finance data bank

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.

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