Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceSpring 2008 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 unless otherwise indicated)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) A decrease in required inventory levels(b) An increase in income taxes paid to the government(c) Labor costs to run the new machinery for the project(d) All of the above should be taken into account2. Anthony has earned actual returns of -5%, -10% and 2% the last three years on an investment he made three years ago. Which of the following must be true about the expected return on this investment? (a) E(r) > Rf(b) E(r) < Rf(c) E(r) = Rf(d) E(r) < 0 3. You currently own only a single stock that has β = 1.5. If you form a portfolio by buying another stock with β = 1.5, are you reducing the expected level of market risk in your portfolio? (a) No, because the portfolio still has a β = 1.5(b) No, because all stocks have risk and you can only reduce risk by adding a bond(c) Yes, because the second stock will cancel out some of the variation in the first stock(d) Yes, because the portfolio will now have a β = .754. Mark each statement about capital budgeting as true or false. (2 points each) a.___If a project has negative cash flows in time periods 0, 1 and 2, then there is no way to calculate the NPVb.___The time value of money is included in the IRR analysis by discounting future cash flows to the presentc.___The Payback method ignores cash flows after the required payback periodd.___To find the IRR, you must first know the discount rate5. If markets follow the semi-strong form of efficient market theory, which is not true? (a) market prices should quickly reflect all public information(b) stock prices will only increase when there is news that is publicly announcedName_________________________________ Student Number___________________________________(c) if stock prices over-react to the announcement of information, the theory is violated(d) all of the above are true 6. A proposed investment will cost $30,000 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 10,000 units at $5 each. The variable cost is $2 per unit and the fixed costs will be $15,000. Working capital in year 0 is $2,000 and this increases to $3,000 in year 1. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (8 points)7. In question 6, which of the following formulas gives the accounting break-even point?(a) (30,000 + 15,000)/5(b) (6,000 + 15,000)/(5-2)(c) (6,000 + 15,000)/5(d) (30,000 + 15,000)/(5-2)8. Using the data in questions 6&7, which of the following is true if the required return = 10%?(a) the economic break-even could be lower than the accounting break-even only if straight-line depreciation is used(b) the NPV of the project will be negative at the accounting break-even level of sales(c) the economic break-even analysis ignores the time value of money(d) none of the above are true9. ABC stock has a price of $10. You expect that one year from now the price will be one of three outcomes: $3, $12 or $20. If each price is equally likely to occur, what is the expected return on the stock over the next year if you invest today? Show your work. (8 points) 10. If the Neptune Company has β = 1.4, the expected market risk premium is 8% and the risk free rate is 1.5%, what is the expected return on Neptune under CAPM? Show your work. (6 points)2Name_________________________________ Student Number___________________________________11. 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 disaster. Which is true? (a) the increased risk from the new product is primarily market risk(b) the increased risk from the new product is primarily unique risk(c) the increased risk cannot be reduced through diversification(d) none of the above are true about the risk12. FFR Co. announced on Wednesday before markets opened that revenues increased by 20% more than was previously forecast. Wednesday’s stock price closed at 49, which was an increaseof $7 from the Tuesday close of $42. The stock prices for FFR from 20 days before to 20 days after the announcement are given below. (Note: the large increase is the announcement day)Are the price movements in the graph on the day of the announcement and the 20 days after consistent with the semi-strong form of the efficient market hypothesis? Explain. (6 points)13. Is the price movement in the 20 days before the announcement in question 12 consistent with the semi-strong form of market efficiency?(a) Yes, if there was no news announced during this period (b) No, because the price did not stay flat(c) No, because there appears to be insider trading(d) none of the above are true14. If markets follow semi-strong form efficiency, which of the following is the best strategy for choosing stocks?(a) performing careful research on the companies you select(b) choosing stocks whose ticker symbols are the same as your friends and families' initials(c) picking stocks based on past results (i.e., picking stocks that have outperformed the market)3Name_________________________________ Student Number___________________________________(d) all of the above have the same chance of beating the market15. An investment project costs 200,000 in time 0 and has the following payouts: C1 = -50,000; C2 = 100,000, C3 = 200,000 and C4 = 200,000. For periods C5 and all periods after in perpetuity, the cash flows will be 250,000. (a) If the discount rate is 12%, set up the formula for calculating the NPV 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 (b) to calculate the IRR and (ii) the rule you would use to accept or reject under the IRR (6 points)16. Which of the following is true concerning the IRR method of capital budgeting?(a) the IRR ignores