[u05a1] Unit 5 Assignment 1
Introduction
In this assignment, you will learn about the capital budgeting process, which is basically how companies evaluate their investment in various projects, such as buying new machinery or expanding into a new plant. In addition, you will learn about the following techniques used in capital budgeting:
Net Present Value.
Internal Rate of Return.
Modified Internal Rate of Return.
Payback Period.
Discounted Payback Period.
Profitability Index.
Instructions
Answer the following questions and complete the following problems, as applicable.
You may solve the following problems algebraically, or you may use a financial calculator or Excel spreadsheet. If you choose to solve the problems algebraically, be sure to show your computations. If you use a financial calculator, show your input values. If you use an Excel spreadsheet, show your input values and formulas.
Note: In addition to your solution to each computational problem, you must show the supporting work leading to your solution to receive credit for your answer.
1. Describe the Net Present Value (NPV) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using NPV?
2. What is the payback period statistic? What is the acceptance benchmark when using the payback period statistic?
3. Describe the Internal Rate of Return (IRR) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using IRR?
4. Describe the Modified Internal Rate of Return (MIRR) method for determining a capital budgeting project’s desirability. What are MIRR’s strengths and weaknesses?
5. Compute the NPV statistic for Project Y and tell [advise] whether the firm should accept or reject the project with the cash flows shown in the chart if the appropriate cost of capital is 12 percent.
Project Y
Time 0 1 2 3 4
Cash Flow -$11,000 $3,350 $4,180 $1,520 $2,000
(Cornett, Adair, &Nofsinger, 2014).
6. Compute the payback period statistic for Project B and decide whether the firm should accept or reject the project with the cash flows shown in the chart if the maximum allowable payback is three years.
Project B
Time 0 1 2 3 4 5
Cash Flow -$11,000 $3,350 $4,180 $1,520 $950 $1,000
(Cornett, Adair, &Nofsinger, 2014).
Question 1
Question: Which factor is not considered when determining a form of business organization?
Answer
a.
Who owns the firm.
b.
The owners’ risks.
c.
The tax ramifications.
d.
The physical location of the business.
4 points
Question 2
What should a firm’s primary objective be, given that it might actually be the most beneficial for society in the long run?
Answer
a.
Minimizing layoffs.
b.
Maximizing market share.
c.
Minimizing costs.
d.
Maximizing shareholder value.
4 points
Question 3
What is the definition of the term agency problem?
Answer
a.
The difficulties that arise in professional baseball when players become free agents.
b.
The difficulties that arise when a principle hires an agency to represent their company.
c.
The difficulties that arise when a principle hires an agent and cannot fully monitor the agent’s actions.
d.
When a principle hires an agent and must monitor every move they make, because they have found the agent to be unethical.
4 points
Question 4
A particular security’s default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security’s liquidity risk premium is 0.35 percent and the maturity risk premium is 0.95 percent. The security has no special covenants. What is the security’s equilibrium rate of return?
Answer
a.
8.50 percent.
b.
6.05 percent.
c.
10.25 percent.
d.
9.90 percent.
4 points
Question 5
Which of the following statements is correct?
Answer
a.
An IPO is an example of a primary market transaction.
b.
Money markets are subject to wider price fluctuations and are therefore more risky than capital market instruments.
c.
A direct transfer of funds is more efficient than using financial institutions.
d.
The market segmentation theory argues that different investors have different risk preferences, which determine the shape of the yield curve.
4 points
Question 6
Which of the following transactions in NOT a secondary market transaction?
Answer
a.
GE sells $30 million of new preferred stock.
b.
Microsoft sells $2 million of IBM preferred stock out of its marketable securities portfolio.
c.
The Magellan Fund buys $100 million of Apple previously issued bonds.
d.
Allstate Insurance Company. Sells $5 million in IBM bonds.
4 points
Question 7
How are future values affected by changes in interest rates?
Answer
a.
The lower the interest rate, the larger the future value will be.
b.
The higher the interest rate, the larger the future value will be.
c.
Future values are not affected by changes in interest rates.
d.
One would need to know the present value to determine the impact.
4 points
Question 8
Which of the following statements about the future value of a dollar is true?
Answer
a.
A dollar paid (or received) in the future is worth more than a dollar paid (or received) today.
b.
A dollar paid (or received) in the future is worth as much as a dollar paid (or received) today.
c.
A dollar paid (or received) in the future is worth less than a dollar paid (or received) today.
d.
A dollar paid (or received) in the future is not comparable to a dollar paid (or received) today.
4 points
Question 9
Which of the following statements about calculating the number of years needed to grow an investment to a specific amount of money is true?
Answer
a.
The lower the interest rate, the shorter the time period needed to achieve the growth.
b.
The higher the interest rate, the shorter the time period needed to achieve the growth.
c.
The interest rate has nothing to do with the length of the time period needed to achieve the growth.
d.
The Rule of 72 is the only way to calculate the time period needed to achieve the growth.
4 points
Question 10
What is the correct term for level sets of frequent, consistent cash flows?
Answer
a.
Loans.
b.
Budgets.
c.
Annuities.
d.
Bills.
4 points
Question 11
What does a loan amortization schedule show?
Answer
a.
The principal balance paid per period only.
b.
The interest paid per period only.
c.
Both the principal balance and interest paid per period.
d.
The present value of the payments due.
4 points
Question 12
Which bond sells for a price lower than its par value?
Answer
a.
A discount bond.
b.
A premium bond.
c.
A junk bond.
d.
A municipal bond.
4 points
Question 13
Which bond makes no interest payments?
Answer
a.
A bond whose coupon rate is equal to the market interest rates.
b.
A bond whose coupon rate is greater than the market interest rates.
c.
A bond whose coupon rate is less than the market interest rates.
d.
A zero coupon bond.
4 points
Question 14
A 6-percent corporate coupon bond is callable in 10 years for a call premium of one year of coupon payments. Assuming a par value of $1,000, what is the price paid to the bondholder, if the issuer calls the bond?
Answer
a.
$60
b.
$600
c.
$1000
d.
$1060
4 points
Question 15
As residual claimants, which investors claim any cash flows to the firm that remain after the firm pays all other claims?
Answer
a.
Creditors.
b.
Bondholders.
c.
Preferred stockholders.
d.
Common stockholders.
4 points
Question 16
What is the composition of the Dow Jones Industrial Average?
Answer
a.
All stock listed on the New York Stock Exchange.
b.
30 of the largest (market capitalization) and most active companies in the U.S. economy.
c.
The 500 largest firms in their respective economic sectors.
d.
Fortune Magazine’s 500 largest-ranked firms.
4 points
Question 17
At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 100 shares of Ralph Lauren (RL), which trades at $85.13?
Answer
a.
$8,503.05.
b.
$8,503.00.
c.
$8,522.95.
d.
$9,508.00.
4 points
Question 18
Which of the following terms is defined as the volatility of an investment, including firm-specific risk, as well as market risk?
Answer
a.
Diversifiable risk.
b.
Market risk.
c.
Standard deviation.
d.
Total risk.
4 points
Question 19
What is the correct ranking for the following stocks, highest to lowest, based on their total risk level?
Night Ryder has an average return of 15 percent and a standard deviation of 35 percent.
WholeMart has an average return of 13 percent and a standard deviation of 25 percent
Fruit Fly has an average return of 19 percent and a standard deviation of 30 percent.
Answer
a.
(1) Fruit Fly, (2) Night Ryder, (3) WholeMart
b.
(1) Night Ryder, (2) WholeMart, (3) Fruit Fly
c.
(1) Night Ryder, (2) Fruit Fly, (3) WholeMart
d.
(1) WholeMart, (2) Fruit Fly, (3) Night Ryder
4 points
Question 20
An investor owns $10,000 of Adobe Systems stock, $15,000 of Dow Chemical, and $25,000 of Office Depot. What are the portfolio weights of each stock?
Answer
a.
Adobe Systems = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333.
b.
Adobe Systems = 0.2, Dow Chemical = 0.3, Office Depot = 0.5.
c.
Adobe Systems = 0.3, Dow Chemical = 0.2, Office Depot = 0.5.
d.
Adobe Systems = 0.2667, Dow Chemical = 0.3333, Office Depot = 0.4.
4 points
Question 21
Which of the following returns is the average of the possible returns weighted by the likelihood of those returns occurring?
Answer
a.
Efficient return.
b.
Expected return.
c.
Market return.
d.
Required return.
4 points
Question 22
What is typically considered to be the return on U.S. government bonds and bills and equals the real interest and the expected inflation premium?
Answer
a.
Required return.
b.
Risk-free rate.
c.
Risk premium.
d.
Market risk premium.
4 points
Question 23
What is a measure of the sensitivity of a stock or portfolio to market risk?
Answer
a.
Behavioral finance.
b.
Beta.
c.
Efficient market.
d.
Hedge.
4 points
Question 24
What is a capital budgeting technique that generates a decision rule and associated metric for choosing projects, based on the total discounted value of their cash flows?
Answer
a.
Payback.
b.
Net present value.
c.
Internal rate of return
d.
Profitability index.
4 points
Question 25
What is a capital budgeting technique that generates decision rules and associated metrics for choosing projects, based on the implicit, expected geometric average of a project’s rate of return?
Answer
a.
Discounted payback.
b.
Net present value.
c.
Internal rate of return.
d.
Profitability index.
