BMA

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If the risk-free rate of interest (rf) is 6%, then you should be indifferent between receiving $250 in one year or....

$235.85 today. $250.00/1.06 = $235.85

If the current rate of interest is 8%, then the present value of an investment that pays $1000 per year and lasts 20 years is closest to:

$9,818

Assume that projects Alpha and Beta are mutually exclusive. Which of the following statements is true regarding the investment decision tools' suitability for deciding between projects Alpha & Beta?

The incremental IRR should not be used since the projects have different discount rates.

The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement. The owner is considering about selling the restaurant now and retiring. If the interest rate is 7%, the NPV of this alternative is closest to:

There is no TVM for alternative #1. The NPV = $350,000.

Which of the following statements regarding Net Present Value (NPV) is INCORRECT?

When faced with a set of alternatives, choose the one with the lowest NPV in order to minimize the present value of costs. Correct one: The NPV represents the value of the project in terms of cash today. Good projects will have a positive NPV. The NPV of a project is the difference between the present value of its benefits and the present value of its costs.

Wyatt oil is considering drilling a new self sustaining oil well at a cost of $1,000,000. This well will produce $100,000 worth of oil during the first year, but as oil is removed from the well the amount of oil produced will decline by 2%, per year forever. If the Wyatt oil's appropriate interest rate is 8%, then the NPV of this oil well is closest to:

Your great aunt Matilda put some money in an account for you on the day you were born. This account pays 8% interest per year. On your 21st birthday the account balance was $5033.83. The amount of money that your great aunt Matilda originally put in the account is closest to:

$1000

An exchange traded fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each share represents a portfolio of two shares of Apple Inc. (APPL), one share of Google (GOOG), and ten shares of Microsoft (MSFT). Suppose the current stock prices of each individual stock are as shown below: Stock Price APPL $200.23 GOOG $570.51 MSFT $29.61 The price per share of this ETF in a normal market is closest to:

$1267 Price = 2 × $200.23 + 1 × $570.51 + 10 × $29.61 = $1267.07

Your great aunt Matilda put some money in an account for you on the day you were born. This account pays 8% interest per year. On your 21st birthday the account balance was $5033.83. The amount of money that would be in the account if you left the money there until your 65th birthday is closest to:

$148,780

Suppose that a young couple has just had their first baby and they wish to ensure that enough money will be available to pay for their child's college education. Currently, college tuition, books, fees, and other costs, average $12,500 per year. On average, tuition and other costs have historically increased at a rate of 4% per year. Assuming that costs continue to increase an average of 4% per year, tuition and other costs for one year for this student in 18 years when she enters college will be closest to:

$25,323

Corporate Governance

- the system of governing a company so that the of corporate owners and other stakeholders are protected The role of the corporate governance system is to mitigate the conflict of interest that results from the separation of ownership and control without unduly burdening managers with the risk of the firm. - Incentives in order to make the manager act in your preferred way would be to give a stock in the company or compensation that is sensitive to performance

An exchange traded fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each share represents a portfolio of two shares of International Business Machines (IBM), three shares of Merck (MRK), and three shares of Citigroup Inc. (C). Suppose the current market price of each individual stock are shown below: Stock Current Price IBM $121.57 MRK $36.59 C $3.15 The price per share of the ETF in a normal market is closest to:

2 × 121.57 + 3 × 36.59 + 3 × 3.15 = $362.36

Consider the following four alternatives: $132 received in two years. $160 received in five years. $200 received in eight years. $220 received in ten years. The ranking of the four alternatives from most valuable to least valuable if the interest rate is 7% per year would be:

3, 1, 2, 4

Which of the following statements is FALSE?

A dollar in the future is worth more than a dollar today. Correct ones: The effect of earning interest on interest is known as compound interest. The process of moving a value or cash flow forward in time is known as compounding. It is only possible to compare or combine values at the same point in time.

Which of the following adjustments to net income is NOT correct if you are trying to calculate cash flow from operating activities?

Add increases in accounts receivable

Due to a pre-existing contract, Recycle America Inc. has the opportunity to acquire 10,000 pounds of scrap aluminum and 2500 pounds of scrap lead for $10,750. If the current market price for scrap aluminum is $0.83 per pound and the current market price for lead is $1.06 per pound, then the added benefit (cost) to you if you acquire this metal is:

Added Benefit = 10,000 × $0.83 + 2500 × $1.06 - $10,750 = $200

Corporate governance tries to

Align interests by providing incentives for taking the right action and punishment for taking the wrong action

Which of the following statements is FALSE?

An annuity is a stream of N equal cash flows paid at irregular intervals. Correct ones: Annuities are paid at regular intervals. The difference between an annuity and a perpetuity is that an annuity ends after some fixed number of payments. Most car loans, mortgages, and some bonds are annuities. A growing perpetuity is a cash flow stream that occurs at regular intervals and grows at a constant rate forever.

Joe just inherited the family business, and having no desire to run the family business, he has decided to sell it to an entrepreneur. In exchange for the family business, Joe has been offered an immediate payment of $100,000. Joe will also receive payments of $50,000 in one year, $50,000 in two years, and $75,000 in three years. The current market rate of interest for Joe is 6%. 10) In terms of present value, how much will Joe receive for selling the family business?

Answer: PV = $100,000 + $50,000/(1.06)1 + $50,000/(1.06)2 + $75,000/(1.06)3 = $254,641

Board with majority of outsider directors

Are more likely to fire the firms CEO for poor performance

Board with majority of outsider directors are

Better monitors of managerial effort and actions

Punishment from Board

Board can fire a manager for poor performance or fraud, or when, upon failure of the board to act, shareholders or raiders launch control contests to replace the board and the management

In corporations, the ultimate decision regarding business matters are made by:

Board of directors

Which of the following statements is true?

Corporations face more regulations when compared to partnerships

Dolan Corporation has Gross Profit of $2.3 million, cost of sales of $1.7 million, operating expenses of $0.8 million, and "other" income of $0.5 million. What is its EBIT?

Cost of goods sold has already been subtracted from Gross Profit, so EBIT = Gross Profit - Operating Expenses + Other Income = $2.3 - $0.8 + $0.5 = $2 million

Operating expenses

Depreciation and amortization Selling, general and administrative expenses Research and development

Low-Grade Copper Ore $640 per Ton High-Grade Copper Ore $940 per Ton Coloma Cooper Incorporated is able to produce $640 worth of copper from one ton of low-grade copper ore. Because of its higher copper content, Coloma can produce $940 worth of copper from one ton of high-grade copper ore. A mining company is offering to trade you 7250 tons of low-grade copper ore for 5000 tons of high-grade copper ore. Assuming you currently have 5000 tons of high-grade ore, what should you do? Trade or not trade?

Do not trade Coloma should keep the high grade ore and refine it. See below: Total Benefits No trade and refine high-grade ore (base case) 5000 tons × $940 of copper/ton = $4,700,000 Trade high-grade for low-grade 7250 tons × $640 of copper/ton = $4,640,000 Added Benefits = Total Benefits - Base Case = $4,640,000 - $4,700,000 = -$60,000 (added cost)

In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. Perrigo's earnings per share (EPS) is closest to:

EPS = (Net Income)/(Shares Outstanding) = $163.82/91.33 = 1.7937

Enterprise Value = MV Equity + Debt - Cash = $39.2 × 91.33 + $845.01 - $257.09 = $4168.06

The Sisyphean Company is planning on investing in a new project. This will involve the purchase of some new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as detailed below: Year One $200,000 Year Two $225,000 Year Three $275,000 Year Four $200,000 The appropriate discount rate for this project is 16%. The NPV for this project is closest to:

Explanation: A) NPV = -450,000+ 200,000/(1.16)1 + 225,000/(1.15)2 + 275,000/(1.15)3 + 200,000/(1.15)4 = 176,265

Nielson Motors is considering an opportunity that requires an investment of $1,000,000 today and will provide $250,000 one year from now, $450,000 two years from now, and $650,000 three years from now. If the appropriate interest rate is 10%, then the NPV of this opportunity is closest to:

Explanation: B) NPV = -1,000,000 + 250,000/(1.10)1 + 450,000/(1.10)2 + 650,000/(1.10)3 = 87,528.17

Boulderado has come up with a new composite snowboard. Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project. Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years. Boulderado's discount rate is 10%. The NPV for Boulderado's snowboard project is closest to:

Explanation: C) CF0 = -250,000 CF1 = -250,000 CF2 = -250,000 CF3 = -250,000 CF4 = +200,000 CF5 = +200,000 CF6 = +200,000 CF7 = +200,000 CF8 = +200,000 CF9 = +200,000 CF10 = +200,000 CF11 = +200,000 CF12 = +200,000 CF13 = +200,000 I = 10 Compute NPV = 51,588

Rearden Metals is considering opening a strip mining operation to provide some of the raw materials needed in producing Rearden metal. The initial purchase of the land and the associated costs of opening up mining operations will cost $100 million today. The mine is expected to generate $16 million worth of ore per year for the next 12 years. At the end of the 12th year Rearden will need to spend $20 million to restore the land to its original pristine nature appearance. The number of potential IRRs that exist for Rearden's mining operation is equal to:

Explanation: C) This problem begins with a negative cash flow that is followed by 11 positive cash flows and finally by one last negative cash flow, giving two changes in the signs of the cash flows. This indicates that there will be two IRRs for this problem.

Consider the following timeline detailing a stream of cash flows: 0 1 2 3 4 1000 2000 3000 4000 ? If the current market rate of interest is 8%, then the future value of this stream of cash flows is closest to:

FV = 1000(1.08)4 + 2000(1.08)3 + 3000(1.08)2 + 4000(1.08)1 = $11,699

Taggart Transcontinental currently has a bank loan outstanding that requires it to make three annual payments at the end of the next three years of $1,000,000 each. The bank has offered to allow Taggart Transcontinental to skip making the next two payments in lieu of making one large payment at the end of the loan's term in three years. If the interest rate on the loan is 6%, then the final payment that the bank will require to make Taggart Transcontinental indifferent between the two forms of payments is closest to:

FV = PV(1 + i)N = $1,000,000(1.06)2 + 1,000,000(1.06)1 + 1,000,000 = 3,183,600

Use the following timeline to answer the question(s) below. 0 1 2 3 $600 $1200 $1800 At an annual interest rate of 7%, the future value of this timeline in year 3 is closest to:

FV = PV(1 + i)N = $600(1.07)2 + 1200(1.07)1 + 1800 = 3770.94

At an annual interest rate of 7%, the future value of $5000 in five years is closest to

FV = PV(1 + i)N = 5000(1.07)5 = 7012.76

Suppose that a young couple has just had their first baby and they wish to insure that enough money will be available to pay for their child's college education. They decide to make deposits into an educational savings account on each of their daughter's birthdays, starting with her first birthday. Assume that the educational savings account will return a constant 7%. The parents deposit $2000 on their daughter's first birthday and plan to increase the size of their deposits by 5% each year. Assuming that the parents have already made the deposit for their daughter's 18th birthday, then the amount available for the daughter's college expenses on her 18th birthday is closest to:

FV of a growing annuity: 2000⋅1/.07−.05(1−(1+.05/(1+.07))^18)x(1.07)^18=97,331

Independent Boards make

Fewer value destroying acquisitions and are more likely to act in shareholders interest if targeted in an acquisition

You are considering investing in a start up project at a cost of $100,000. You expect the project to return $500,000 to you in seven years. Given the risk of this project, your cost of capital is 20%. The IRR for this project is closest to:

IRR = 7te Wurzel√500,000/100,000-1 = 0.2584

Which of the following statements is FALSE?

Income Tax = EBIT × (1 - τc).

Directors who are employees, former employees, or family members of employees are

Inside directors

Firms stock price increases on the announcement of:

Its addition off an independent board member the increased firm value appears to come from the potential for the board to make better decisions on acquisitions and CEO turnover rather than from improvements in the firms operating performance

Market cap = price × shares outstanding = $39.2 × 91.33 million = $3580.14 million

Market to Book = (MV Equity)/(BV Equity) = ($39.2 × 91.33 million)/(BV Equity) = 3.76;

Market-to-Book Ratio

MtB= (MV Equity) / (BV Equity) = (24 x 25) / 100 = 6.0 MtB = (Strock price x Shares Outstanding) / Shareholders Equity

Which of the following formulas regarding NPV is INCORRECT?

NPV + PV(benefits) = PV(Cost) Correct ones: NPV + PV(costs) = PV(benefits) NPV = PV(All project cash flows)

Use the following information to answer the question. Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book took one year to write. In the time she spent writing, Palin could have been paid to give speeches and appear on TV news as a political commentator. Given her popularity, assume that she could have earned $8 million over the year (paid at the end of the year) she spent writing the book. Assume that once her book is finished, it is expected to generate royalties of $5 million in the first year (paid at the end of the year) and these royalties are expected to decrease by 40% per year in perpetuity. Assuming that Palin's cost of capital is 10% and given these royalties payments, the NPV of Palin's book deal is closest to:

NPV = $11 - $8/(1.10)^1 + $5/(.10 - -0.40) = $ 13.72727

You have an investment opportunity in Germany that requires an investment of $250,100 today and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk-free rate of interest in Germany is 7% and the current competitive exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the project?

NPV = -$100; No NPV = -$250,100 + (€208,650/1.07) × $1.00/€0.78 = -$100, so since NPV < 0, reject

NPV = -100,000 + 500,000/(1.020)^7 = 39,540.82

Year Cash Flow 0 -10,000 1 4000 2 4000 3 4000 4 4000 Assume the appropriate discount rate for this project is 15%. The payback period for this project is closest to:

Payback = 10,000/4000 = 2.5

Wyatt Oil has a net profit margin of 4.0%, a total asset turnover of 2.2, total assets of $525 million, and a book value of equity of $220 million. Wyatt Oil's current return-on-equity (ROE) is closest to:

ROE = net profit margin x total asset turnover x leverage ROE = 0.04 x 2.2 x (525/220) = 0.21 = 21%

Which of the following statements is FALSE?

Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions Correct ones: The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital. The IRR investment rule states that you should take any investment opportunity where the IRR exceeds the opportunity cost of capital. There are situations in which multiple IRRs exist

Shareholders can

Submit shareholders resolutions directing the board to take specific actions -withhold votes for the board of directors candidates -initiate a proxy contest -shareholders can vote on directors who then hire or fire management

You are offered an investment opportunity in which you will receive $23,750 today in exchange for paying $25,000 in one year. Suppose the risk-free interest rate is 6% per year. Should you take this project? The NPV for this project is closest to:

Yes; NPV = $165 NPV = 23,750 - 25,000/(1.06) = 165, since NPV > 0 accept the project

principal-agent problem is/arises

a problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him Because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest Also because of the separation of ownership and control in a corporation

The internal rate of return rule can result in the wrong decision if the projects being compared have:

differences in scale. differences in timing.

The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement. The owner is considering the following three alternatives: Sell the restaurant now and retire. Hire someone to manage the restaurant for the next year and retire. This will require the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one year the owner will sell the restaurant for $350,000. Scale back the restaurant's hours and ease into retirement over the next year. This will require the owner to spend $40,000 on expenses now, but will generate $75,000 in profit at the end of the year. In one year the owner will sell the restaurant for $350,000. If the interest rate is 7%, the alternative with the highest NPV is:

lternative #2 with an NPV of approximately $370,561 There is no TVM for alternative #1. The NPV = $350,000. Alternative #2: NPV = -50,000 + (100,000 + 350,000)/1.07 = $370,561 Alternative #3: NPV = -40,000 + (75,000 + 350,000)/1.07 = $357,196

When we express the value of a cash flow or series of cash flows in terms of dollars today, we call it the ________ of the investment. If we express it in terms of dollars in the future, we call it the ________.

present value; future value

By evaluating cost and benefits using competitive market prices, we can determine whether a decision will make the firm and its investors wealthier. This central concept is called:

BMA

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