Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation Finance Version IFall 2010 Please sign name in boxPlease 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)1. The following arise out of a new project implemented by YT Inc. Which of the following does not represent a cash flow that should be taken into account for capital budgeting purposes? (a) an increase in overall company sales because of the project(b) a decrease in income taxes paid to the government because of the project(c) allocation of existing overhead expenses to the project(d) all of the above should be taken into account2. Jon is conducting a capital budgeting analysis using NPV for a major expansion of his company. He is concerned because there is a lot of uncertainty about what the market conditions will be for his product the next few years. Jon has decided to decrease all of his revenue estimates because of the high risk of a bad outcome. Is this the correct way to handle uncertainty in an NPV analysis?(a) No, because increased uncertainty is accounted for in an NPV analysis through a higher discount rate(b) No, because uncertainty about estimates is not important to capital budgeting decisions(c) Yes, NPV analysis requires the use of cash flows adjusted downward for risk(d) Jon will get the same NPV regardless of the cash flows he uses3. Halle put $10,000 into a fund run by a professional manager three years agoat the end of 2007. Jason, the professional manager, uses public information and his 30 years of experience to try and pick winning stocks. Halle's investment balance at the end of each year is as follows:2007 = $10,000 2008 = $8,000 2009 = $9,500 2010 = $10,000Mark each statement below as (T)rue or (F)alse. (2 points each) a.___ After three years, Halle ended up with the same amount she started with so the E(r) of joining this fund in 2007 must have been 0 b.___Halle has decided to fire Jason and buy stocks herself by throwing darts at a list of companies. If stocks follow the semi-strong form of market efficiency theory, then Halle would be expected to have as much success in picking winning stocks as Jason c.___ There is very little risk in Halle's investment the last three years because she ended up breaking evenName_________________________________ Student Number___________________________________4. AGG Inc.’s earnings are very dependent on the economy. They have high earnings when theeconomy is booming and large losses in recessions. Which is true about the AGG? (a) the company has high market risk(b) the company has no unique risk(c) the company has a β less than 1(d) none of the above5. Mark each statement about capital budgeting as true or false. (2 points each) a.___A discount rate is required in each of the NPV, payback and IRR methods of capital budgeting b.___The time value of money is an important consideration in each of the NPV, payback and IRR methods of capital budgetingc.___ NPV, payback and IRR each has a different decision rule for deciding whether to accept a project 6. Using the same assumptions for Rf and E(Rm), an analyst has used CAPM to calculate the E(r) of four stocks: stock A has E(r)= 10%; stock B has E(r)= 8%; stock C has E(r)=11%; and Stock D has E(r)=7%. Which stock must have the higher beta? (a) Stock D(b) All four stocks have the same beta because the analyst used the same estimates for Rf and E(Rm)(c) Stock C(d) Cannot be determined7. A project costs $2 million (time 0). The expected cash flows are $300,000 per year for 10 years (time periods 1-10). The discount rate is 8%(a) If the payback cutoff set by management is 7 years, should we accept the project under the payback method? Calculate and Explain your answer. (6 points)(b) If the annuity factor for 10 years at 8% is 6.710, should we accept the project under the NPV method? Calculate and Explain your answer. (6 points)(c) Write out the calculation you would do to find the IRR for the project (you do not need to solve it) and explain how you would decide whether to accept the project under the IRR. (6 points)2Name_________________________________ Student Number___________________________________8. If β = 1.5 for company JKL, and the market was down by 10% last year, which of the following is the most likely actual return earned by investors in JKL last year? (a) -15%(b) -10% (c) 0% (d) +10% 9. A proposed investment will cost $1,500,000 in year 0. It will have a life of 5 years. The cost will be depreciated straight-line to a zero salvage value, and will be worthless after 5 years. For each year 1-5, the revenues from the project will be $5,000,000 per year, the fixed costs will be $2,000,000 and the variable costs will be $2,000,000. Working capital requirements are $100,000 in time 0 and $300,000 in time 1. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (10 points)10. In question 9, if the variable margin for each unit is $4, which formula gives the accounting break-even point? (a) 1,500,000/4 (b) (300,000 + 2,000,000)/4 (c) (100,000 + 2,000,000)/2,000,000 (d) none of the above11. Using CAPM, the following have been calculated:Stock E(r) σ A 12% .30 B 11% .32How is it possible that B has higher total risk but lower E(r) than A? Explain. (6 points)12. In time 1, ABC was selling for $24. In time 0, the investor bought ABC for $32. If a dividend of$1 was paid in time 1, calculate the actual return of ABC from time 0 to time 1. (6 points) 3Name_________________________________ Student Number___________________________________13. Scenario analysis is useful to NPV calculations because(a) It can show where there are mistakes in the calculation(b) It can show which individual assumptions are the most crucial (c) It can show how bad things will be if many things go wrong at the same time(d) None of the above14. Your friend has noticed that whenever a company announces that it is laying off more than 5% of its workforce, the stock price goes down on the day of the announcement, but then recovers half of this decrease over the next week. Does this violate the semi-strong form of market efficiency theory? Explain. (6 points)15. Which of the following is not true about capital budgeting methods?(a) the