16) Which of the following statements is TRUE? [I] An increase in depreciation e
ID: 2721649 • Letter: 1
Question
16) Which of the following statements is TRUE? [I] An increase in depreciation expenses would generally cause a firm's net income to rise [II] An increase in depreciation expenses would generally cause a firm's net cash flow to rise [III] If a single project has a normal cash flow pattern, the NPV, IRR and MIRR would give the same accept/reject decision [IV] When a project has non normal cash flows, there may be more than one IRR although the MIRR would usually produce a unique solution [V] If mutually exclusive projects have unequal lives, the IRR, and not the NPV, should be used to make capital budgeting decision
A) II, III, IV
C) I, III, IV
D) II, IV, V
E) IV and V
18) For this and the next question: Consider the following mutually exclusive projects, P and Q with r = 10%: Which of the two projects should be accepted?
Year
P
Q
0
-$1,100
-$1,100
1
800
200
2
500
400
3
100
1,000
A) Both projects
C) Project Q, because its NPV is $163.71
D) None of the projects should be selected
22) For this and the next question (Assume earnings growth): Aon Electronics has EBIT of $200,000, a growth rate of 6%, and faces a tax rate of 40%. In order to support growth, Aon must reinvest 20% of its EBIT in net operating assets. The firm has $300,000 in 8% debt outstanding. A similar company with no debt has a cost of equity of 11% (i.e. rEU = 11%). According to the MM extension with growth, what is the value of Aon's interest tax savings?
A) $87,273
C) $288,000
D) $192,000
E) $300,000
Year
P
Q
0
-$1,100
-$1,100
1
800
200
2
500
400
3
100
1,000
Explanation / Answer
Answer 16 The answer is option D i.e. II,IV,V Answer 18 Calculation of Net present value at discount factor of 10% Year PV factor Project P Project Q Cash Flow Present Value of cash flow Cash Flow Present Value of cash flow 0 1 -$1,100.00 -$1,100.00 -$1,100.00 -$1,100.00 1 0.909091 $800.00 $727.27 $200.00 $181.82 2 0.826446 $500.00 $413.22 $400.00 $330.58 3 0.751315 $100.00 $75.13 $1,000.00 $751.31 $115.63 $163.71 The answer is Project Q because its NPV is $163.71 Answer 22 MM Extension with growth formula is as under VTS = rdTD/(rEU – g) VTS = Value of tax saving rd = interest rate on debt = 8% T = tax rate = 40% D = Debt = $300000 rEU = 11% g = growth rate = 6% Value of Interest tax saving = 0.08(0.40)(300000) / (0.11 - 0.06) = $192000 The answer is option D
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