# UB MGF 401 - MGF301_Test_2_-_Fall_2010_-_Version_I_ (7 pages)

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## MGF301_Test_2_-_Fall_2010_-_Version_I_

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- Pages:
- 7
- School:
- University at Buffalo, The State University of New York
- Course:
- Mgf 401 - Financial Institutions

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Name MGF 301 Corporation Finance Fall 2010 Student Number TEST 2 Version I 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 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 account 2 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 uses 3 Halle put 10 000 into a fund run by a professional manager three years ago at 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 10 000 2009 9 500 2010 Mark 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 even Name Student Number 4 AGG Inc s earnings are very dependent on the economy They have high earnings when the economy 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 less than 1 d none of the above 5 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 budgeting c 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 determined 7 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 2 Name Student Number 8 If 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 above 11 Using CAPM the following have been calculated Stock A B E r 12 11 30 32 How 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 3 Name 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 above 14 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 IRR generally requires a trial and error solution b the IRR always gives the same acceptance decision as CAPM c NPV is generally preferred to other methods of capital budgeting d …

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