# UB MGF 401 - MGF301_Test_2_-_Fall_2008_Version_II (6 pages)

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## MGF301_Test_2_-_Fall_2008_Version_II

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- Pages:
- 6
- School:
- University at Buffalo, The State University of New York
- Course:
- Mgf 401 - Financial Institutions

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Name Student Number TEST 2 MGF 301 Corporation Finance Fall 2008 Please sign name in box Please tear off the answer sheet and answer all of the following questions on the answer sheet Note Total Points 100 Multiple Choice 4 points each unless otherwise indicated 1 Stocks A B C have the following historical standard deviations A 25 B 35 C 20 In 2007 the stocks had the following returns rA 12 rB 05 rC 15 Which of the stocks had the highest E r in the beginning of 2007 a B b C c A d more information is required to answer this question 2 ABC stock sells today for 20 You expect that one year from now one of three outcomes will occur with the following probabilities and prices there is a 20 chance P 10 a 40 chance P 20 and a 40 chance P 30 What is the expected return on the stock over the next year if you invest today Show your work 8 points 3 If markets follow the semi strong form of efficient market theory which is true a as long as there is a quick initial movement in price there is no violation of the theory if the price returns to where it started by the end of the first trading day b the price of a stock will not change unless new information is announced c if stock prices are slow to react to the announcement of information the theory is violated d all of the above are true 4 The cash flows for a project are as follows initial cost of 1 000 000 C1 200 000 C2 500 000 C3 600 000 C4 2 000 000 C5 10 000 000 If the company uses the payback method with a three year payback which of the following is true a The company will reject the project under the payback method even though it most likely has a positive NPV b The company should accept the project because it pays back within 3 years c The company cannot calculate the payback period in this case d None of the above is true Name Student Number 5 7 You have purchased a portfolio of equal investments in 4 stocks X Y W Z that have the following s W 2 X 1 5 Y 1 Z 5 5 Calculate the portfolio Show your calculation 6 points 6 If E Rm 11 and rf 2 what is the expected return on your portfolio in question 3 above Show your calculation 6 points 7 Have you reduced any risk by combining the 4 stocks above into a portfolio a No because the of the portfolio represents market risk and this type of risk cannot be diversified b No because all stocks have risk and you can only reduce risk by adding a bond c Yes because each individual stock will cancel out some of the unique risks in the other stocks d Yes because the portfolio will now have a 75 8 Which of the following is most likely to represent a cash flow that should be taken into account for capital budgeting analysis of a new product a The cost of developing the new product over the last two years b The new project s share of the CEO s salary c The depreciation expense charged under generally accepted accounting principals GAAP d The increased revenue expected from an existing product related to the new product 9 Mark each statement about capital budgeting as true or false 2 points each a To find the payback period under the payback method you must first know the discount rate b The time value of money is included in the NPV analysis by discounting future cash flows to the present c If you are choosing between two mutually exclusive projects the IRR method can lead to choosing the project with the lower NPV 2 Name Student Number d The IRR method ignores cash flows after the required payback period 10 A proposed investment will cost 60 000 in year 0 It will have a life of 5 years and the cost will be depreciated using straight line to a zero salvage value For year 1 the company expects sales of 20 000 units at 7 each The variable cost is 3 per unit and the fixed costs will be 35 000 Working capital in year 0 is 10 000 and this increases to 12 000 in year 1 If taxes are 35 what is the incremental cash flow for year 1 Show your calculation 8 points 11 In question 6 which of the following formulas gives the accounting break even point a 60 000 20 000 7 3 b 12 000 35 000 7 3 c 20 000 60 000 7 d 35 000 12 000 3 12 An investment project costs 1 200 000 in time 0 and has the following payouts C1 250 000 C2 300 000 C3 600 000 C4 800 000 and C5 900 000 a Set up the formula for calculating the IRR in as much detail as possible Note you do not have to actually solve for the answer 6 points b Describe i how you would modify your answer in part a to calculate the NPV and ii the rule you would use to accept or reject under the NPV 6 points 13 Which of the following is true about the NPV method of capital budgeting a NPV is flawed because it ignores cash flows after the cut off b A project with a positive NPV will increase firm value c Sensitivity analysis is a way to determine how bad things can be if several things go wrong with the project at the same time d None of the above is true 3 Name Student Number 14 You purchased a stock for 30 per share one year ago During the year the stock paid a 2 dividend per share and the stock price is now 26 per share Calculate the actual return or percentage return on your investment over the last year Show your calculation 6 points 15 AGG Inc s earnings are not very dependent on the economy They have stable earnings regardless of whether the economy is booming or not Which is true about the company a an investor in the company can diversify some of the company s overall risk b the company has a greater than 1 c the company has no unique risk d the company has high market risk 16 If markets follow semi strong form efficiency which of the following is the best strategy for choosing stocks a choosing stocks whose ticker symbols are the same as your friends and families initials b picking stocks based on past results i e picking stocks that have outperformed the market c performing careful research on the companies you select d all of the above have the same chance of beating the market 17 A company is replacing its main product with an updated version This is a big gamble for the company because the new product will either be a big hit or a …

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