MIME 310 ENGINEERING ECONOMY CLASS TEST

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1 FAMILY NAME / INITIAL STUDENT ID # S O L U T I O N S MIME 310 ENGINEERING ECONOMY CLASS TEST 25 May, :30 to 10:30 Part 1. Multiple-choice Statements Circle the correct answer on this paper and record it on the computer answer sheet. (3 points each for a total of 15) Note: There are no penalties for incorrect answers. 1. If you are willing to pay $20 for a shirt but you only have to pay the market price of $16, the $4 difference is: A) your consumer surplus. B) the producer s deficit. C) your consumer deficit. D) the producer s surplus. E) None of the choices listed above 2. Which one of the following statements is true about the differences between long-term debt and common stock? A) Long-term debt is ownership in a firm but equity is not. B) Creditors have voting power while stockholders do not. C) Periodic payments associated with either class of security are tax deductible for the issuer. D) Interest payments on long-term debt are promised while dividend payments are not. E) Bondholders can also own equity, but not vice versa. 3. In a total production cost function, if the marginal cost is above the average cost at a particular production rate, then the production of one additional unit will cause the: A) average cost to increase. B) average cost to remain unchanged. C) marginal cost to decrease. D) marginal cost to remain unchanged. E) average cost to decrease. 4. In a statement of cash flow, which one of the following elements would be considered a use of funds? A) An increase in fixed assets at cost B) An increase in retained earnings C) A decrease in accounts receivables D) An increase in accounts payable E) An increase in long-term debt

2 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page 2 5. The present value ratio (PVR) rule can be stated as: A) A project is acceptable if its PVR is greater than zero. B) A project is acceptable if its PVR is greater than one. C) A project is acceptable if its PVR is greater than the internal rate of return. D) A project is acceptable if its PVR is less than the net present value. is acceptable. Part 2. Multiple-choice Problems Circle the correct answer on this paper and record it on the computer answer sheet. (4 points each for a total of 72) Note: There are no penalties for incorrect answers. Use the following information to answer questions 6 to 8. An asset costs $ and has an estimated salvage value of $5000 at the end of a useful life of 5 years. 6. Using the straight-line method to depreciate the asset over its useful life, the depreciation charge for tax purposes in the third year of ownership of the asset is: A) $5000 B) $6000 C) $ The salvage value is ignored when depreciating for tax purposes. DC = / 5 = 6000 D) Cannot determine depreciation charge without annual depreciation rate 7. Using the declining-balance method with an annual depreciation rate of 20 percent, the book value of the asset after three years of ownership is: A) $3840 B) $ C) $ BV 3 = (1-0.2) 3 = D) $ Using the sum-of-the-years -digits method and assuming a constant annual production rate, the depreciation charge for accounting purposes in the second year of ownership of the asset is: A) $6667 B) $8000 C) $ Sum-of-the-years -digits: = 15 DC 2 = ( ) (4 / 15) = D) Cannot determine depreciation charge without annual depreciation rate

3 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page 3 9. The production cost function of a firm is given by: TC = R - 4 R R 3 in which TC is the total annual production cost in thousands of dollars and R, the annual production rate in thousands of units. The average production costs at a production rate of units per year is: A) $0.6 For production rate of , R=10 B) $20 C) $37 TC = (10) - 4 (100) (1000) = 370 D) $ AC = 370 / 10 = 37 E) None of the choices listed above Use the financial statements shown below to answer questions 10 to 13. Marble Comics Group Year-end Balance Sheets ($ millions) Cash Accounts payable Accounts receivable Notes payable Inventory Current liabilities Current assets Long-term debt Net fixed assets Common stock Retained earnings Total Assets Total Liab. & S. Equity Income Statement for 1999 ($ millions) Net sales 905 Less: Cost of goods sold522 Less: General & admin. expenses 93 Less: Depreciation 110 EBIT 180 Less: Interest on long-term debt 61 Earnings before taxes 119 Less: Taxes 30 Net income 89 Dividends paid 56 Addition to retained earnings Marble Comics' debt ratio at the end of 1999 is: A) 0.46 B) 0.70 Debt ratio: Liabilities / Liabilities + Shareholders Equity C) 0.74 D) 0.89 ( ) / ( ) = E) 2.28

4 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page Marble Comics profit margin for 1999 is: A) 3.6 % B) 9.8 % C) 13.1 % D) 19.9 % E) 22.3 % Profit margin: EBIT / Sales 180 / 905 = Marble Comics' return on equity for 1999 is: A) 6.2 % B) 20.5 % C) 21.3 % D) 22.1 % E) % Return on equity: Net income / Average common shareholders equity 89 / [ ( ) + ( ) ] / 2 = If you were to prepare a statement of cash flow for 1999, what is the cash flow from investment activities? A) ($175) B) $0 C) ($102) D) $102 Cash flow from investment activities: Change in net fixed assets + Depreciation ( ) = 212 (investment, therefore negative) 14. A firm s total cost function is given by: TC = Q + 2 Q 2 in which TC is the total annual production cots in dollars and Q, the number of cases of widgets produced per year. The production rate that minimizes the average cost, and the average cost at that rate are, respectively: A) 7.5 and $ B) 300 and $ C) and $ D) 300 and $1230 E) None of the choices listed above 15. The present value (at t=0) of the following stream of monetary flows (MF) is $ when discounted at 12 % per period. What is the value of the missing cash flow at t=2? MF $0 $1000? $2000 $ Time AC = / Q Q To minimize AC set dac/dq to 0 and solve for Q dac/dq = / Q Q = 300 Q 2 = / 2 = At Q=300, AC = / (300) = 1230 A) $979 B) $1691 C) $2392 D) $3000 E) $3422 Summation of PVs at t=0 of MFs at t=0,1,3 and 4: / / / = MF 2 = ( ) =

5 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page 5 The following information applies to questions 16 to 21. Floyd Clymer is the CFO of Bonavista Mustang, a parts manufacturer for classic automobiles. Floyd is considering the purchase of a two-tonne press designed to stamp out auto fenders. The equipment costs $ and will last for 5 years. The project is expected to produce an operating cash flow of $ over the first year, increasing by $ annually to reach $ in year 5. Liquidation of the equipment will bring the firm $ at the end of five years, thus producing a cash flow of $ in that year. Bonavista requires a 15 % return on investment. 16. What is the project s payback period? A) 2.0 years B) 2.4 years C) 3.0 years D) 3.4 years E) The investment is not paid back. Time CF Cum. + CF PP: 3 + (40 / 90) = 3.44 years 17. What is the project s internal rate of return? A) 2.1 % B) 15.0 % Using the cash flow worksheet in the BA II Plus, C) 16.4 % CPT IRR % D) 17.1 % E) 32.1 % 18. What is the project's profitability index? A) 0.98 B) 1.01 C) 1.06 D) 1.12 E) 1.28 Using the cash flow worksheet in the BA II Plus, CPT NPV with i=15% PI: ( / ) + 1 = Assuming that the liquidation of the equipment at the end of five years would net the firm $ , rather than $10 000, what would be the project s payback period? A) 2.0 years B) 2.4 years C) 3.0 years D) 3.4 years E) The investment doesn't pay back The salvage value only affects the cash flow in year 5. Thus, the payback period, which is less than 5 years, does not change. 20. Given that the required return on investment is 15 %, what is the project's discounted payback period? A) less than 2 years Discounted cash 15%: , , , , and B) less than 3 years Cumulative discounted cash flows: C) less than 4 years , , , , and D) less than 5 years DPP: 4 + ( / ) = 4.75 years E) Longer than the project's life

6 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page Given that the required return on investment is 15 %, what is the project's net present value? A) The NPV is negative B) $ C) $ D) $ E) $ Discounted cash 15%: , , , , and Cumulative discounted cash flows: , , , , and An analyst has obtained the following information about the Velo Co.: book value of total assets, $27 000; book value of common equity, $10 000; book value of preferred stock, $5000; book value of current liabilities, $2000. The company has 4000 common shares outstanding which are currently trading at $5 per share, and 3000 preferred shares currently trading at $2 per share. The yield to maturity on the long-term debt equals the coupon rate. The weights for common equity, preferred equity and long-term debt, used to determine the firm s weighted-average cost of capital are, respectively: A) 55.5 %; 16.7 % and 27.8 % B) 40 %; 20 % and 40 % C) 80 %; 10 % and 10 % D) 62.2 %, 14.5 % and 23.3 % E) Cannot be determined because the market value of debt is required. 23. The Oolong Tea Company has just paid a dividend of $3 per share. The dividends are expected to grow at a rate of 4 % per year forever. The current market price of the stock is $25 per share. The firm s corporate tax rate is 40 % and issuing expenses on new stock issues are 5 % of market price. The cost of equity for new funds is: A) 9.89 % B) % C) % D) % NP: (0.05) (1 0.4) = Ke: 3 (1.04) / = 16.87% Market values Common: 4000 (5) = QUESTION 22 Preferred: 3000 (2) = 6000 Book value Debt: = Since YTM on bonds equals coupon rate, market value equals book value. Total market value: = Weights Common: / = 55.56% Preferred: 6000 / = 16.67% Debt: / = 27.78%

7 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page 7 Part 3. Full-solution Problem For full marks, show your full solutions on the lines provided and write your answers in the boxes. Write legibly, otherwise your solution will NOT be corrected. 24. A firm is considering the purchase of new manufacturing equipment with a cost of $ , a useful life of 3 years and an estimated salvage value of $ The equipment s annual operating expenses will amount to $50 000, $ and $ in years 1, 2 and 3, respectively. Given a cost of capital of 14 percent, determine the minimum annual benefit required to justify the purchase of the equipment. (13 points) (V2: $ cost, and $60 000, $ and $ operating expenses) Annualised net capital expenditure: VERSION 1 With PV= , SV= , N=3 and I/Y=14%, CPT PMT PV of operating expenses: / / / = Annualised operating expenses: With PV= , N=3 and I/Y=14%, CPT PMT Minimum annual benefit = = Annualised net capital expenditure: VERSION 2 With PV= , SV= , N=3 and I/Y=14%, CPT PMT PV of operating expenses: / / / = Annualised operating expenses: With PV= , N=3 and I/Y=14%, CPT PMT Minimum annual benefit = = ANSWER $ THIS IS THE LAST PAGE OF THE TEST PAPER

8 MIME 310 ENGINEERING ECONOMY CLASS TEST Monday, 25 May, :30 to 10:30 Page 8 Answer Key for Version #2 1. B 2. E 3. B 4. B 5. B 6. C 7. D 8. B 9. D 10. C 11. E 12. D 13. A 14. C 15. E 16. A 17. E 18. D 19. A 20. A 21. E 22. D 23. B

MULTIPLE-CHOICE QUESTIONS Circle the correct answers on this test paper and record them on the computer answer sheet.

MULTIPLE-CHOICE QUESTIONS Circle the correct answers on this test paper and record them on the computer answer sheet. #18: /10 #19: /15 Total: /25 VERSION 1 M I M E 3 1 0 E N G I N E E R I N G E C O N O M Y Class Test #1 Wednesday, 13 February, 2008 90 minutes PRINT your family name / initial and record your student ID