Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceSpring 2015Please sign name in box (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) The annual bonus paid to the YT Inc. President based on last year'searnings(b) Development costs for the project that the company has paid over the last two years(c) Expected lost sales in a related YT Inc. product caused by the new product(d) None of the above should be taken into account2. Anthony has earned actual returns of -4% in 2012, -12% in 2013 and 3% in 2014 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 2012? Explain. (6 points)The big loss in 2013 shows that this investment has a lot of risk because you can only have a big loss if there is a big risk. Because there is a big risk, the E(r ) must have been high back when he made the investment or he wouldn't have made it. As for what a good estimate would have been, this depends on the actual expected risk of the investment. Anywhere between 7% and 15% is probably a good estimate (the market return would have been about 8%. 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) none of the above are true 4. Mark each statement about capital budgeting as true or false. (2 points each) a._F_In scenario analysis, one assumption at a time is changed to see the effect on NPVb._F_The NPV is flawed because it ignores payments after the cutoffc._T_The Payback method does not adjust cash flows for the time value of money5. Under CAPM, if the Neptune Company has β = .8, which is true? (a) E(Ri) must be greater than E(RM)Name_________________________________ Test 2 – Spring 2015 Student Number_______________________(b) E(Ri) must be less than E(RM)(c) E(Ri) will be set independently of E(RM)(d) E(Ri) will be set based on Ri6 John Starr has just published a book called "Beating the market for 10 years" where he discusses his success in outperforming the S&P 500 over the past 10 years. He is convinced that efficient market theory is not true and that anyone can beat the market using the strategy he outlines in his book. Based on evidence we discussed in class, critically discuss John Starr's claims about market efficiency. (6 points)It would not work for everyone to make money based on his strategy as the act of profiting from a mis-priced stock moves the price towards the correct level. So prices would quickly move to the new level based on information in his book. The semi-strong form of market efficiency says that you can't make money from public information because of this price movement towards the correct price. 7. Jill is conducting a capital budgeting analysis using NPV for a major expansion of her company. She wants to increase the chances on having her project accepted because it will likelymean a promotion for her. Jill has decided that she will use a discount rate that is too low to increase the NPV and make her project more attractive to management. Is this a correct approachto capital budgeting? (a) Yes it is correct because the analyst needs to make sure the project is approved(b) No it is not correct because the NPV will be lower than it would be if she did the analysis correctly(c) No it is not correct because this approach could end up losing money for the company(d) It doesn’t matter what discount rate Jill uses as she will get the same NPV8. An investment project costs 2,000,000 in time 0 and has a payout of $600,000 per year from time 1 through time 5. (a) If the annuity factor at r=.10 and t=5 is 3.7908, calculate the NPV. Show your work. (6 points)NPV = -2,000,000 + 3.7908x600,000 = 274,480(b) Set up the problem in part (a) to find the IRR. (Note: you do not need to solve)(6 points)0 = -2,000,000 + 600,000/(1+r) + 600,000/(1+r)2 + 600,000/(1+r)3 + 600,000/(1+r)4 + 600,000/(1+r)5Solve for r to find IRR9. Which of the following is true concerning the IRR method of capital budgeting?(a) the IRR ignores cash flows after the cutoff period2Name_________________________________ Test 2 – Spring 2015 Student Number_______________________(b) the IRR always selects the project with the highest NPV when choosing between mutually exclusive projects(c) a discount rate is not required to calculate the IRR(d) none of the above are true10. ABC stock has a current price of $50. You expect that one year from now there is a 20% chance the price is $20, a 50% chance the price will be $55 and a 30% chance the price will be $80. What is the expected return on the stock over the next year? Show your work. (6 points) E(r ) = .20 x (20-50)/50 + .5 x (55-50)/50 + .3 x (80-50)/50 = .11 or 11%11. A proposed investment will cost $400,000 in year 0. It will have a life of 4 years and the cost will be depreciated using straight-line to a zero salvage value. For year 1, the company expects sales of 200,000 units at $6 each. The variable cost is $2 per unit and the fixed costs willbe $250,000. Working capital in year 0 is $40,000 and this increases to $60,000 in year 1. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (8 points)change in WC in time 1 = 60,000 - 40,000 = 20,000 depreciation = 400,000/4 = 100,000cash flow from WC in time 1 = -20,000Pre-Tax Operations: 200,000x6 - 200,000x2 - 250,000 - 100,000 = 450,000Tax = 450,000 x .35 = 157,500After Tax Cash Flow = (450,000-157,500) + 100,000 = 392,500 Overall Cash Flow time 1 = 392,500 - 20,000 = 372,50012. Which of the following is the accounting break-even level of sales for the company in question 11?(a) 400,000/4(b) 200,000/6(c) (250,000 + 100,000)/4(d) (200,000+40,000)/(6-2) 13. The working capital requirements for a new project are due to the required inventory levels. The firm requires an inventory valued at $20,000 in time