Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceFall 2014Please 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 X 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) allocation of pre-existing overhead expenses to project X(b) an increase in sales of a related YT Inc. product caused by project X(c) a decrease in income taxes paid to the government because of expenses of project X(d) expected revenues from project X2. Jon is conducting a capital budgeting analysis using NPV for a major expansion of his company’s product. He is concerned that there is a lot of uncertainty about what the market conditions will be for this product the next few years. Does the NPV analysis we reviewed in class consider the uncertainty of cash flows like revenues?(a) Yes, NPV analysis uses worst case scenario cash flows so that we do not accept projects that can lose money(b) Yes, uncertainty about cash flows is included through the discount rate(c) No, no adjustment should be made to cash flows because uncertainty about outcomes is not important to capital budgeting decisions(d) It doesn’t matter what cash flows Jon uses as he will get the same NPV3. In which of the following investments is an investor expected to earn the highest return over a 40 year period? A: E(r)=8% and σ = 30% B: E(r)= 8% and σ = 25% C: E(r)= 7% and σ = 20%Explain your answer. (6 points)The highest expected return is the same for A and B at 8% per year. It is true that A has a higher standard deviation, but this does not affect the expectation for return only the dispersion of results. Also,note that the fact that A and B have the same E(r) means that A andB have the same beta.4. Mark each statement about capital budgeting as true or false. (2 points each) ___T__a. The IRR decision rule will accept the same projects as the NPV decision rule for projects where none of the flaws with IRR are present. ___F__b. The time value of money is an important consideration in each of the NPV, payback and IRR methods of capital budgetingName_______________________________ Test 2 – Fall 2014 Student Number______________________5. Which of the following is true about the strong-form of market efficiency theory?(a) in a market that is strong-form efficient, it should not be possible to make moneyfrom public information(b) if the strong-form of market efficiency is violated, then the semi-strong must hold(c) laws against insider trading make it more likely that markets follow the strong-form ofmarket efficiency theory(d) none of the above6. You are comparing 2 delivery trucks. Truck A is new and is expected to last for 7 years with a PV of total costs of $100,000 and Truck B is used and is expected to last for 5 years with a PV oftotal costs of $80,000. If the discount rate is 7%, use the annuity table below to calculate the Equivalent Annual Annuity for each option and determine which Truck is preferred. Show your work (6 points)EAA = PV/Annuity factorEAAA=100000/5.389=18,556.32EAAB=80000/4.100=19,512.20So Truck A is preferred because it has a lower equivalent cost per year7. You are analyzing the stock of a Hollywood movie studio. You find that the company has a high standard deviation of stock returns, which means it has high overall risk. But when you calculate beta, you find β = .8. Is it possible to have high overall risk and low market risk? Explain. (6 points)Overall risk = Market risk + Firm-specific riskYes is it possible if the company has a high firm-specific risk. As movie studios have high risk of a big hit or a big miss, there is a lot of firm-specific risk that can be diversified away.This means that it is possible to have a high overall risk but a low market risk.8. If the Neptune Company has β = 1.3, the E(RM) = 11% and RF = 3%, what is the E(R) of Neptune under CAPM?(a) .134(b) .11(c) .143(d) more information is required9. An investment project costs 250 in time 0 and has the following payouts: C1 = 75, C2 = 125, C3 = 100, and C4 = -100. If the discount rate is 10%, set up the calculation to find the NPV. (Note: you do not need to solve) (6 points):NPV = -250 + 75/(1.10) + 125/(1.102) + 100/(1.103) – 100/(1.104)r =.07 r =.08 r =.09T=5 4.100 3.383 2.810T=6 4.767 3.838 3.129T=7 5.389 4.244 3.4032Name_______________________________ Test 2 – Fall 2014 Student Number______________________10. If β = .5 for company JKL, and the market was down by 20% last year, which of the following is the most likely actual return earned by investors in JKL last year? (a) +10% (b) -10% (c) -20%(d) 0% 11. A proposed investment will cost $600,000 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. The company expects revenues of $500,000 in time 1 and $550,000 in time 2. The variable cost is 50% of revenues and the fixed costs will be $50,000. Working capital is 10% of next year's revenues. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculations. (8 points)Depreciation = 600,000/4 = 150,000Working Capital: time 0 $50,000 time 1 $55,000Change in working capital: time 1 = $5,000CF working capital (time 1) = $-5,000CF operationsPre-tax income = 500,000 – 250,000 – 50,000 – 150,000 = $50,000Net income = $50,000 (1-.35) = $32,500CF operations = $32,500 + 150,000 = $182,500Overall Cash Flow (time 1) = 182,500-5,000 = $177,50012. Assuming you have the per unit data for question 11, if you calculate the accounting break-even and the economic breakeven, which will require the sale of more units?(a) the accounting breakeven because Generally Accepted Accounting Principles (GAAP) are conservative(b) both give the same breakeven (c) the economic breakeven because the depreciation calculation under the accounting breakeven is too low if the time value of money is considered(d) none of the above is true13. If investors in the market are expecting that quarterly earnings of BCJ will be 25% above last year’s earnings, draw a graph indicating the market reaction to the announcement by the company that