FNCE90060 - 2019 - S1 - Practice Questions for Mid-Semester PDF

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Question 1 A project that you are considering today is expected to provide benefits worth $168,000 in one year. If the risk-free rate of interest (rf) is 4%, then the value of the benefits of this project today are closest to: A) $160,440 B) $160,766 C) $168,000 D) $175,560 E) None of the above Use ...

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Question 1 A project that you are considering today is expected to provide benefits worth $168,000 in one year. If the risk-free rate of interest (rf) is 4.5%, then the value of the benefits of this project today are closest to: A) $160,440 B) $160,766 C) $168,000 D) $175,560 E) None of the above Use the following information to answer the next two questions. 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 $5,033.83. Question 2 The amount of money that your great aunt Matilda originally put in the account is closest to: A) $600 B) $800 C) $1,000 D) $1,200 E) None of the above Question 3 The amount of money that would be in the account if you left the money there until your 65th birthday is closest to: A) $29,556 B) $148,780 C) $168,824 D) $748,932 E) None of the above Question 4 VictoriaCampGrounds Pty. is considering purchasing a parcel of wilderness land near a popular historic site. Although this land will cost VictoriaCampGrounds $400,000 today, by renting out wilderness campsites on this land, VictoriaCampGrounds expects to make $35,000 at the end of every year indefinitely. If the appropriate discount rate is 8%, then the NPV of this new wilderness campsite is closest to: A) -$50,000 B) -$37,500 C) $37,500 D) $50,000 E) None of the above

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Question 5 You are offered an investment opportunity in which you will receive $25,000 in one year in exchange for paying $23,750 today. Suppose the risk-free interest rate is 6% per year. Should you take this project? The NPV for this project is closest to: A) Yes; NPV = $165 B) No; NPV = $165 C) Yes; NPV = -$165 D) No; NPV = -$165 E) None of the above Question 6 Big Mac Sandwich Large Coke Large Fry

$2.99 $1.39 $1.09

A McDonald's Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a Large Fry. Assuming that there is a competitive market for McDonald's food items, at what price must a Big Mac value meal sell to insure the absence of an arbitrage opportunity and uphold the law of one price? A) $4.08 B) $4.38 C) $5.47 D) $5.77 E) None of the above Use the following information to answer the next two questions. 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. Question 7 If the appropriate interest rate is 10%, then the NPV of this opportunity is closest to: A) ($88,000) B) $88,000 C) $300,000 D) $1,300,000 E) None of the above

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Question 8 If the appropriate interest rate is 10%, then Nielson Motors should: A) invest in this opportunity since the NPV is positive. B) not invest in this opportunity since the NPV is positive. C) invest in this opportunity since the NPV is negative. D) not invest in this opportunity since the NPV is negative. E) None of the above Question 9 You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last for 17 years. You expect that the drug will produce cash flows of $10 million in its first year and that this amount will grow at a rate of 4% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce generic equivalents of your drug and competition will drive any future profits to zero. If the interest rate is 12% per year, then the present value of producing this drug is closest to: A) $71 million B) $90 million C) $170 million D) $105 million E) None of the above Question 10 You are thinking about investing in a mine that will produce $10,000 worth of ore in the first year. As the ore closest to the surface is removed first, it will become more difficult to extract the ore over time. Therefore, the value of the ore that you mine will decline at a rate of 8% per year forever. If the appropriate interest rate is 6%, then the value of this mining operation is closest to: A) $71,429 B) $500,000 C) $166,667 D) $250,000 E) None of the above

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Question 11 Carlton Metals is considering opening a strip mining operation to provide some of the raw materials needed in producing Carlton 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 Carlton will need to spend $20 million to restore the land to its original pristine nature appearance. The number of potential IRRs that exist for Carlton's mining operation is equal to: A) 0 B) 1 C) 2 D) 12 E) None of the above Question 12 Which of the following statements is FALSE? A) It is possible that an IRR does not exist for an investment opportunity. B) If the payback period is less than a pre-specified length of time you accept the project. C) The internal rate of return (IRR) investment rule is based upon the notion that if the return on other alternatives is greater than the return on the investment opportunity you should undertake the investment opportunity. D) It is possible that there is no discount rate that will set the NPV equal to zero. E) None of the above is false Question 13 The effective annual rate (EAR) for a loan with a stated APR of 10% compounded quarterly is closest to: A) 9.65% B) 10.00% C) 10.38% D) 12.50% E) None of the above Question 14 Bruce Wayne’s auto loan requires monthly payments and has an effective annual rate of 6.43%. The APR on this auto loan is closest to: A) 6.00% B) 6.25% C) 6.50% D) 6.62% E) None of the above

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Question 15 Which of the following statements is FALSE? A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond. B) The bond certificate indicates the amounts and dates of all payments to be made. C) The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date. D) The face value of a bond is repaid at maturity. E) The simplest type of bond is a zero-coupon bond. Question 16 Consider a zero-coupon bond with 20 years to maturity. If the YTM is 6%, the price that this bond will trade is closest to: A) B) C) D) E)

$215 $312 $335 $346 None of the above

Use the following information to answer the next four questions. South Melbourne Motors currently produces 500,000 electric motors a year and expects output levels to remain steady in the future. It buys armatures from an outside supplier at a price of $2.50 each. The plant manager believes that it would be cheaper to make these armatures rather than buy them. Direct in-house production costs are estimated to be only $1.80 per armature. The necessary machinery would cost $700,000 and would be used for 10 years. This investment would be depreciated to zero for tax purposes using a 10-year straight line depreciation. The plant manager estimates that the operation would require additional working capital of $40,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. The expected proceeds from scrapping the machinery in year 11 are estimated to be $10,000. South Melbourne Motors pays tax at a rate of 35% and has an opportunity cost of capital of 14%. Question 17 The incremental cash flow that South Melbourne Motors will incur today (Year 0) if they elect to manufacture armatures in house is closest to: A) -740,000 B) -700,000 C) -660,000 D) 740,000 E) None of the above

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Question 18 The incremental cash flow that South Melbourne Motors will incur in year 4 if they elect to manufacture armatures in house is closest to: A) 25,000 B) 150,000 C) 252,000 D) 1,250,000 E) None of the above Question 19 The incremental cash flow that South Melbourne Motors will incur in year 10 if they elect to manufacture armatures in house is closest to: A) 40,000 B) 135,000 C) 252,000 D) 292,000 E) None of the above Question 20 The NPV for South Melbourne Motors of manufacturing the armatures in house is closest to: A) 95,000 B) 215,000 C) 586,800 D) 1,250,000 E) None of the above

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Answers Question 1 B $168,000/1.045 = $160,765.55 Question 2 C PV = FV/(1 + i)N = 5033.83(/1.08)21 = 1,000 Question 3 B FV = PV(1 + i)N = 5033.83(1.08)(65 - 21) = $148,779.85 Question 4 C NPV = -400,000 + $35,000/.08 = 37,500 Question 5 D NPV = -23,750 + 25,000/1.06 = -165, since NPV < 0 you should reject project Question 6 C 2.99 + 1.39 + 1.09 = 5.47 Question 7 B NPV = -1,000,000 + 250,000/(1.10)1 + 450,000/(1.10)2 + 650,000/(1.10)3 = 87,528.17 Question 8 A NPV = -1,000,000 + 250,000/(1.10)1 + 450,000/(1.10)2 + 650,000/(1.10)3 = 87,528.17 Question 9 B $10 ×

 1  0.12−0.04 1 −   

17   =   

 1+ .04     1+ .12 

$89.53 million

Question 10 A PVP = C/r - g = 10,000/(.06 - -.08) = 10,000/.14 = $71,429 Question 11 C This question 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. 7

Question 12 C Question 13 C EAR = (1 + APR/k)k - 1 = (1 + .10/4)4 - 1 = .1038 or 10.38% Question 14 B APR = (1.06431/12 − 1)× 12 = .062479 Question 15 C Question 16 B PV = 1,000/(1.06)20 = 311.80 Question 17 A CF0 = -700,000 + - 40,000 = -740,000 Question 18 C Incremental cash flow = 500,000 units × ($2.50 - $1.80) × (1 – 0.35) + 0.35 × 700,000/10 = 252,000 Question 19 D Incremental cash flow = 500,000 units × ($2.50 - $1.80) × (1 – 0.35) + 0.35 × 700,000/10 + 40,000 = 292,000 Question 20 C CF0 = -700,000 + - 40,000 = -740,000 CF(1 - 9) = 500,000 units × ($2.50 - $1.80) × (1 – 0.35) + 0.35 × 700,000/10 = 252,000 CF(10) = 500,000 units × ($2.50 - $1.80) × (1 – 0.35) + 0.35 × 700,000/10 + 40,000 = 292,000 CF(11) = $10,000 – ($10,000 – $0) × (0.35) = $6,500 (the machine is used for 10 years and sold in year 11) r = 14%, NPV = $586,788.90

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