CORP FIN: CH. 9-13

A project has an initial cost of $6,900. The cash inflows are $850, $2,400, $3,100, and $4,100 over the next four years, respectively. What is the payback period?

3.13 years

The most important characteristic in determining the expected return of a well-diversified portfolio is the variance of the individal assets in the portfolio.

False

Suppose the government announces that, based on a just-completed survey, the growth rate i the economy is likely to be 2% in the coming year, as compared to 5% for the past year. Will security prices increase decrease or stay the same following this announcement? Does it make any difference whether the 2% figure was anticipated by the market?

If the expected market growth rate in the coming year is 2%, then there would be no change in security prices if this expectation had been fully anticipated and priced. If the market had been expecting a growth rate that's different than 2% and the expectation was incorporated into security prices, then the government's announcement would most likely cause security prices to change. This would cause prices to drop if the anticipated growth rate had been more than 2%, and prices would rise if the anticipated growth rate had been less than 2%.

A project has a net present value of zero. Given this information:

the project's cash inflows equal its cash outflows in current dollar terms.

An investment project provides cash flows of $7,000 per year for 10 years. If the initial cost is $20,000, what is the payback period?

2.9 years

The length of time a firm must wait to recoup the money it has invested in a project is called the:

payback period.

A project has a required return of 12.6 percent, an initial cash outflow of $42,100, and cash inflows of $16,500 in Year 1, $11,700 in Year 2, and $10,400 in Year 4. What is the net present value?

$-11,748.69

A project has an initial cash outflow of $42,600 and produces cash inflows of $17,680, $19,920, and $15,670 for Years 1 through 3, respectively. What is the NPV at a discount rate of 12 percent? Question 3Answera. $311.16

$219.41

Assume an investment has cash flows of −$105,000, $140,000, $200,000, and $485,000 for Years 0 to 3, respectively. What is the NPV if the required return is 13.5 percent? Should the project be accepted or rejected?

$505,307; accept

A project will produce cash inflows of $5,400 per year for 3 years with a final cash inflow of $2,400 in Year 4. The project's initial cost is $13,400. What is the net present value if the required rate of return is 14.2 percent?

$505.92

The range of possible correlations between two securities is defined as:

+1 to -1

The relevant discount rate is 14 percent for a project with cash flows of −$9,200, $4,600, $3,300, and $3,800 for Years 0 to 3, respectively. What is the profitability index?

.99

Assume a project has cash flows of −$54,300, $18,200, $37,300, and $14,300 for Years 0 to 3, respectively. What is the profitability index given a required return of 12.6 percent?

1.02

A project has cash flows of −$152,000, $60,800, $62,300, and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?

1.02; accept

Stock A has a beta of 1.2, Stock B's beta is 1.46, and Stock C's beta is .72. If you invest $2,000 in Stock A, $3,000 in Stock B, and $5,000 in Stock C, what will be the beta of your portfolio?

1.038

The common stock of CTI has an expected return of 14.48 percent. The return on the market is 11.6 percent and the risk-free rate of return is 3.42 percent. What is the beta of this stock?

1.35

A stock has an expected return of 13.4 percent, the risk free rate is 3.8 percent, and the market risk premium is 7 percent. What must the beta of the stock be?

1.37

The expected return on HiLo stock is 14.08 percent while the expected return on the market is 11.5 percent. The beta of HiLo is 1.26. What is the risk-free rate of return?

1.58%

It will cost $15,000 to acquire a used food truck that is expected to produce cash inflows of $8,500 per year for five years. After the five years, the truck is expected to be worthless. What is the payback period?

1.8 years

Zelo stock has a beta of 1.23. The risk-free rate of return is 2.86 percent and the market rate of return is 11.47 percent. What is the amount of the risk premium on Zelo stock?

10.59%

A project has cash flows of -$343,200, $56,700, $138,500, and $245,100 for Years 0 to 3, respectively. The required rate of return is 10.5 percent. Based on the internal rate of return of _____ percent for this project, you should _____ the project.

10.93; accept

Stock M has a beta of 1.2. The market risk premium is 7.8 percent and the risk-free rate is 3.6 percent. Assume you compile a portfolio equally invested in Stock M, Stock N, and a risk-free security that has a portfolio beta equal to the overall market. What is the expected return on the portfolio?

11.4%

A portfolio consists of three stocks. There are 540 shares of Stock A valued at $24.20 share, 310 shares of Stock B valued at $48.10 a share, and 200 shares of Stock C priced at $26.50 a share. Stocks A, B, and C are expected to return 8.3 percent, 16.4 percent, and 11.7 percent, respectively. What is the expected return on this portfolio?

12.47%

The stock of Big Joe's has a beta of 1.38 and an expected return of 16.26 percent. The risk free rate of return is 3.42 percent. What is the expected return on the market?

12.72%

The risk-free rate of return is 3.68 percent and the market risk premium is 7.84 percent. What is the expected rate of return on a stock with a beta of 1.32?

14.03%

A project has cash flows of −$35,000, $0, $10,000, and $42,000 for Years 0 to 3, respectively. The required rate of return is 15 percent. Based on the internal rate of return of _____ percent, you should _____ the project.

15.21; accept

The Whey Station is considering a project with an initial cost of $146,500 and cash inflows for Years 1 to 3 of $56,700, $68,500, and $71,200, respectively. What is the IRR?

15.56%

The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6 percent and the market risk premium is 9 percent. What is the expected rate of return?

16.47%

A firm evaluates all of its projects by applying the IRR rule. The current proposed project has cash flows of −$37,048, $16,850, $15,700, and $19,300 for Years 0 to 3, respectively. The required return is 18 percent. What is the project IRR? Should the project be accepted or rejected?

18.42%; accept

A project has cash flows of -$108,000, $52,800, $53,200, and $83,100 for Years 0 to 3, respectively. The required payback period is two years. Based on the payback period of _____ years for this project, you should _____ the project.

2.02; reject

A 5-year project requires a $20,000 investment in machinery that will be depreciated on a straight-line basis to a value of $0 over its 5-year life. The project will have net income of $6,000 per year and operating cash inflows of $7,500 per year. What is the payback period?

2.7 years

A project has an initial cost of $7,900 and cash inflows of $2,100, $3,140, $3,800, and $4,500 per year over the next four years, respectively. What is the payback period?

2.7 years

The market has an expected rate of return of 9.8 percent. The long-term government bond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4 percent. The inflation rate is 3.1 percent. What is the market risk premium?

6.4%

Projects A and B are mutually exclusive and have an initial cost of $82,000 each. Project A provides cash inflows of $34,000 per year for three years while Project B produces a cash inflow of $115,000 in Year 3. Which project(s) should be accepted if the discount rate is 11.7 percent? What if the discount rate is 13.5 percent?

Accept B at 11.7 percent and neither at 13.5 percent

You are considering two mutually exclusive projects. Project A has cash flows of −$72,000, $21,400, $22,900, and $56,300 for Years 0 to 3, respectively. Project B has cash flows of −$81,000, $20,100, $22,200, and $74,800 for Years 0 to 3, respectively. Both projects have a required 2.5-year payback period. Should you accept or reject these projects based on payback analysis?

Accept Project A and reject Project B

Project A costs $47,800 with cash inflows of $34,200 in Year 1 and $28,700 in Year 2. Project B costs $63,200 with cash inflows of $21,900 in Year 1 and $59,200 in Year 2. These projects are independent and have an assigned discount rate of 15 percent. Based on the profitability index, what is your recommendation concerning these projects?

Accept both projects.

A project has an initial cost of $52,700 and a market value of $61,800. What is the difference between these two values called?

Net Present Value

Which one of the following methods predicts the amount by which the value of a firm will change if a project is accepted?

Net Present Value

Describe how NPV is calculated and describe the information this measure provides about a sequence of cash flows: What is the NPV criterion decision rule?

Net Present Value is the sum of the present values of a project's cash flows. It evaluates the profitability of the project; this helps determine whether or not a project is worth the costs. The NPV criterion decision rule is used to accept projects that have a positive Net Present Value and reject projects with a negative Net Present Value.

A proposed project has an initial cost of $74,200 and cash inflows of $23,900, $34,700, and $40,200 for Years 1 through 3, respectively. The required rate of return is 15.2 percent. Based on IRR, should this project be accepted? Why or why not?

No; The IRR is less than the required return.

You estimate that a project will cost $33,700 and will provide cash inflows of $14,800 in Year 1 and $24,600 in Year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14.2 percent? Why or why not?

No; The PI is .87.

Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why?

Project A, because it has the larger NPV.

Bui Bakery has a required payback period of two years for all of its projects. Currently, the firm is analyzing two independent projects. Project X has an expected payback period of 1.4 years and a net present value of $6,100. Project Z has an expected payback period of 2.6 years with a net present value of $18,600. Which project(s) should be accepted based on the payback decision rule?

Project X only

Project A has a required return on 9.2 percent and cash flows of −$87,000, $32,600, $35,900, and $43,400 for Years 0 to 3, respectively. Project B has a required return of 12.7 percent and cash flows of −$85,000, $14,700, $21,200, and $89,800 for Years 0 to 3, respectively. Which project(s) should you accept based on net present value if the projects are mutually exclusive?

Reject Project A and accept Project B

A project has a discount rate of 15.5 percent, an initial cost of $109,200, an inflow of $56,400 in Year 1, and an inflow of $75,900 in Year 2. Your boss requires that every project return a minimum of $1.06 for every $1 invested. Based on this information, what is your recommendation on this project?

Reject the project because the PI is .97.

In broad terms, why are some risks diversifiable? Why are some risks nondiversifiable? Does it follow than an investor can control the level of unsystematic risk in a portfolio, but no the level of systemic risk?

Some risks are unique to that asset and can be eliminated by investing in different assets. Some risk applies to all assets. Systematic risk can be controlled but can be costly to estimated returns.

Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule

The IRR is the rate of return earned on an investment. It is the discount rate that causes the Net Present Value of cash flows to be equal to zero at the IRR discount rate. If this is the case, the net value of the project is zero. The IRR criterion decision rule is used to whether or not to accept projects based on whether the IRRs are greater than the discount rate, and to reject projects with IRRs less than the discount rate.

If a portfolio has a positive investment in every asset, can the expected dreturn on the portfolio be greater than that on every asset i the portfolio? Can it be less than that on every asset in the portfolio?

The answer is no for both. The answer is no because the expected return of the portfolio is a weighted average of the returns from its assets. Because of this, the expected return must be less than the returns from the largest asset and greater than the returns from the smallest asset.

Why is payback often used as the sole method of analyzing a proposed small project?

The benefits of payback analysis usually outweigh the costs of the analysis.

Describe how the profitability index is a calculated, and describes the information this measure provides about a sequence of cash flows. What is the profitability index decision rule?

The profitability index is the present value of cash inflows divided by the project's initial cost. It is a benefit/cost ratio, that provides a measure of the relative profitability of a project. The profitability index decision rule is used to determine whether or not to accept projects with a Profitability Index greater than one, and to reject projects with a Profitability Index less than one.

If a portfolio has a positive investment in every asset, can the standard deviation on the portfolio be less than that on every asset asset in the portfolio? What about the portfolio beta?

The standard deviation can be less than the value of every asset in the portfolio. This is because that's the whole point of modern portfolio theory. The portfolio's beta can't be less than the smallest beta because the portfolio beta is a weighted average of the individual asset betas.

Which one of the following is the best example of two mutually exclusive projects?

Waiting until a machine finishes molding Product X before being able to mold Product Z

Alicia is considering adding toys to her gift shop. She estimates the cost of new inventory will be $9,500 and remodeling expenses will be $850. Toy sales are expected to produce net cash inflows of $1,300, $4,900, $4,400, and $4,100 over the next four years, respectively. Should Alicia add toys to her store if she assigns a 3-year payback period to this project? Why or why not?

Yes; The payback period is 2.94 years.

a. Describe how the payback period is calculated b. What are the problems associated with using the payback period to evaluate cash flows? c. What are the advantages of using the payback period to evaluate cash flows?

a. Payback period is the accounting break-even point of cash flows. To compute the payback period, a company must calculate the initial cost of the project or investment. Once that's determined, the yearly cash flow from the project or investment must also be calculated. After both of those are determined, divide the cost of the project by the yearly cash flow to determine the payback period. b. Some problems associated with the payback period is that it ignores the time value of money, the selection of a hurdle point for a payback period isn't stable and lacks rules or method, the payback period doesn't work in the favor of short-term projects, and it fully ignores any cash flows that occur after the cutoff point. c. The analysis is straightforward and simple, and the accounting numbers and estimates are available and accessible.

You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for Years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for Years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should:

accept Project A and reject Project B.

Which one of the following is an example of unsystematic risk?

an oil tanker runs aground and spills its cargo

Net present value:

is the best method of analyzing mutually exclusive projects.

When computing the expected return on a portfolio of stocks the portfolio weights are based on the:

market value of the total shares held in each stock.

If a firm accepts Project X it will not be feasible to also accept Project Z because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:

mutually exclusive.

Which one of the following is the best example of systematic risk?

the Federal Reserve increases interest rates

If a project has a net present value equal to zero, then:

the project earns a return exactly equal to the discount rate.

Risk that affects at most a small number of assets is called ________________ risk

unsystematic