Financial Management Practice Problems

This article contains practice problems on various topics related to financial management such as cost of debt, cost of equity, NPV, IRR, payback period, and more. Each problem comes with step-by-step solutions and explanations.

1. LL Incorporated's currently outstanding 7% coupon bonds have a yield to maturity of 14%. LL
believes it could issue new bonds at par that would provide a similar yield to maturity. If its
marginal tax rate is 35%, what is LL's after-tax cost of debt? Round your answer to two decimal
places.2.
2. Summerdahl Resor t's common stock is currently trading at $39.00 a share. The stock is
expected to pay a dividend of $1.25 a share at the end of the year (D1 = $1.25), and the
dividend is expected to grow at a constant rate of 5% a year. What is the cost of common
equity? Round your answer to two decimal places.
3. Booher Book Stores has a beta of 0.7. The yield on a 3-month T-bill is 3% and the yield on a
10-year T-bond is 8%. The market risk premium is 4.5%, and the return on an average stock in
the market last year was 12.5%. What is the estimated cost of common equity using the
CAPM? Round your answer to two decimal places.
4. David Ortiz Motors has a target capital structure of 45% debt and 55% equity. The yield to
maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%.
Ortiz's CFO has calculated the company's WACC as 8.58%. What is the company's cost of
equity capital? Round your answer to two decimal places.
5. A project has an initial cost of $36,525, expected net cash inflows of $12,000 per year for 12
years, and a cost of capital of 13%. What is the project's NPV? (Hint: Begin by constructing a
time line.) Do not round your intermediate calculations. Round your answer to the nearest
cent.
6. A project has an initial cost of $60,000, expected net cash inflows of $14,000 per year for 9
years, and a cost of capital of 14%. What is the project's IRR? Round your answer to two
decimal places.
7. A project has an initial cost of $60,575, expected net cash inflows of $14,000 per year for 7
years, and a cost of capital of 14%. What is the project's MIRR? Do not round intermediate
calculations. Round your answer to two decimal places.
8. A project has an initial cost of $36,475, expected net cash inflows of $9,000 per year for 12
years, and a cost of capital of 8%. What is the project's PI? Do not round your intermediate
calculations. Round your answer to two decimal places.
9. A project has an initial cost of $45,975, expected net cash inflows of $13,000 per year for 9
years, and a cost of capital of 12%. What is the project's payback period? Round your answer
to two decimal places.
10. A project has an initial cost of $60,000, expected net cash inflows of $14,000 per year for 7
years, and a cost of capital of 13%. What is the project's discounted payback period? Round
your answer to two decimal places.
11. Edelman Engineering is considering including two pieces of equipment, a truck and an
overhead pulley system, in this year's capital budget. The projects are independent. The cash
outlay for the truck is $17,100 and that for the pulley system is $22,430. The firm's cost of
capital is 14%. After-tax cash flows, including depreciation, are as follows:
Year Truck Pulley
1 $5,100 $7,500
2 5,100 7,500

3 5,100 7,500
4 5,100 7,500
5 5,100 7,500
a. Calculate the IRR for each project. Round your answers to two decimal places.
Truck: %
What is the correct accept/reject decision for this project?
Pulley: %
What is the correct accept/reject decision for this project?
b. Calculate the NPV for each project. Round your answers to the nearest dollar, if necessary.
Enter each answer as a whole number. For example, do not enter 1,000,000 as 1 million.
Truck: $
What is the correct accept/reject decision for this project?
Pulley: $
What is the correct accept/reject decision for this project?
c. Calculate the MIRR for each project. Round your answers to two decimal places.
Truck: %
What is the correct accept/reject decision for this project?
Pulley: %
15
Accept Item 2
20%
Accept Item 4
408.71
Accept Item 6
3318.11
Accept Item 8
15
Accept Item 10
17

What is the correct accept/reject decision for this project?
12. Talbot Industries is considering launching a new product. The new manufacturing equipment
will cost $8 million, and production and sales will require an initial $2 million investment in net
operating working capital. The company's tax rate is 30%.
a. What is the initial investment outlay? Write out your answer completely. For example, 2
million should be entered as 2,000,000.
$
b. The company spent and expensed $150,000 on research related to the new project last
year. Would this change your answer?
c. Rather than build a new manufacturing facility, the company plans to install the equipment
in a building it owns but is not now using. The building could be sold for $1.5 million
aftertaxes and real estate commissions. How would this affect your answer?
The project's cost will .
13. The financial staff of Cairn Communications has identified the following information for the first
year of the roll-out of its new proposed service:
Projected sales $25 million
Operating costs (not including
depreciation)
$10 million
Depreciation $6 million
Interest expense $5 million
The company faces a 40% tax rate. What is the project's operating cash flow for the first year
(t = 1)? Write out your answer completely. For example, 2 million should be entered as
2,000,000.
$
14. Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally
cost $17 million, of which 70% has been depreciated. The used equipment can be sold today
for $5.95 million, and its tax rate is 35%. What is the equipment's after-tax net salvage value?
Write out your answer completely. For example, 2 million should be entered as 2,000,000.
$
15. Although the Chen Company's milling machine is old, it is still in relatively good working order
and would last for another 10 years. It is inefficient compared to modern standards, though,
and so the company is considering replacing it. The new milling machine, at a cost of $40,000
delivered and installed, would also last for 10 years and would produce after-tax cash flows
(labor savings and depreciation tax savings) of $8,900 per year. It would have zero salvage
Accept
10000000
No Item 2
decrease Item 3
8400000
5652500

value at the end of its life. The Project cost of capital is 11%, and its marginal tax rate is 35%.
Should Chen buy the new machine?
16. The Campbell Company is considering adding a robotic paint sprayer to its production line. The
sprayer's base price is $1,100,000, and it would cost another $19,500 to install it. The machine
falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%,
44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $617,000. The machine
would require an increase in net working capital (inventory) of $16,000. The sprayer would not
change revenues, but it is expected to save the firm $478,000 per year in before-tax operating
costs, mainly labor. Campbell's marginal tax rate is 35%.
a. What is the Year 0 net cash flow?
$
b. What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate
calculations. Round your answers to the nearest dollar.
Year 1
$
Year 2
$
Year 3
$
c. What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working
capital)? Do not round intermediate calculations. Round your answer to the nearest dollar.
$
d. If the project's cost of capital is 11 %, what is the NPV of the project? Do not round
intermediate calculations. Round your answer to the nearest dollar.
$
Should the machine be purchased?
17. Broussard Skateboard's sales are expected to increase by 20% from $7.6 million in 2016 to
$9.12 million in 2017. Its assets totaled $5 million at the end of 2016. Broussard is already at
full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016,
current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of
notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 4%,
and the forecasted payout ratio is 60%. Use the AFN equation to forecast Broussard's
additional funds needed for the coming year. Round your answer to the nearest dollar. Do not
round intermediate calculations.
Yes Item 1
1135500
441295
484866
368729
590084
356667
Yes

$
18. Broussard Skateboard's sales are expected to increase by 25% from $8.8 million in 2016 to
$11.00 million in 2017. Its assets totaled $5 million at the end of 2016. Broussard is already at
full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016,
current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of
notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 7%,
and the forecasted payout ratio is 60%. What would be the additional funds needed? Do not
round intermediate calculations. Round your answer to the nearest dollar.
$
Assume that an otherwise identical firm had $6 million in total assets at the end of 2016. Broussard's
capital intensity ratio (A0*/S0) is than the otherwise identical firm;
therefore, Broussard is capital intensive - it would
require increase in total assets to support the increase in sales.
795680
563,000
low er than Item 2
less Item 3
a smaller Item 4