Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceFall 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. Stocks A, B & C have the following historical standard deviations: σA = .25, σB = .35, σC = .20. In 2007, the stocks had the following returns: rA = .12; rB= -.05; rC = .15 Which of thestocks had the highest E(r) in the beginning of 2007?(a) A(b) B(c) C(d) more information is required to answer this question2. ABC stock sells today for $20. You expect that one year from now one of three outcomes willoccur with the following probabilities and prices: there is a 20% chance P=$10; a 40% chance P=$20 and a 40% chance P=30. What is the expected return on the stock over the next year if you invest today? Show your work. (8 points) E(r) = .2x((10-20)/20) + .4x((20-20)/20) + .4x((30-20)/20) = .10 or 10%3. If markets follow the semi-strong form of efficient market theory, which is true? (a) the price of a stock will not change unless new information is announced(b) if stock prices are slow to react to the announcement of information, the theory is violated(c) as long as there is a quick initial movement in price, there is no violation of the theoryif the price returns to where it started by the end of the first trading day(d) all of the above are true 4. The cash flows for a project are as follows: initial cost of $1,000,000, C1 = -200,000, C2 = 500,000, C3 = 600,000, C4 = 2,000,000, C5 = 10,000,000. If the company uses the payback method with a three year payback, which of the following is true?(a) The company should accept the project because it pays back within 3 years(b) The company cannot calculate the payback period in this case(c) The company will reject the project under the payback method even though it most likely has a positive NPV(d) None of the above is trueName_________________________________ Student Number___________________________________5-7. You have purchased a portfolio of equal investments in 4 stocks X,Y,W,Z that have the following β's: βW = 2; βX = 1.5; β Y = 1; βZ =.5. 5. Calculate the portfolio β. Show your calculation (6 points)Portfolio β = (.25 x 2) + (.25 x 1.5) + (.25 x 1) + (.25 x .5) = 1.256. If E(Rm) = 11% and rf = 2%, what is the expected return on your portfolio in question3 above? Show your calculation. (6 points)E(Ri) = RF + βi (E(RM) – RF) = .02 + 1.25x(.11 - .02) = .1325 or 13.25%7. Have you reduced any risk by combining the 4 stocks above into a portfolio? (a) No, because all stocks have risk and you can only reduce risk by adding a bond(b) Yes, because each individual stock will cancel out some of the unique risks in the other stocks(c) No, because the β of the portfolio represents market risk and this type of risk cannot be diversified(d) Yes, because the portfolio will now have a β = .758. Which of the following is most likely to represent a cash flow that should be taken into account for capital budgeting analysis of a new product? (a) The new project's share of the CEO's salary(b) The cost of developing the new product over the last two years(c) The increased revenue expected from an existing product related to the new product(d) The depreciation expense charged under generally accepted accounting principals (GAAP)9. Mark each statement about capital budgeting as true or false. (2 points each) a._T__The time value of money is included in the NPV analysis by discounting future cash flows to the presentb._F__To find the payback period under the payback method, you must first know the discount ratec._F___The IRR method ignores cash flows after the required payback periodd._T___If you are choosing between two mutually exclusive projects, the IRR method can lead to choosing the project with the lower NPV2Name_________________________________ Student Number___________________________________10. A proposed investment will cost $60,000 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 20,000 units at $7 each. The variable cost is $3 per unit and the fixed costs will be $35,000. Working capital in year 0 is $10,000 and this increases to $12,000 in year 1. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (8 points)Cash flow from working capital = 10,000 - 12,000 = -2,000Pre-tax income = revenue - variable cost - fixed cost - depreciation expense Pre-tax income = 140,000 - 60,000 - 35,000 - 12,000 = 33,000Tax = 33,000 x .35 = 11,550Net Income = 33,000 - 11,550 = 21,450Cash flow from operations = Net Income + Depreciation = 21,450 + 12,000 = 33,450Overall cash flow = 33,450 - 2,000 = 31,45011. In question 6, which of the following formulas gives the accounting break-even point?(a) (20,000 + 60,000)/7(b) (35,000 + 12,000)/3(c) (60,000 + 20,000)/(7-3)(d) (12,000 + 35,000)/(7-3)12. An investment project costs 1,200,000 in time 0 and has the following payouts: C1 = -250,000; C2 = 300,000, C3 = 600,000, C4 = 800,000 and C5 = 900,000. (a) Set up the formula for calculating the IRR in as much detail as possible (Note: you do not have to actually solve for the answer) (6 points)0 = -1,200,000 - 250,000/(1+r) + 300,000/(1+r)2 + 600,000/(1+r)3 + 800,000/(1+r)4 + 900,000/(1+r)5To find IRR, solve for r in the above expression(b) Describe (i) how you would modify your answer in part (a) to calculate the NPV and (ii) the rule you would use to accept or reject under the NPV (6 points)(i) To calculate NPV, find the appropriate discount rate r and substitute this into the equation in 12(a). Calculate the NPV as the value of the equation (which will no longer equal 0). (ii) The rule for accepting under NPV is to accept projects with a positive NPV13. Which of the following is true about the NPV method of capital budgeting?(a) A project with a positive NPV will increase firm value(b) Sensitivity analysis is a way to determine how bad things can be if several things go wrong with the project at the same time(c) NPV is flawed because it ignores cash flows after the cut-off(d) None of the above is true3Name_________________________________ Student