ch15

24) Your uncle wants to help you with your college expenses, and he promised to pay you $10,000 next year and $15,000 in two years. The current interest rate is 6%, and you expect that this interest rate will be the same for the next year and will increase to 8% in the year after. What is the formula that you should use to compute the present discounted value of your uncleʹs contribution to your education expenses? A) 0 + 10,000 + 15,000 B) 10,000/(1.06) + 15,000/((1.06)*(1.06)) C) 10,000/(1.06) + 15,000/((1.06)(1.08)) D) 10,000/(1.06) + 15,000/((1.08)(1.08))

c

26) A bond has a current market value of $800. The holder of the bond will receive a single payment of $1,000 one year from now. The interest rate is 10 percent. The effective yield on the bond is: A) $200. B) 10 percent. C) 25 percent. D) negative. E) The yield cannot be determined with the information provided.

c

4) If a firm can earn a profit stream of $50,000 per year for 10 years, that profit stream is worth A) more than $500,000 today. B) $500,000 today. C) less than $500,000 today, but a positive amount. D) nothing today E) some amount, but whether it is more, less or the same as $500,000 cannot be determined.

c

5) To avoid the stock versus flow issue in production, some economists discuss capital usage in terms of rented capital. For example, your firm may not directly own some of the capital inputs to your production operation, and these capital inputs are employed on an hourly or daily basis. Which of the following inputs is a good example of a capital input that acts like a flow? A) Land and buildings that are owned by the firm B) A long-term licensing agreements that allow you to use a patented idea owned by another firm C) A forklift that is rented on an hourly basis D) all of the above

c

6) The present value formula makes it apparent that: A) a decline in the interest rate will cause a decision maker to weigh recent period returns relatively more heavily than before the decline. B) an increase in the interest rate will cause a decision maker to weigh distant (or future) returns relatively more heavily than before the increase. C) the present value of a fixed sum decreases as the time until it is to be paid increases. D) all of the above E) both A and C.

c

75) For an investment in a hybrid auto like the Toyota Prius, the car owner typically pays a higher initial price for the car but enjoys lower fuel costs for the life of the vehicle. The authors note that consumers tend to use discount rates that are too high when computing the net present value of these investment decisions. If this is true, consumers would tend to place too __________ emphasis on the initial purchase price and too __________ emphasis on the future fuel savings when computing the net present value of the investment. A) much, much B) little, much C) much, little D) little, little

c

8) If the interest rate is 10%, the present value of $1 next year is A) $1.20. B) $1.10 C) 91 cents.

c

83) What is the ʺHotelling ruleʺ for situations in which a producer can determine when a good is sold? A) Price must rise at exactly the rate of interest. B) Marginal cost must rise at exactly the rate of interest. C) Price minus marginal cost must rise at exactly the rate of interest. D) Price plus marginal cost must rise at exactly the rate of interest. E) Price and marginal cost must be independent of the rate of interest.

c

If the inflation rate falls and nominal interest rates are unchanged A) inflation will fall. B) inflation will continue C) real interest rates rise. D) real interest rates are unaffected. E) real interest rates fall.

c

In the consumerʹs NPV decision, the correct value for the interest rate R is A) the interest rate that could be earned in a savings account when the consumer must borrow to finance the purchase. B) the interest rate that would have to be paid on a loan when the consumer could pay for the purchase with funds in a savings account. C) the interest rate charged for the loan when the consumer must borrow to finance the purchase. D) the prime rate, irrespective of whether when the consumer must borrow to finance the purchase. E) the prime rate plus the rate of inflation as measured by the CPI, irrespective of whether when the consumer must borrow to finance the purchase.

c

Len is putting in a new swimming pool. He can either heat his pool with natural gas or with solar power. If he chooses solar power it will cost him more today, but he will recover these costs over the next 7 years in savings on his natural gas bill. The solar heater is expected to last 12 years. Len: A) will put in the solar heater regardless of the discount rate because the savings in natural gas outweigh the initial cost of the solar heater. B) is more likely to install the solar heater as the discount rate increases. C) is more likely to install the solar heater as the discount rate declines. D) will not put in the solar heater unless he is an environmentalist.

c

Of the following endeavors of Happy Home Insurance Company of California, which involves the most nondiversifiable risk? A) Fire insurance B) Home burglary insurance C) Earthquake insurance D) Personal accident insurance E) Home office insurance

c

The beta for General Motors (GM) is 0.5, the risk-free rate is 4%, and the market return is 9%. What is GMʹs risk-adjusted discount rate? A) 4% B) 4.5% C) 6.5% D) 9%

c

The real discount rate and the nominal discount rate differ in their treatment of A) risk. . B) market return. C) inflation. D) expected risk.

c

The ʺCapital Asset Pricing Modelʺ measures the risk premium for a capital investment by comparing the expected return on that investment with the A) average return on other investments of similar risk. B) average return on the past several yearsʹ investments made by the firm. C) expected return on the entire stock market. D) expected return on the government bond market. E) expected return on the corporate bond market.

c

1) The marginal revenue product of capital inputs does not provide complete information about optimal use because capital is: A) money. B) not an input. C) an output as well as an input. D) durable. E) all of the above

d

23) Suppose you are an attorney, and you are defending a client in a wrongful death suit. The deceased was a pilot for an aerial acrobatics team, and the opposing attorney has prepared an an estimate of the value of lost income that includes the mortality rate for all pilots. You should argue that the attorneyʹs estimate of lost earnings is too __________ because the mortality rate for aerial acrobats is __________ than for other types of pilots. A) low, lower B) low, higher C) high, lower D) high, higher

d

28) The PDV of a perpetuity with a yearly payment of $500 at an interest rate of 5% is A) $100. B) $5,000. C) $25,000. D) $10,000. E) $100,000.

d

3) Which is a stock variable? A) Labor B) Profit C) Income D) Capital E) Price

d

32) If a coupon bond has a ʺface valueʺ of $1000, it means that A) the original purchaser paid $1000 for it. B) each purchaser must pay $1000 for it. C) it was purchased for at least $1000 and perhaps more. D) the holder will be paid $1000 when the bond matures. E) the holder will be paid $1000 plus accumulated interest when the bond matures.

d

60) The decision firms make about new capital projects is most like the decision consumers make when they decide A) whether to take a new job. B) which of two new jobs to take. C) what brand of coffee to buy. D) whether to buy a new house. E) whether to go on vacation.

d

80) Suppose that many consumers tend to over-state the discount rate that should be used for computing the net present value of education, just as they do when making investments in durable goods like cars and appliances. What would happen if consumers (as a group) started to use lower discount rates when making decisions about their education? A) NPV of a degree declines, demand for eduction declines B) NPV of a degree declines, demand for education increases C) NPV of a degree increases, demand for education declines D) NPV of a degree increases, demand for education increases

d

9) If an individual has $10,000 nominal interest rate is A) 3% and the real rate is 5% B) 5% and the real rate is 7% C) 5% and the real rate is 3% D) 3% and the real rate is 1% E) 5%.

d

9) You have won a contest and are allowed to choose between two prizes. One option is to receive $200 today and another $200 one year from now. The second option is $100 today and an additional $325 one year from now. At what interest rate (if any) is the present value of the two prizes identical? A) 0 percent B) 5 percent C) 10 percent D) 25 percent E) none of the above

d

An assetʹs beta can be used to compute its discount rate for an NPV calculation because the discount rate is equal to A) rf + b(rm + rf). B) rf - b(rm + rf). C) rf - b(rm - rf). D) rf + b(rm - rf). E) beta itself.

d

For net present value calculations, the rate of return that one could earn by investing in another project with similar risk is known as the: A) real interest rate. B) nominal interest rate. C) prime interest rate. D) opportunity cost of capital.

d

Some universities now offer ʺtuition bonds.ʺ Parents can purchase a bond at the time their child is born. The bond is redeemable in 18 years for an amount of money equal to the cost of the universityʹs tuition at that time. Which of the following would reduce the market price of these bonds? A) An increase in the rate of interest B) A decrease in the rate of interest C) The passage of legislation limiting increases in college tuition to the rate of inflation D) both A and C E) both B and C

d

The higher the beta, A) the smaller the diversifiable risk. B) the smaller the nondiversifiable risk. C) the larger the diversifiable risk. D) the larger the nondiversifiable risk.

d

36) The first term in an NPV calculation is usually A) positive, because firms consider only positive returns. B) positive, because interest charges do not accrue until the second period. C) zero, because interest charges do not accrue until the second period. D) negative, because funds for the project have to be borrowed up front before it is begun. E) negative, because the cost of the project is immediate, but revenue streams from the project come later.

e

If a projectʹs only risk is diversifiable, A) only half the risk premium should be added to the discount rate. B) only half the risk premium should be subtracted from the discount rate. C) the risk premium should be added to the discount rate. D) the risk premium should be subtracted from the discount rate. E) no risk premium should be attached to the discount rate.

e

Which is the best example of a nondiversifiable risk for Stalwart Shoes? A) A project to open a new store in Texas B) A project to open a new factory in Texas C) A project to move into the sock market D) The state of the economy in Texas E) The state of the U.S. economy

e

The authors cite a recent study of MBA programs that compares pre-MBA salaries with post-MBA salaries. For some of the highest ranked schools, the salary difference was roughly $100,000 per year, and the difference was roughly $60,000 for some schools ranked near the bottom of the top 20. Is it possible that the financial returns from an MBA earned at a lower ranked school may actually exceed the returns from a top ranked school? A) Yes, the lower ranked schools may provide a higher net present value for the degree if their tuition is low enough. B) Yes, but the potential gains depend on the discount rate and not the tuition. C) No, the salary advantages of the top ranked schools always payoff in the long run. D) We do not have enough information to answer the question.

a

The ʺNPV Criterionʺ is that a firm should invest in a new capital project if A) the present value of the expected future cash flows is larger than the present value of the cost of the investment. B) the future value of the expected future cash flows is larger than the cost of the investment. C) financing can be secured on the basis of new bonds. D) financing can be secured on the basis of new stocks. E) financing is not necessary because there are enough liquid assets in the companyʹs portfolio to afford the investment.

a

Which kind of risk affects the opportunity cost of capital? A) Nondiversifiable risk B) Diversifiable risk C) Both nondiversifiable and diversifiable risk D) The risk inherent in ʺrisklessʺ assets such as U.S. Treasury bills E) The risk inherent in ʺrisklessʺ portfolios such as broad stock market holdings

a

10) When the interest rate is R, the formula for finding the value of a current amount $M one year from now is A) M (1 + R/100). B) M (1 + R). C) M/(1+R). D) M / R. E) M / (100R).

b

25) Two bonds of equal risk are for sale on the secondary bond market. The two bonds have the same face value, and both mature in 10 years. Bond A pays $10 per year and bond B pay $15 per year. Which bond will sell for a higher price? A) Bond A B) Bond B C) They will sell for the same price. D) The relative prices will depend on the expected interest rate over the next 10 years.

b

29) A perpetuity for sale at $100,000 that promises a yearly payment of $5000 has an effective yield of A) 2%. B) 5%. C) 20%. D) 50%. E) 2000%.

b

31) If the payment stream of a bond remains the same and the price of the bond goes down, the A) effective yield is unchanged. B) effective yield rises. C) effective yield decreases. D) bond is reissued to reflect the higher interest rate. E) bond is reissued to reflect the lower interest rate.

b

34) Two corporations (TruBlu and FlyByNight) issue perpetuities that both pay $1,000 per year, but the market price of the FlyByNight bonds are much lower. The difference in the bond prices may reflect the belief that the bonds issued by FlyByNight are __________ risky when compared to the TruBlu bonds. A) less B) more C) equally D) none of the above

b

38) The real interest rate is A) the nominal rate plus the rate of inflation. B) the nominal rate minus the rate of inflation. C) the nominal rate divided by the rate of inflation. D) the nominal rate multiplied by the rate of inflation. E) the nominal rate.

b

47) Another name for diversifiable risk is A) systematic risk. B) nonsystematic risk. C) nominal risk. D) portfolio risk. E) meta-portfolio risk.

b

7) If the interest rate is 5%, in one period the value of $1 today is A) $1.20. B) $1.05. C) 95 cents.

b

74) When purchasing autos and other durable goods, consumers tend to use discount rates that are inversely proportional to their income, so the discount rates are lower for consumers with higher income. The key reason for this behavior is that: A) lower income consumers face very strict cash constraints, and they expect these problems to get worse in the future. B) high income consumers tend to have lower opportunity costs for money. C) high income consumers tend to make long-term investments (e.g., 30-year bonds), which always pay lower interest rates than short-term investments. D) none of the above

b

76) Knowledge, skills, and experience that make an individual more productive and able to earn a higher income are known as: A) mental capital. C) sweat equity. B) human capital. D) intangible capital.

b

77) Suppose you plan to retire in eight years, but your boss would like you to earn an online MBA in order to take on a new managerial position. The firm will continue to pay your salary while you are working through the online courses, and the new position pays an additional $15,000 per year. The online MBA tuition is $35,000 per year, and your discount rate is 5%. Should you complete the degree? A) No, the net present value of the degree is negative. B) Yes, the net present value of the degree is about $4,300 C) Yes, the net present value of the degree is about $20,000 D) We do not have enough information to answer this question.

b

A ʺriskyʺ asset will earn a rate of return close to that of ʺrisklessʺ assets if its risk is A) nondiversifiable. B) diversifiable. C) nominal, as opposed to real. D) related to the rate of inflation. E) no greater than the risk of similar assets.

b

If an assetʹs beta is high, its A) diversifiable risk and expected return are high. B) nondiversifiable risk and expected return are high. C) diversifiable risk is high; its expected return is low. D) nondiversifiable risk is high; its expected return is low. E) total risk is high; its return could be any amount.

b

The authors note that an appropriate discount rate for most U.S. households is near 5%. However, suppose you are considering the decision to attend graduate school, and you already have large credit card balances from your undergraduate years. If you decide to use a higher discount rate (e.g., 10%) to reflect your higher opportunity cost of money, what impact does this change in the discount rate have on the net present value of a graduate degree? A) Increases NPV B) Decreases NPV C) NPV would not change as long as we use nominal costs and returns. D) NPV may increase or decrease, and we cannot determine the direction of change without more information.

b

You manage a new product development team for an electronics manufacturer, and your firmʹs policy is that all new projects must pay for themselves in the first five years. Your team has projected that the first year of the project requires an initial investment of $2 million with no revenue, the second year loss is $500,000, the net revenue for year 3 is zero, and you earn $1.8 million in both year 4 and year 5. If the opportunity cost of capital for your firm is 8%, should you go ahead with this project? A) No, the expected NPV is negative B) Yes, the expected NPV is roughly $290,000 C) Yes, the expected NPV is $1.1 million D) We do not have enough information to answer this question.

b

11) The formula for finding the present value of an amount M that will be received one year from now, when the interest rate is R, is A) M × (1 + R/100). B) M × (1 + R). C) M/(1+R). D) M / R. E) M / (100R).

c

12) When the interest rate is R, the formula for finding the value of $M two years from now is A) M (1 + R)2. B) M (1 + R2). C) M / (1 + R)2. D) M / (1 + R2).

a

13) A certain magazine offers its subscribers the opportunity to ʺBuy Now and Save.ʺ If at the time their subscription renewal is due they agree to pay for 2 years rather than 1, the renewal price will be $50 per year rather than the usual $60 per year. At what interest rate will the consumer, who is certain she will subscribe to the magazine for the next 2 years, decide to ʺBuy Now and Saveʺ? A) any interest rate under 50 percent B) any interest rate over 1.5 percent C) any interest rate over 150 percent D) any interest rate under 5 percent E) She will always take this offer if she is absolutely certain to buy the magazine for another 2 years.

a

2) Which of the following questions is addressed when hiring capital, but not addressed when hiring labor? A) How much are future profits worth today? B) How much are todayʹs profits worth in the future? C) How much are the futureʹs profits worth in the future? D) How much are todayʹs profits worth today? E) All questions present when capital is purchased are present when labor is purchased.

a

27) As interest rates fall, A) the values of bonds rise. B) the values of bonds fall. C) the values of bonds are unchanged. D) the value of perpetuities are unchanged, but the value of other bonds change in value. E) the value of all bonds except perpetuities change.

a

30) A perpetual payment of $10,000, offered for sale at $125,000, is being offered at an effective yield of A) 8%. B) 9.2% C) 12.5%. D) 80%. E) 92%.

a

37) The interest rate R in an NPV calculation should always A) be the return that the firm could earn on a similar investment. B) be the riskless interest rate (e.g., U.S. Treasury bills). C) be the rate on corporate bonds. D) be the rate of return available in the stock market. E) be the interest rate at which the firm has to borrow.

a

42) A $130,000 investment in new equipment this year will increase your firmʹs profits by $50,000 in each of the next 3 years. What is the net present value of this investment if your firmʹs opportunity cost of capital is 10 percent? A) -5,657 B) 5,657 C) 124,343 D) 128,850

a

If the rate of return on the stock market is rm and the rate of return on a risk-free asset is rf, then A) rm - rf measures the risk, all of it nondiversifiable, one has to accept in the stock market. B) rm - rf measures the risk, all of it diversifiable, one has to accept in the stock market. C) rm + rf measures the risk, all of it nondiversifiable, one has to accept in the stock market. D) rm + rf measures the risk, all of it diversifiable, one has to accept in the stock market. E) rm rf measures the stock marketʹs total risk.

a

The asset beta in the Capital Asset Pricing Model is a moderate number that measures A) how sensitive the assetʹs return is to market movements. B) how sensitive the assetʹs discount rate is to changes in inflation. C) the risk premium on the stock market. D) the risk premium on an individual stock.

a