) $ 20,000
Required: For each of the following cases, place your answer in the box and provide
supporting calculations.
Part A. What is the expected value of each contract option?
Expected Value of Contract A
$
Expected Value of Contract B
$
Part B. What is the expected value of perfect information?
Expected Value of Perfect Information
$
Part C. The WeatherEx Company tells Easton they can provide a 100% accurate weather
forecast for $10,000. They offer a 100% money-back guarantee should their forecast prove
wrong. Easton pays them $10,000 for a weather forecast. WeatherEx tells Easton the
weather will be good. However, WeatherEx is a fraud. They simply predicted good because
it was the more likely event. If the weather is good, they keep the money. If the weather is
bad, they refund the $10,000 to Easton. Easton uses the WeatherEx forecast of good as if it
is a perfect forecast. What is Easton’s expected value of this project to Easton, fully
reflecting the WeatherEx interaction?
Expected Value considering WeatherEx
$
Page 7 of 7
Present Value of $1
Periods
1
2
3
4
5
8%
0.926
0.857
0.794
0.735
0.681
Interest Rate
9%
10%
0.917 0.909
0.842 0.826
0.772 0.751
0.708 0.683
0.650 0.621
11%
0.901
0.812
0.731
0.659
0.593
Present Value of Annuity of $1 in Arrears
Periods
1
2
3
4
5
8%
0.926
1.783
2.577
3.312
3.993
Interest Rate
9%
10%
0.917 0.909
1.759 1.736
2.531 2.487
3.240 3.170
3.890 3.791
11%
0.901
1.713
2.444
3.102
3.696