MGF 301 Exam 2

Topics: Net present value, Fundamental analysis, Interest Pages: 9 (1861 words) Published: April 14, 2014
TEST 2
MGF 301 Corporation Finance
Fall 2013
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(Note: Total Points = 100; Multiple Choice = 4 points each unless otherwise indicated)

1. YT Inc. is considering implementing a new project. Which of the following is a cash flow that should be taken into account for capital budgeting purposes? (a) Expected lost sales in a related YT Inc. product caused by the new product

(b) The annual bonus paid to the YT Inc. President based on last year's earnings (c) Development costs for the project that the company has paid over the last two years
(d) None of the above should be taken into account

2. Anthony has earned actual returns of -4% in 2010, -12% in 2011 and -3% in 2012 on an investment he made three years ago. If the risk-free rate has been 1% over the last three years, what is a good estimate of the annual E(r) Anthony expected at the beginning of 2010? Explain. (6 points)

As there were losses in three straight years, this investment definitely has some risk to it. So it must have an E(r) that is greater than the risk-free rate because no one would enter a risky investment if the E(r ) was negative or less than what they could earn guaranteed with no risk (which is the risk-free rate). As for whether the E(r ) is 5% or 15%, there is no way to tell from the data, but it should be significantly above Rf.

3. If markets follow the semi-strong form of efficient market theory, which is true?
(a)market prices should quickly reflect all private information
(b)stock prices will only increase when there is news that is publicly announced
(c)if stock prices over-react to the announcement of information, there is no violation of the theory as long as the price returns to its initial level
(d)all of the above are true
Note: none of the answers is true here which is not one of the choices

4. Mark each statement about capital budgeting as true or false. (2 points each)

a.__F_The Payback method includes the time value of money because it uses a discount rate b.__T_In sensitivity analysis, one assumption at a time is changed to see the effect on NPV

c.__F_The NPV and IRR always give the same answer in terms of which project to select

5. If the Neptune Company has β = .8, which is true?
(a) E(Ri) = E(RM)
(b) E(Ri) > E(RM)
(c) E(Ri) < E(RM)
(d) cannot be determined
6 Your uncle runs an investment fund that has earned an average of 2% more than the S&P500 over the last 10 years. He tells you that markets are not efficient and offers his success as proof. Based on concepts we discussed in class, describe how his results could be consistent with the semi-strong form of market efficiency. Explain (6 points)

If my uncle’s portfolio outperformed the S&P500 by an average of 2% a year over a 10 year period, this appears to violate the semi-strong form of market efficiency because he should not be able to beat the market by using public information. But there are two ways this result could be consistent with the theory: the first is that my uncle may have chosen a portfolio with an average beta >1 which would then have an E(r) greater than E(Rm) and should lead to him outperforming the market. The other way this is consistent is to note that he can beat the market just by pure luck even if he has no ability to pick winning stocks. In an efficient market, at any time half the traders will be expected to beat the market and half will be expected to earn less than the market. So if someone was extra lucky over 10 years, this does not violate the theory.

7.Jon is conducting a capital budgeting analysis using NPV for a major expansion of his company. He wants to increase the chances on having his project accepted because it will likely mean a promotion for him. Jon has decided that he will use a discount rate that is too high to increase the NPV and make his project more attractive to management. Is this a correct approach to...
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