Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceFall 2011 12:03Please 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. Last year, stocks A, B & C had historical standard deviations: σA = .25, σB = .35, σC = .20. Which stock has the highest E(r) for the year 2012?(a) A(b) B(c) C(d) more information is required to answer this question market risk instead of overall risk.2. ABC stock sells today for $35. You expect that one year from now one of three outcomes willoccur with the following probabilities and prices: there is a 20% chance P=$30; a 40% chance P=$40 and a 40% chance P=50. What is the expected return on the stock over the next year if you invest today? Show your work. (6 points) E(r) = .20 x [(30-35)/35] + .4 x [(40-35)/35] + .4 x [(50-35)/35] = .20 or 20%3. In 2010, stocks A,B,C had the following returns: rA = .12; rB= -.10; rC = .15 Which of the following is true? One year return, cannot tell the probability distribution.(a) Stock B has E(r)>0 stock B has a loss. risk involved, the expected return will be at least risk free rate + risk premium. Investor will not invest the stock that has negative expected return. The higher risk , the higher expected return. (b) E(rc) must be greater than E(rA) don’t have to(c) A, B, C will have the same E(r) because they are all stocks based on the market risk(d) None of the above is true4. If markets follow the semi-strong form of efficient market theory, which is true about the stock price reaction to public announcements of information? If a news comes out, the stock prices will change immediately to a level, and stays there.(a)The price of a stock changes only when there is a public announcement of information(b) If stock prices are slow to react to public announcements of information, the theory is violated(c) As long as there is a quick initial movement in price after the announcement, there is no violation of the theory if the price returns to where it started(d) None of the above is true 5. 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, should they take the project? Show your calculation and explain your answer. (6 points)Name_________________________________ Student Number___________________________________Test 2 – Fall 2011Sum of cash flows received after 3 years = -200,000 + 500,000 + 600,000 = 900,000. As this isless than the 1,000,000 cost, this project does not payback within 3 years and should be rejected.6. Sensitivity analysis is useful to NPV calculations because(a) It can show where there are mistakes in the calculation(b) It can show which individual assumptions are the most crucial (c) It can show how bad things will be if many things go wrong at the same time(d) None of the above7-9. You have purchased a portfolio of equal investments in 4 stocks X,Y,W,Z that have the following β's: βW = 1.25; βX = 1.5; β Y = .7; βZ =.5. 7. Calculate the portfolio β. Show your calculation (6 points)Portfolio beta = average of the stock betas = (1.25+1.5+.7+.5)/4 = .9875 overall risk can be canceled out as you put the stocks into portfolio. β risk cannot be canceled out , can be average, different than canceling.8. Using the portfolio beta from question 7, if E(Rm) = 9% and rf = 1%, what is the expected return using CAPM? Show your calculation. (6 points)E(r) = .01 + .9875(.09 - .01) = .089 or 8.9%9. 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 some unique risk for each company will be canceled by 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 = .7510. 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? One cash flow that we have because of the new project.(a) The new project's share of the CEO's salary(b) The cost of developing the new product over the last two years sunk cost (c) The decrease in revenue from an existing product that is caused by the availability of the new product(d) The depreciation expense charged under generally accepted accounting principals (GAAP) not include the cash 2Name_________________________________ Student Number___________________________________Test 2 – Fall 201111. Mark each statement about capital budgeting as true or false. (2 points each) a._T__The time value of money is included in the IRR 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 rate no discountingc._T__ If you are choosing between two mutually exclusive projects, the IRR method can lead to choosing the project with the lower NPV mutually exclusive project12. A proposed investment will cost $1,000,000 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 $45 each. The variable cost is $23 per unit and the fixed costs will be $150,000. Working capital in year 0 is $100,000 and this increases to $120,000 in year 1.If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (8 points)Change in working capital = 120,000 – 100,000 = 20,000Cash flow from working capital = -20,000 working capital goes up, it costs cash.Depreciation Expense = 1,000,000/5 = 200,000Pre-tax Operating Cash flow = (20,000 x 45) – (20,000 x 23) – 150,000 – 200,000 = 90,000Operating Cash Flow = 90,000 x (1-.35) +200,000 (depreciation)– 20,000 = 238,50013. An investment project costs 2,000,000 in time 0 and has the following payouts: C1 = -250,000; C2 = 600,000, C3 = 900,000, C4 = 1,200,000 and C5 = 1,400,000. 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 = -2,000,000 – 250,000/(1+r) + 600,000/(1+r)2 +