Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation Finance Version IFall 2010 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)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 account2. 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 NPVanalysis 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 uses3. Halle put $10,000 into a fund run by a professional manager three years agoat 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 2009 = $9,500 2010 = $10,000Mark each statement below as (T)rue or (F)alse. (2 points each) a.__F_ 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.__T_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.__F_ There is very little risk in Halle's investment the last three years because she ended up breaking evenName_________________________________ Student Number___________________________________4. AGG Inc.’s earnings are very dependent on the economy. They have high earnings when theeconomy 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 β less than 1(d) none of the above5. Mark each statement about capital budgeting as true or false. (2 points each) a._F__A discount rate is required in each of the NPV, payback and IRR methods of capital budgeting b._F__The time value of money is an important consideration in each of the NPV, payback and IRR methods of capital budgetingc._T__ 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 determined7. 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)After 7 years, $2,100,000 is received which is greater than the initial cost of $2 million. So the project pays back before the deadline of 7 years and we should accept the project. –calculat how????(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)NPV = -2,000,000 + (300,000 x 6.710) = 13,000 We should accept the project because the NPV is greater than 0.(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)0 = -2,000,000 + 300,000/(1+r) + 300,000/(1+r)2 + ... + 300,000/(1+r)102Name_________________________________ Student Number___________________________________Solve for r to find the IRR. If the IRR is greater than the required rate of return (discount rate), then we accept the project.8. If β = 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% 7(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)Revenue 5,000,000 Net Working Capital = 100,000 - 300,000 = -200,000VC 2,000,000FC 2,000,000 Depreciation = 1,500,000 / 5 = 300,000Depreciation 300,000Taxable Income 700,000Tax (at 35%) 245,000Net Income 455,000Cash Flow = 455,000 + 300,000 (Depreciation) - 200,000 (Net Working Capital) = 555,00010. 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 above11. Using CAPM, the following have been calculated:Stock E(r) σ A 12% .30 B 11% .32How is it possible that B has higher total risk but lower E(r) than A? Explain. (6 points)Total risk includes market risk and diversifiable risk. If B has lower market risk than A but higher diversifiable risk, then the E(r) for B from CAPM will be