Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceSpring 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. Plasma Inc. is considering expanding production to build a new television, XScreen. The CEO is concerned that the new television will reduce sales of the current models. Does the capital budgeting process we learned in class addressthe CEO's concern? (a) Yes, because the discount rate is increased to reflect the effect of lostsales(b) No, because the sales of the other television are not an incremental cash flow(c) No, because each product should be evaluated separately(d) None of the above is correct2. Anthony has earned actual returns of 7%, -12% and 11% over a three year period on an investment. During the same time period, the return on the market was 10%, 5%, 12%. Applying finance theory we learned in class, mark the following as true or false. (2 points each)a._T__ The beta of the investment is most likely less than 1 b._T_ A negative actual return during one year means the expected return on the investment must have been > 0 for that year.c._F_ The actual return on the market each year is the same as the expected return on the market at the beginning of each year. 3. You currently own only a single stock that has β = .5. If you form a portfolio by buying another stock with β = .5, are you reducing the expected level of overall risk in your portfolio? (a) No, because the portfolio still has a β = .5(b) No, because all stocks have risk and you can only reduce risk by adding a bond(c) Yes, because the second stock will cancel out some of the variation in the first stock(d) Yes, because the portfolio will now have a β = .254. A publicly traded company has discovered a new battery that has double the life of any competitor's battery. The new discovery has not yet been announced to the public. Two days before the company makes the public announcement, one of the scientists at the company brags about the discoveryto his friends and relatives. If the market follows the semi-strong form of market efficiency, draw a graph showing the stock price of the company from the period three days before the announcement to three days after. (6 points) Clearly mark the days on your graph.You should chart 3 days before the day of the announcement and 3 days after on the horizontal axis and the stock price on the verticalName_________________________________ Student Number___________________________________axis. In the three days before, there will some increase in price due to the news leaking out then the remainder of the price increase due to the announcement will happen immediately when markets open on day 0. For the three days after the announcement, the stock price should remain flat.5. Mark each statement about capital budgeting as true or false. (2 points each) a._T_ Scenario analysis is a useful way to calculate how NPV will change if you change several assumptions at the same time. b._F_ NPV analysis does not require a discount ratec._F_ If a project is accepted under the payback method, that means it will also be accepted under the IRR method6. You are interested in buying a stock that has a price of $32. You have projected that next year there is: a 15% probability the stock will equal $5, a 35% probability the stock will equal $28 and a50% probability the stock will equal $50. What is the expected return on the stock if you buy today and sell next year? (6 points)E(r) = p1r1 + p2r2 + ... + pnrnE(r) = .15 x (5-32)/32 + .35 x (28-32)/32 + .5 x (50-32)/32E(r) = .1109 or 11.09%7. A proposed investment will cost $1,000,000 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 45,000 units at $17 each. The variable cost is $10 per unit and the fixed costs will be $150,000. Working capital in year 0 is $100,000 and this increases to $130,000 in year 1. If taxes are 35%, what is the incremental cash flow for year 1? Show your calculation. (8 points)Change in net working capital (time 1) = 130,000 - 100,000 = 30,000cash flow from net working capital (time 1) = -30,000depreciation = 1,000,000/4 = 250,000Cash flow from operations = 45,000 x 17 - 45,000 x 10 - 150,000 - 250,000 = -85,000Assuming no tax due to the loss, cf from operations = -85,000 + 250,000 = 165,000overall incremental cash flow (year 1) = 165,000 - 30,000 = 135,0008. In question 7, will the accounting break-even or the economic break-even give a higher number of units? Explain your answer. (6 points)The economic break-even will give a higher number of units because the accounting break-even spreads the initial cost of the project over time without considering the time value of money. Hence the depreciation charge in the accounting break-even will be too low and the accounting break-even will occur at a point where the NPV is negative. 2Name_________________________________ Student Number___________________________________9. If stock XYZ paid a dividend of $1 last year and the dividend yield was 2% what was the stock price at the beginning of the year?(a) $50(b) $20(c) $10(d) $110. The estimated standard deviations for stocks A and B are: σA = .25 σB = .35. Under finance theory, which stock has a higher expected return? Explain. (6 points)Under finance theory, the expected return on a stock depends only on the market risk of the stock not the overall risk. CAPM says that stocks with higher betas (which measures market risk) will have higher returns. In this example, the standard deviation measures overall risk which does not directly translate into market risk. Hence, more information about beta is required to determine which stock has a higher expected return.11. If the Neptune Company has an expected return = 12% under CAPM, the expected Rm is 10% and the risk free rate is 1%, what is the beta of Neptune? Show your calculation. (6 points) E(Ri) = RF + βi (E(RM) – RF).12 = .01 + βi(.10 - .01)βi = 1.2212. While markets were closed, a company announced that its earnings were 20% higher than last year's earnings. When markets opened, the company's stock started trading at a level 10% belowthe previous day's closing trade. How