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UB MGF 301 - MGF301 Test 2 -Spring 2011 Version II (answers)

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Name_________________________________ Student Number___________________________________TEST 2MGF 301 Corporation FinanceSpring 2011Please 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) a decrease in income taxes paid to the government because of expenses of project X(b) increase in electricity usage because of new machinery(c) an increase in sales of a related YT Inc. product caused by project X(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 conditionswill be for his product the next few years. Jon has decided to use his best estimate for the revenue even though there is a lot of uncertainty. Is this the correct way to handle uncertainty in an NPV analysis?(a) No, he should use worst case estimates for cash flows if there is a lot of uncertainty(b) No, NPV analysis requires the use of best case scenario cash flows.(c) Yes, because increased uncertainty is accounted for in an NPV analysis through a higher discount rate(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 most over a 40 year period? 4. Mark each statement about capital budgeting as true or false. (2 pointseach) __ a. If a company accepts a project with a positive NPV, the value of the company increases by the NPV__ __b. The IRR decision rule will give the same answer as the NPV decision rule for projects where none of the flaws with IRR are present. ____c. The payback method is not used as often as NPV because it is more difficult to calculate payback 5. AGG Inc.’s earnings are very dependent on the economy. They have high earnings when the economy is booming and large losses in recessions. Which is not true about the company? (a) the company has a β greater than 1(b) the company has no unique risk(c) an investor in the company can diversify some of the company’s overall risk(d) the company has high market riskName________________________________ Test 2 - Spring 2011 Student Number_______________________6. 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)7. Using estimates for E(Rm) and Rf based on our discussions in class as to what is reasonable, if the Neptune Company has β = 1.1, what is an appropriate estimate for the E(r) nextyear under CAPM? (6 points) Show your estimates and calculation.8. An investment project costs 250 in time 0 and has the following payouts: C1 = 75, C2 = 125, C3 = 100, and C4 = -100. The cost of capital for the firm is 13%. Which of the following is the formula for NPV:(a) =-250 + 75/1.13 + 125/1.132 + 100/1.133 -100/1.134(b) =-250 + 75/1.13 + 125/1.132 + 100/1.133 + 100/1.134(c) 0=-250 + 75/(1+r) + 125/(1+r)2 + 100/(1+r)3 - 100/(1+r)4 and solve for r(d) =-250/1.13 + 75/1.132 + 125/1.133 + 100/1.134 - 100/1.1359. Sensitivity analysis is useful to NPV calculations because(a) It shows which individual assumptions are the most crucial (b) It shows how bad things will be if several bad events occur at the same time(c) It shows where there are mistakes in the calculation(d) None of the above10. The cash flows for a project are as follows: initial cost of $2,000,000, C1 = -200,000, C2 = 800,000, C3 = 1,200,000, C4 = 2,000,000, C5 = 3,000,000. If the company uses the payback method with a three year payback, should they accept the project? Explain. (6 points)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 $600,000 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. (10 points)12. 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 economic breakeven because the depreciation calculation under the accounting breakeven is too low if the time value of money is considered(b) the accounting breakeven because Generally Accepted Accounting Principles (GAAP) are conservative(c) both give the same breakeven (d) none of the above is true2Name________________________________ Test 2 - Spring 2011 Student Number_______________________13. If investors in the market are expecting that quarterly earnings of BCJ will be 25% below last year’s earnings, draw a graph indicating the market reaction to the announcement by the company that its quarterly earnings turned out to be 20% below last year’s earnings. Assume semi-strong market efficiency. (6 points)14. If the actual return over the last year was -7.2% and the dividend yield was 1.2%, which of the following is the percentage capital gain?(a) 6%(b) 8.4%(c) -6%(d) -8.4%15. Which of the following is not true about methods of capital budgeting?(a) a discount rate is required to calculate IRR(b) NPV is generally preferred over the payback method because NPV includes discounting for the time value of money(c) the payback method ignores cash flows after the cutoff period(d) all of the above are true16. The company is considering a new project that costs $1 million (in time 0). If the cash flows from the project are $200,000 per year for years 1-10 and the discount rate is 8%, calculate the NPV of the project using the following annuity table: (6 points) time periods 9 10 11interest rate 8% 6.247 6.710 7.13917. Some analysts have argued that stock prices follow trends in public culture. One example is that the stock market is said to go up


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UB MGF 301 - MGF301 Test 2 -Spring 2011 Version II (answers)

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