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Mini case on page 329, 330 calendonia

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It’s been two months since you took a position as an assistant financial analyst at Caledonia Products.  Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision.  Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects.  Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process.  The memorandum you received outlining your assignment follows:

To: The Assistant Financial Analyst

From: Mr. V. Morrison, CEO, Caledonia Products

Re:  Cash Flow Analysis and Capital Rationing

We are considering the introduction of a new product.  Currently we are in the 34% tax bracket with a 15% discount rate.  This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated.  The following information describes the new project:

Cost of new plant and equipment: $7,900,000

Shipping and Installation Costs: $100,000

Unit Sales:  

Sales Price per Unit:  $300/unit in years 1-4 and $260/unit in year 5

Variable Cost per Unit: $180/unit

Annual Fixed Costs:  $200,000 per year

Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started.  For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year.  Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4.  Finally, all working capital is liquidated at the termination of the project at the end of year 5.  Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.

Years     Unit Sold

1         70,000

2         120,000

3         140,000

4         80,000

5         60,000   

 

Question 1 – What is the project’s net present value?

 

 

 

parts “a” to “d,” summarize your analysis in a concise management statement not to exceed a total of 1,200 words. For parts “e” to “k,” use formulas to calculate the ratios and format the cells to insert a comma if there is more than three numbers. Round to the nearest whole number. Clearly label your analysis and your conclusions in not more than 500 words. Mini Case: We are considering the introduction of a new product. Currently we are in the 34% marginal tax bracket with a 15% required rate of return or cost of capital. This project is expected to last 5 years and then, because this somewhat of a fad product, be terminated. The following information describes the new project. Cost of new plant & equipment= $7,900,00 Shipping and installation costs=$100,000 Unit Sales: Year 1 units sold 70,000 Year 2 units sold 120,000 Year 3 units sold 140,000 Year 4 units sold 80,000 Year 5 units sold 60,000 Sales price per unit= $300/unit in the years 1-4, Year 5 $260/unit Variable costs per unit = $280/unit Annual fixed costs= $200,000 Working capital requirements: There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in the net working capital will be equal to 10% of the dollar value of the sales for that year. Thus, the investment in working capital will increase during years 1-3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5. The depreciation method: Use the simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvage value after 5 years.   A)should the company focus on cash flow or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits? B) How does depreciation affect free cash flows? C) How do sunk costs effect the determination of cash flows? D) What is the projects initial outlay? E) What are the differential cash flows over the projects life? F) What is the terminal cash flow? G) Draw a cash flow diagram for this project H) What is its net present value? I)What is the internal rate of return? J) Should the project be accepted? Why or why not? K) In Capital budgeting, risk can be measured from 3 perspectives. What are those 3 measures of a projects risk? L) According to the CAPM, which measurement of a projects risk is relevant? What complications does reality introduce into CAPM view of risk, and what does that mean for our view of the relevant measure of a projects risk? M) Explain how simulation works. What is the value of using the simulation approach? N) What is sensitivity analysis and what is its purpose?

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41) A consumer is in equilibrium when the

A) consumer is buying any combination of goods and services on his or her budget line.

B) consumer is buying the combination of goods and services on the budget line and on the highest attainable indifference curve.

C) marginal rate of substitution is as small as possible.

D) marginal rate of substitution is as large as possible.

E) marginal rate of substitution exceeds the relative price of the two goods by as much as possible.

42) Luke enjoys eating tuna sashimi and drinking Pepsi. His consumer equilibrium occurs where his budget line

A) just touches the lowest indifference curve at one point.

B) just touches the highest indifference curve at one point.

C) touches every indifference curve.

D) is below every indifference curve.

E) More information about Luke's budget is needed to determine his consumer equilibrium.

 

43) The point where an indifference curve just touches the budget line at one point

A) is the best affordable point.

B) is where the marginal rate of substitution exceeds the relative price by as much as possible.

C) is a point on the consumer's supply of spending curve.

D) cannot be possible because indifference curves always cross the budget line at two points.

E) None of the above answers is correct.

 

44) In a budget line/indifference curve diagram, at the consumer's equilibrium at the best affordable point,

A) any movement upward or downward on the budget line will move the consumer to a less preferred point.

B) any movement to the northeast to higher indifference curves moves the consumer to a less preferred point.

C) the slope of the budget line exceeds the marginal rate of substitution by as much as possible.

D) the budget line has a positive slope and the indifference curve has a negative slope.

E) the budget line has a negative slope and the indifference curve has a positive slope.

45) If a person consumes only two goods, which of the following is NOT necessary for a consumer to be at his or her best affordable point of consumption?

A) The consumer chooses a bundle of goods that lies on his or her budget line.

B) The consumer is on his or her highest attainable indifference curve.

C) The consumer chooses equal amounts of both goods.

D) The marginal rate of substitution between the two goods is equal to the relative price of those two goods.

E) The indifference curve is tangent to the budget line.

 

46) If a consumer's marginal rate of substitution is greater than the relative price of the goods, the consumer is

A) at his or her best affordable point.

B) perhaps at his or her best affordable point.

C) not at his or her best affordable point and should move along his or her indifference curve to a higher budget line.

D) not at his or her best affordable point and should move along his or her budget line to a higher indifference curve.

E) More information is needed to determine if the consumer is or is not at his or her best affordable point.

 

47) At her best affordable point, Kris

i.is on her budget line.

ii.is on the highest attainable indifference curve.

iii.has a marginal rate of substitution equal to the relative price of the goods.

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

48) When Bo is at his best affordable consumption point, his marginal rate of substitution is

A) greater than the relative price.

B) equal to the relative price.

C) less than the relative price.

D) equal to one.

E) maximized.

 

49) A consumer's demand for tuna can be found from an indifference curve diagram by doing which of the following?

A) observing what happens to the consumption of tuna for different income levels

B) finding where the budget line is tangent to an indifference curve for one price of tuna

C) allowing the price of tuna to change and observing the different best, affordable levels of tuna

D) changing the indifference curves and seeing the changes in the quantity of tuna the consumer demands

E) It is impossible to derive a demand curve from an indifference curve graph.

 

50) Using Gabriel's budget line and his indifference curves between horseback riding lessons and baseball lessons, and then changing the prices of each activity holding his income constant, which of the following can be derived?

A) Gabriel's demand curve for each activity

B) Gabriel's supply curve for each activity

C) Gabriel's marginal benefit for each activity

D) Gabriel's net gain for each activity

E) Both answers A and B are correct.

 

 

 

default image
July 1, 2023
    

 

41) A consumer is in equilibrium when the

A) consumer is buying any combination of goods and services on his or her budget line.

B) consumer is buying the combination of goods and services on the budget line and on the highest attainable indifference curve.

C) marginal rate of substitution is as small as possible.

D) marginal rate of substitution is as large as possible.

E) marginal rate of substitution exceeds the relative price of the two goods by as much as possible.

42) Luke enjoys eating tuna sashimi and drinking Pepsi. His consumer equilibrium occurs where his budget line

A) just touches the lowest indifference curve at one point.

B) just touches the highest indifference curve at one point.

C) touches every indifference curve.

D) is below every indifference curve.

E) More information about Luke's budget is needed to determine his consumer equilibrium.

 

43) The point where an indifference curve just touches the budget line at one point

A) is the best affordable point.

B) is where the marginal rate of substitution exceeds the relative price by as much as possible.

C) is a point on the consumer's supply of spending curve.

D) cannot be possible because indifference curves always cross the budget line at two points.

E) None of the above answers is correct.

 

44) In a budget line/indifference curve diagram, at the consumer's equilibrium at the best affordable point,

A) any movement upward or downward on the budget line will move the consumer to a less preferred point.

B) any movement to the northeast to higher indifference curves moves the consumer to a less preferred point.

C) the slope of the budget line exceeds the marginal rate of substitution by as much as possible.

D) the budget line has a positive slope and the indifference curve has a negative slope.

E) the budget line has a negative slope and the indifference curve has a positive slope.

45) If a person consumes only two goods, which of the following is NOT necessary for a consumer to be at his or her best affordable point of consumption?

A) The consumer chooses a bundle of goods that lies on his or her budget line.

B) The consumer is on his or her highest attainable indifference curve.

C) The consumer chooses equal amounts of both goods.

D) The marginal rate of substitution between the two goods is equal to the relative price of those two goods.

E) The indifference curve is tangent to the budget line.

 

46) If a consumer's marginal rate of substitution is greater than the relative price of the goods, the consumer is

A) at his or her best affordable point.

B) perhaps at his or her best affordable point.

C) not at his or her best affordable point and should move along his or her indifference curve to a higher budget line.

D) not at his or her best affordable point and should move along his or her budget line to a higher indifference curve.

E) More information is needed to determine if the consumer is or is not at his or her best affordable point.

 

47) At her best affordable point, Kris

i.is on her budget line.

ii.is on the highest attainable indifference curve.

iii.has a marginal rate of substitution equal to the relative price of the goods.

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

48) When Bo is at his best affordable consumption point, his marginal rate of substitution is

A) greater than the relative price.

B) equal to the relative price.

C) less than the relative price.

D) equal to one.

E) maximized.

 

49) A consumer's demand for tuna can be found from an indifference curve diagram by doing which of the following?

A) observing what happens to the consumption of tuna for different income levels

B) finding where the budget line is tangent to an indifference curve for one price of tuna

C) allowing the price of tuna to change and observing the different best, affordable levels of tuna

D) changing the indifference curves and seeing the changes in the quantity of tuna the consumer demands

E) It is impossible to derive a demand curve from an indifference curve graph.

 

50) Using Gabriel's budget line and his indifference curves between horseback riding lessons and baseball lessons, and then changing the prices of each activity holding his income constant, which of the following can be derived?

A) Gabriel's demand curve for each activity

B) Gabriel's supply curve for each activity

C) Gabriel's marginal benefit for each activity

D) Gabriel's net gain for each activity

E) Both answers A and B are correct.

 

 

 

default image
July 1, 2023
    

 

41) A consumer is in equilibrium when the

A) consumer is buying any combination of goods and services on his or her budget line.

B) consumer is buying the combination of goods and services on the budget line and on the highest attainable indifference curve.

C) marginal rate of substitution is as small as possible.

D) marginal rate of substitution is as large as possible.

E) marginal rate of substitution exceeds the relative price of the two goods by as much as possible.

42) Luke enjoys eating tuna sashimi and drinking Pepsi. His consumer equilibrium occurs where his budget line

A) just touches the lowest indifference curve at one point.

B) just touches the highest indifference curve at one point.

C) touches every indifference curve.

D) is below every indifference curve.

E) More information about Luke's budget is needed to determine his consumer equilibrium.

 

43) The point where an indifference curve just touches the budget line at one point

A) is the best affordable point.

B) is where the marginal rate of substitution exceeds the relative price by as much as possible.

C) is a point on the consumer's supply of spending curve.

D) cannot be possible because indifference curves always cross the budget line at two points.

E) None of the above answers is correct.

 

44) In a budget line/indifference curve diagram, at the consumer's equilibrium at the best affordable point,

A) any movement upward or downward on the budget line will move the consumer to a less preferred point.

B) any movement to the northeast to higher indifference curves moves the consumer to a less preferred point.

C) the slope of the budget line exceeds the marginal rate of substitution by as much as possible.

D) the budget line has a positive slope and the indifference curve has a negative slope.

E) the budget line has a negative slope and the indifference curve has a positive slope.

45) If a person consumes only two goods, which of the following is NOT necessary for a consumer to be at his or her best affordable point of consumption?

A) The consumer chooses a bundle of goods that lies on his or her budget line.

B) The consumer is on his or her highest attainable indifference curve.

C) The consumer chooses equal amounts of both goods.

D) The marginal rate of substitution between the two goods is equal to the relative price of those two goods.

E) The indifference curve is tangent to the budget line.

 

46) If a consumer's marginal rate of substitution is greater than the relative price of the goods, the consumer is

A) at his or her best affordable point.

B) perhaps at his or her best affordable point.

C) not at his or her best affordable point and should move along his or her indifference curve to a higher budget line.

D) not at his or her best affordable point and should move along his or her budget line to a higher indifference curve.

E) More information is needed to determine if the consumer is or is not at his or her best affordable point.

 

47) At her best affordable point, Kris

i.is on her budget line.

ii.is on the highest attainable indifference curve.

iii.has a marginal rate of substitution equal to the relative price of the goods.

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

48) When Bo is at his best affordable consumption point, his marginal rate of substitution is

A) greater than the relative price.

B) equal to the relative price.

C) less than the relative price.

D) equal to one.

E) maximized.

 

49) A consumer's demand for tuna can be found from an indifference curve diagram by doing which of the following?

A) observing what happens to the consumption of tuna for different income levels

B) finding where the budget line is tangent to an indifference curve for one price of tuna

C) allowing the price of tuna to change and observing the different best, affordable levels of tuna

D) changing the indifference curves and seeing the changes in the quantity of tuna the consumer demands

E) It is impossible to derive a demand curve from an indifference curve graph.

 

50) Using Gabriel's budget line and his indifference curves between horseback riding lessons and baseball lessons, and then changing the prices of each activity holding his income constant, which of the following can be derived?

A) Gabriel's demand curve for each activity

B) Gabriel's supply curve for each activity

C) Gabriel's marginal benefit for each activity

D) Gabriel's net gain for each activity

E) Both answers A and B are correct.

 

 

 

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