Engineering Economy

Practice Exam
1. In the Canadian tax system, the sale of an asset in a particular
asset class can simultaneously trigger a depreciation recapture
and a loss on disposal.
A) T B) F

2. For given demand and supply schedules, the market

equilibrium is always in a price interval in which demand is elastic
b
because th
the ttotal
t l consumer expenditure
dit in
i thi
this price
i range
decreases.
A) T B) F

3. When using the equivalent annual value criterion to compare

equipment alternatives, it is assumed that continuous replace-
ments are made for as long as the service of such equipment is
required.
A) T B) F
4. A capital gain occurs when a depreciable asset is sold for
more than its undepreciated balance at the time of sale
sale, but for
less than its purchase price.
A) T B) F

5. In the Canadian tax system, assets belonging to a particular

class depreciated by the declining-balance method are grouped
i t one common pooll and
into dddepreciated
i t d ttogether.
th

A) T B) F

6. The discounted payback period is superior to the payback

period because it considers the cash flows that occur beyond the
discounted capital recovery period.
A) T B) F
7. When using an integrated company basis of taxation in
project evaluation
evaluation, any excess of operating expenses and tax
allowances over a project's revenue in a particular year is
assumed to be fully absorbed by other taxable corporate income
of the company
company.
A) T B) F

8. A change
8 h iin supply
l tto hi
higher
h quantity
tit llevels
l iis reflected
fl t d bby a
vertical upward shift of the supply curve.
A) T B) F

9. The law of diminishing marginal returns states that

decreasing amounts of output will inevitably be obtained from
successive additions of equal amounts of variable input in a
system where fixed resources have achieved their optimum
efficiency.
A) T B) F
10. When using the capital tax factor on a capital expenditure, it
is assumed that depreciation allowances generated by that capital
expenditure can be fully absorbed (i.e. there is enough net
income before allowances and taxes) in the year in which they are
claimed.
claimed
A) T B) F

11. Cash
11 C h flflows th
thatt result
lt ffrom debt
d bt and
d equity
it fifinancing
i
transactions, including incurrence and repayment of debt,
cash inflows from the sale of stock, and cash outflows to
pay dividends or repurchase stock are called:

A) financing flows.
flows
B) operating flows.
C) investment flows.
D) monetary flows.
flows
E) none of the choices listed above.
12. The half-year rule in the Canadian tax system was
probabl implemented to
probably to:
A) discourage firms from acquiring depreciable assets at
year end to take advantage of the fact that a full
year-end full-year
year’s
s
depreciation could be claimed on those assets.
B) encourage the purchase of depreciable assets later in
the year.
th
C) satisfy political lobbyists.
D)) increase corporate
p tax savings
g resulting
g from the CCA.
E) none of the choices listed above.
13. Which one of the following is not tax-deductible?
A) Capital cost allowances
B) Interest charges
C) Preferred dividends
D) Issuing expenses on securities
E) Operating costs

14. When using the internal rate of return criterion to compare

projects, it is assumed that cash flows can be reinvested at
the:
A) cost of raising funds through equity sources (i.e. issuing
shares)
h )
B) cost of capital
C)) internal rate of return
D) prevailing interest rate
E) all of the choices listed above
15. If a firm were to shift towards a more leveraged capital
structure (i
(i.e.,
e use a greater proportion of debt in its capital
structure), its weighted-average cost of capital would:
A) remain unchanged.
B) decrease.
decrease
C) increase.
D) Not enough information to determine.
E) Firms
Fi should
h ld never shift
hift to
t a more leveraged
l d capital
it l structure.
t t

16. Liquidity and activity ratios rely most heavily on entries taken
from the:
A) income statement
B) balance sheet
C) statement of cash flow
D) statement of earned surplus
E) all of the financial statements listed above
17. If a negative pool balance occurs as a result of the
disposal of an asset in the Canadian ta
tax ssystem,
stem then a firm
firm:
A) can claim the balance as a tax deductible expense
B) must add that balance (as a positive amount) to its
taxable income
C) should sell all of the assets in that pool
D) can calculate
l l the
h CCA ffor the
h year using
i the
h negative
i
balance
E)) can use the negative
g balance as a loss for tax
purposes in subsequent years
The table below reports the average annual copper prices
o er the 1990
over 1990-2000
2000 period
period, along with
ith the Gross Domestic
Product implicit price index for the same period.

GDP Implicit
Copper Price
Year Price Index
(U.S. $/lb)
(1986=100)
1990 1.232 118.5
1991 1.093 121.9
1992 1.074 123.4
1993 0 916
0.916 124 7
124.7
1994 1.110 125.6
1995 1.383 127.5
1996 1 092
1.092 129 1
129.1
1997 1.069 130.7
1998 0.786 133.3
1999 0 759
0.759 133 9
133.9
2000 0.890 135.1
18. Determine the 1992 copper Copper Price
GDP Implicit
Year Price Index
price in constant money of the (U S $/lb)
(U.S.
(1986=100)
year 2000. 1990 1.232 118.5
1991 1.093 121.9
1992 1 074
1.074 123 4
123.4
1993 0.916 124.7
1994 1.110 125.6
1995 1.383 127.5
19. What was the average 1996 1.092 129.1
1997 1.069 130.7
annual compound rate of 1998 0.786 133.3
inflation over the 1990-2000
1990 2000 1999 0 759
0.759 133 9
133.9
period? 2000 0.890 135.1
20. What was the real average Copper Price
GDP Implicit
Year Price Index
annual compound rate of (U S $/lb)
(U.S.
(1986=100)
change in the copper price over 1990 1.232 118.5
the 1990-2000 period? 1991 1.093 121.9
1992 1 074
1.074 123 4
123.4
1993 0.916 124.7
1994 1.110 125.6
1995 1.383 127.5
1996 1.092 129.1
1997 1.069 130.7
1998 0.786 133.3
1999 0 759
0.759 133 9
133.9
2000 0.890 135.1
Use the financial statements below to answer questions 13 to 17.

BJL Incorporated
Income Statement for 1999
((‘000
000 000 $)

Net sales 1384

Less: Cost of goods sold 605
Less: Depreciation 180
Earnings before interest and taxes 599
Less: Interest on long-term debt 80
Taxable income 519
Less: Income taxes 156
Net income 363

Addition to retained earnings 254

Dividends paid 109
 BJL Incorporated
Balance Sheets at 12/31/98 and 12/31/99
(‘000 000 $)

1998 1999 1998 1999

Cash 100 121 Accounts payable 400 350
Accounts receivable 350 425 Notes payable 390 370
Inventory
y 440 410 Total 790 720
Total 890 956 Long-term debt 500 550
Shareholders’ equity
Net fixed assets 1556 1704 Common stock 600 580
Retained earnings 556 810
Total 1156 1390
Total Assets 2446 2660 Total Liab. & S.E. 2446 2660

Note: The long-term debt consists of bonds with a face value of $1000 each.
Additional bonds with the same face value were issued on the first day of
1999.
21. What was the firm's inventory turnover ratio?

A) (1.42)
B) 1.42
C) 1.47
D) 1.38
E) None of the choices given above
22. Determine the cash flow from financing activities for
1999 (in $ mil
mil.))

A) ($99)
B) $50
C) $30
D) $10
E) None of the choices given above
23. If the firm had 180 million shares of common stock
o tstanding at the end of 1999
outstanding 1999, what
hat was
as the dividend
di idend per
share?

A) $0.50
B) $0.61
C) $1.41
D) $1.83
E) $2.02
24. Determine the total uses of funds for 1999 (in $ mil.)
[consider appropriate income statement entries and changes
in all balance sheet accounts except the cash account].
A) $422
B) $623
C) $582
D) $602
E) None of the choices given above
WBM Corporation has been operating for 15 years. The company
was originally financed by issuing one million common shares at a
par value of $20 each. WBM’s capital structure is now composed
of the following:
Common Equity – 1 million shares outstanding, with a market
price of $40 per share, an expected dividend yield (D1/P) of 10 %
this y
year,, and an expected
p annual growth
g rate of 5.9 %.
Bonds – 10 000 bonds outstanding, with a face value of $1000
each, an annual coupon of 8 %, 12 years to maturity and a market
price
i off $1105 per b
bond.
d
WBM’s corporate income tax rate is 34 %.
25. WBM’s after-tax cost of common equity capital is:

A) 5.9 %
B) 10.0 %
C) 15.9%
D) 10.5 %
E) None of the choices given above.
26. WBM’s after-tax cost of debt capital is:

A) 4.2%
B) 6.7%
C) 8.0%
D) 4.4%
E) None of the choices given above.
27. Assuming before-tax costs of 8 % and 15 % for debt
and equity
eq it capital
capital, respecti
respectively,
el WBM’s after
after-tax
ta cost of
capital is:
A) 8.4
8 4%
B) 8.9 %
C) 11.8 %
D) 12 9 %
12.9
E) None of the choices given above.
28. Suppose that you purchase a stripped bond (i.e. a bond
that pays
pa s no interest beca
because
se it has been stripped of its
coupons) with a face value $1000 maturing in 20 years for
$214.55. If the yield to maturity on the bond remains
unchanged over its life, what will be its market value five
years from now?
A) $315.24
$315 24
B) $387.52
C)) $410.91
D) $680.58
E) $1000
29. You have to chose between two mutually exclusive projects with
cash flows as shown below. If y
you have unlimited funds and you
y require
q
a 14% return on investment, which project should you choose?

Project A B
Year Cash Flow Cash Flow
Time 0 -150 000 -120 000
1 50 000 72 000
2 90 000 50 000
3 70 000 40 000

A) Project B
B, because it has a smaller initial investment
investment.
B) Project A, because it has a higher NPV.
C) Either one, because they have the same life.
D) Project B
B, because it has a higher internal rate of return
return.
E) Project B, because it has a shorter payback period.
FS1. A project has the following specifications:
Preproduction period 2
Production period 5
Preproduction capital expenditures (mil. $)
Year 1 25
Year 2 40
Working capital 6
Projected annual revenues (mil. $) 60
Projected annual expenses (mil. $) 24
Projected
j salvage
g value ((mil. $)) 10
• Depreciation: SL at 20 % per year (do not use the half-year rule)
• Project basis of taxation in which depreciation cannot be used to create
a loss
• Income tax rate: 40 %
• Any gain (loss) on disposal of an asset is taxed (written off) in the year
of disposal

Determine the project’s cash flow in production year 5.

FS2. Cinch Corporation plans to purchase an asset worth $10 000
to reduce its variable costs of production by $5000 in each of years
1 and 2, and by $6000 in each of years 3 and 4. Although straight-
line depreciation over a 4-year useful life using a salvage of $5000
is suitable for accounting purposes
purposes, declining-balance
declining balance depreciation
(with the half-year rule) at an annual rate of 30% is applicable for
tax purposes. Cinch is subject to a corporate income tax rate of 40
percent and requires an 11 % return on investment
investment. Compute the
payback period associated with this investment project.
FS3. Your firm needs a computerized line-boring machine
that costs $100 000
000, requires $20 000 of annual operating
and maintenance expenses over its three-year life, and has a
salvage value of $25 000. The machine is a Class 10 asset
qualifying
lif i ffor a CCA ratet off 30 % per year on a d
declining-
li i
balance basis. The corporate income tax rate is 34 % and
the cost of capital
p is 10 %.

1. Determine the annual after-tax operating and maintenance

expenses.
2. Determine the after-tax salvage value.
At the final exam…
• Pay attention to the terminology.
• Use common sense in judging the validity of your results.
• Record your name and code your ID and checkbits on the computer
answer sheet.
• Record your name and ID on the exam paper.
• Circle your multiple choice question answers on the exam paper
and code them on the computer answer sheet.
• Record yyour full-solution pproblem answers in the boxes.

The TAs and

Professors Jassim and Bilodeau
wish you success !!!