16.3 Illustrative Case: Cemex Enters Indonesia
1) Given a
current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation
rates of 6% in Norway and 3% per annum in the U.S., use the formula for
relative purchasing power parity to estimate the one-year spot rate of krone
per dollar.
A) 7.87 krone per
dollar
B) 8.10 krone per
dollar
C) 8.34 krone per
dollar
D) There is not
enough information to answer this question.
2) When
evaluating capital budgeting projects, which of the following would NOT
necessarily be an indicator of an acceptable project?
A) an NPV > $0
B) an IRR >
the project’s required rate of return
C) an IRR > $0
D) All of the
above are correct indicators.
3) Given a
current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation
rates of 3% in Norway and 6% per annum in the U.S., use the formula for
relative purchasing power parity to estimate the one-year spot rate of krone
per dollar.
A) 7.87 krone per
dollar
B) 8.10 krone per
dollar
C) 8.34 krone per
dollar
D) There is not
enough information to answer this question.
4) When
determining a firm’s weighted average cost of capital (wacc) which of the
following terms is NOT necessary?
A) the firm’s tax
rate
B) the firm’s
cost of debt
C) the firm’s
cost of equity
D) All of the
above are necessary.
5) When
determining a firm’s weighted average cost of capital (wacc) which of the
following terms is NOT necessary?
A) the firm’s
weight of equity financing
B) the
accumulated depreciation
C) the firm’s
weight of debt financing
D) All of the
above are necessary to determine a firm’s wacc.
6) Of the
following, which would NOT be considered an initial outlay at time 0 (today)?
A) investment in
new equipment
B) initial
investment in additional net working capital
C) shipping and
handling costs associated with the new investment
D) All of the
above are initial outlays.
Instruction 16.1:
Use the
information for the following question(s).
The Wheel Deal
Inc., a company that produces scooters and other wheeled non-motorized
recreational equipment is considering an expansion of their product line to
Europe. The expansion would require a purchase of equipment with a price of
euro 1,200,000 and additional installation of euro 300,000 (assume that the
installation costs cannot be expensed, but rather, must be depreciated over the
life of the asset). Because this would be a new product, they will not be
replacing existing equipment. The new product line is expected to increase
revenues by euro 600,000 per year over current levels for the next 5 years,
however; expenses will also increase by euro 200,000 per year. (Note: Assume
the after-tax operating cash flows in years 1-5 are equal, and that the
terminal value of the project in year 5 may change total after-tax cash flows for
that year.) The equipment is multipurpose and the firm anticipates that they
will sell it at the end of the five years for euro 500,000. The firm’s required
rate of return is 12% and they are in the 40% tax bracket. Depreciation is
straight-line to a value of euro 0 over the 5-year life of the equipment, and
the initial investment (at year 0) also
requires an increase in NWC of euro 100,000 (to be recovered at the sale of the
equipment at the end of five years). The current spot rate is $0.95/euro , and
the expected inflation rate in the U.S. is 4% per year and 3% per year in
Europe.
7) Refer to
Instruction 16.1. What are the annual after-tax cash flows for the Wheel Deal
project?
A) euro 400,000
B) euro 240,000
C) euro 120,000
D) euro 360,000
8) Refer to
Instruction 16.1. What is the initial investment for the Wheel Deal project?
A) $1,500,000
B) euro 1,600,000
C) $1,600,000
D) euro 1,500,000
9) Refer to
Instruction 16.1. What is the NPV of the European expansion if Wheel Deal first
computes the NPV in euros and then converts that figure to dollars using the
current spot rate?
A) $1,520,000
B) $1,684,210
C) -$75,310
D) -$71,544
10) Refer to
Instruction 16.1. In euros, what is the NPV of the Wheel Deal expansion?
A) euro 1,524,690
B) $1,611,317
C) -euro 75,310
D) -euro 111,317
11) Refer to
Instruction 16.1. What is the IRR of the Wheel Deal expansion?
A) 14.4%
B) 10.3%
C) 12.0%
D) 8.6%
12) Refer to
Instruction 16.1. The European expansion would have a greater NPV in dollar
terms if the euro appreciated in value over the five-year life of the project
and the project had a positive NPV, other things equal.
13) The only
proper way to estimate the NPV of a foreign project is to discount the
appropriate cash flows first and then convert them to the domestic currency at
the current spot rate.
14) Benson
Manufacturing has an after-tax cost of debt of 7% and a cost of equity of 12%.
If Benson is in a 30% tax bracket, and finances 40% of assets with debt, what
is the firm’s wacc?
A) 11.20%
B) 10.36%
C) 9.72%
D) 7.68%
15) If a firm
undertakes a project with ordinary cash flows and estimates that the firm has a
positive NPV, then the IRR will be ________.
A) less than the
cost of capital
B) greater than
the cost of capital
C) greater than
the cost of the project
D) cannot be
determined from this information
16) Generally
speaking a firm’s cost of ________ capital is greater than the firm’s ________.
A) debt; equity
B) debt; wacc
C) equity; wacc
D) None of the
above is true.
17) When
estimating a firm’s cost of equity capital using the CAPM, you need to estimate
A) the risk-free
rate of return.
B) the expected
return on the market portfolio.
C) the firm’s
beta.
D) all of the
above.
18) Calculate the
cost of equity for Boston Industries using the following information: The cost
of debt is 7%, the corporate tax rate is 40%, the rate on Treasury Bills is 4%,
the firm has a beta of 1.1, and the expected return on the market is 12%.
A) 12.8%
B) 12.6%
C) 13.2%
D) 6.6%
19) ________ is
the risk that a foreign government will place restrictions such as limiting the
amount of funds that can be remitted to the parent firm, or even expropriation
of cash flows earned in that country.
A) Exchange risk
B) Foreign risk
C) Political risk
D) Unnecessary
risk
20) Which of the
following is NOT an example of political risk?
A) There could be
expropriation of cash flows by a foreign government.
B) The U.S.
government restricts trade with a foreign country where your firm has
investments.
C) The foreign
government nationalizes all foreign-owned assets.
D) All of the
above are examples of political risk.
21) Generally
speaking, a firm wants to receive cash flows in a currency that is ________
relative to their own, and pay out in currencies that are ________ relative to
their home currency.
A) appreciating;
depreciating
B) depreciating;
depreciating
C) appreciating;
appreciating
D) depreciating;
appreciating
22) When dealing
with international capital budgeting projects, the value of the project is NOT
sensitive to the firm’s cost of capital.
Answer: FALSE
23) Projects that
have ________ are often rejected by traditional discounted cash flow models of
capital budgeting.
A) long lives
B) cash flow
returns in later years
C) high risk
levels
D) all of the
above
TABLE 16.1
Use the
information to answer the following question(s).
Jensen Aquatics
Inc., which manufactures and sells scuba gear worldwide, is considering an
investment in either Europe or Great Britain. Consider the following cash flows
for each project, assume a 12% wacc, and consider these to be average risk
projects for the firm. Answer the questions that follow.
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24) Refer to
Table 16.1. The NPV for the British investment is estimated at ________.
A) $3,092
B) $6,420
C) £3,092
D) $0
25) Refer to
Table 16.1. The NPV for the European investment is estimated at ________.
A) euro 4,945
B) $4,945
C) $6,420
D) euro 6,420
26) Refer to
Table 16.1. Which of the following best summarizes the preliminary results of
the investment analysis for the two prospective investments?
A) The British
investment should be accepted, the European investment rejected.
B) The British
investment is superior to the European investment.
C) Both
investments are acceptable.
D) None of the
above is true.
27) Refer to
Table 16.1. If the euro was forecast to remain constant at $1.00/euro
throughout the investment period, how would the investment decision now be
characterized?
A) The project
would be even better than forecast.
B) The British
investment should be chosen over the European investment.
C) The NPV is
$6,420.
D) All of the
above are true.
28) When a
foreign project is analyzed from the parent’s point of view, the additional
risk that stems from it’s “foreign” location is typically measured by
________ or ________.
A) adjusting the
discount rates; adjusting the timing
B) adjusting the
timing; adjusting the cash flows
C) adjusting the
discount rates; adjusting the cash flows
D) none of the
above
29) Which is NOT
considered a shortcoming of the parent simply adjusting discount rates to account
for the additional risk that stems from a project’s foreign location?
A) Cash flows are
already highly subjective.
B) Two-sided risk
in that foreign currency may appreciate or depreciate.
C) Increased
sales volume might offset the lower value of a local currency.
D) These are all
shortcomings associated with discount rate adjustment.
30) Hydrotech
Manufacturing of Houston Texas expects to receive dividends each year from a
foreign subsidiary for the next 5 years.
The dividend is expected to grow at a rate of 7% per year. If the euro appreciates in value against the
dollar at a rate of 2% per year over the life of the dividends, then the
present value of the euro dividends to Hydrotech will be ________ if there had
been no change in the relative values of the euro and dollar.
A) less than
B) greater than
C) the same as
D) There is not
enough information to answer this question.
16.4 Real Option Analysis
1) Real option
analysis allows managers to analyze all of the following EXCEPT
A) the option to defer.
B) the option to
abandon.
C) the option to
alter capacity.
D) All of the
above may be analyzed using real option analysis.
2) At its core,
real option analysis is a cross between decision-tree analysis and pure
option-based valuation.
3) Real option
analysis is a particularly powerful device when addressing potential investment
projects ________.
A) that do not
commence until future dates.
B) with extremely
long life spans.
C) both A and B.
D) None of the
above.
4) Real option
analysis treats cash flows in terms of future value in a negative sense,
whereas DCF treats future cash flows positively.
16.5 Project Financing
1) Project
financing is the arrangement of financing for very large individual long-term
capital projects.
Answer: TRUE
2) Which of the
following is NOT a factor critical to the success of project financing?
A) separability
of the project from its investors
B) long-lived and
capital intensive singular projects
C) cash flow
predictability from third part commitments
D) All of the
above are critical factors for project financing.
16.6 Cross-Border Mergers and Acquisitions
1) The process of
acquiring an enterprise anywhere in the world has the following common elements
EXCEPT ________.
A) identification
and valuation of the target
B) the tender
offer
C) management of
the post-acquisition transition
D) All of the
above are common elements in the process.
2) Which of the
following would NOT be a potential reason for firms to pursue a cross-border
merger or acquisition?
A) gaining access
to strategic proprietary assets
B) gaining market
power and dominance
C)
diversification and the spreading of risk
D) All of the
above are potential reasons for an M & A.
3) Generally
speaking, currency risk decreases as time prior to acquisition of a foreign
firm decreases.
Answer: TRUE