Review Questions

Here are some questions to consider in your preparation for the second exam. There is a formula sheet for all the exams here.  The answers to the review questions will be at the bottom of this page after 12:00 PM on Monday, March 29th.  Viewing some of the answers on this page will require the plugin from LiveMath.

1. A security's value equals the compound value of dividends investors expect to receive. T F


2. You are considering purchasing common stock in AMZ Corporation. You anticipate that the company will pay dividends of $5.00 per share next year and $7.50 per share in the following year. You also believe that you can sell the common stock two years from now for $30.00 per share. If you require a 14 percent rate of return on this investment, what is the maximum price that you would be willing to pay for a share of AMZ common stock?



3. The Bolster Company is considering two mutually exclusive projects:

Year Cash Flow A Cash Flow B
0 - $100,000 - $100,000
1 31,250 0
2 31,250 0
3 31,250 0
4 31,250 0
5 31,250 $200,000

The required rate of return on these projects is 12 percent.

a. What is each project's payback period?
b. What is each project's net present value?
c. What is each project's internal rate of return?
d. Fully explain the results of your analysis. Which project do you prefer?

4. The Deacon Company is considering two mutually exclusive projects with depreciable lives of 3 and 6 years. The after-tax cash flows for projects S and L are listed below.

Year Cash Flow S Cash Flow L
0 -$50,000 -$50,000
1 25,625 16,563
2 25,625 16,563
3 25,625 16,563
4 16,563
5 16,563
6 16,563

The required rate of return on these projects is 15 percent. Which project should be accepted?


5. Your company is considering the purchase of a piece of equipment. It will cost $6,500 and will require an increase in inventory of $500 initially. It will be depreciated straight line for 3 years. It is expected to lower operating costs by 500 per year and generate new sales of $2,800 per year for the next 4 years. Expected salvage value of the machine at the end of 4 years is $1,200. The firm's marginal tax rate is 40%. If the firm's discount rate is 18%, compute the net present value (NPV) of this project.

a. $1,287
b. - $181.30
c. $840
d. $582.35


6. You are in charge of one division of Bigfella Conglomerate Inc. Your division is subject to capital rationing. Your division has 4 indivisible projects available, detailed as follows:

Project Initial Outlay IRR NPV
1 2 million 18% 2,500,000
2 1 million 15% 950,000
3 1 million 10% 600,000
4 3 million 09% 2,000,000

If you must select projects subject to a budget constraint of 5 million dollars, which set of projects should be accepted so as to maximize firm value?

a. Projects 1, 2 and 3
b. Project 1 only
c. Projects 1 and 4
d. Projects 2, 3 and 4


7.  The risk-return relationship for each financial asset is shown on:

a. the capital market line
b. the New York Stock Exchange market line
c. the security market line
d. none of the above


8.  You have invested in a project that has the following payoff schedule:

Probability of Occurrence


.15 $40
.20 $50
.30 $60
.30 $70
.05 $80

What is the expected value of the investment's payoff? (Round to the nearest $1)

a. $60
b. $65
c. $58
d. $70


9.  Security A has an expected rate of return of 22 percent and a beta of 2.5. Security B has a beta of 1.20. If the treasury bill rate is 10 percent, what is the expected rate of return for Security B?


10.  You are considering the purchase of 100 shares of Slick-Tex, Inc.’s common stock. The beta on the security is 1.65, and the current market premium is 5.6%.

(a) If the safe rate of interest is currently 12%, what will your required rate of return be?
(b) Given the rate of return computed in (a), an expected dividend of $8.50, and a 5% growth rate, what value do you place on the stock?


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