# Finance

**Topics:**Capital asset pricing model, Investment, Weighted average cost of capital

**Pages:**7 (1415 words)

**Published:**June 21, 2013

AMME

Individual Assignment #2

FORMAT: You can use a Word document, an Excel spreadsheet or both. If you use Excel, submit the Excel file rather than embedding Excel into a Word document. Please use single-space, 11 pt. or 12 pt. font.

Multiple Choice: Select the best response (3 points each). You may add comments to explain your reasons.

1. If the correlation coefficient is 0,

A) You can completely eliminate risk by short selling the riskier asset and investing the proceeds in the less risk one. B) You can completely eliminate risk by investing positive amounts in each security. C) You cannot completely eliminate the risk.

ANSWER IS C

2. Which factor(s) influence a firm’s business risk (and therefore, its asset beta)?

A) Cyclical revenues

B) Operating leverage

C) Both A and B influence business risk.

ANSWER IS C

3. In a world with only corporate taxes, firm value is maximized by

A) All equity financing

B) All debt financing

C) A weighted average of debt and equity financing

D) Capital structure is irrelevant in this case

ANSWER IS B

4. The ____ theory states that there is a tradeoff between the benefits of debt (interest tax shield) and the costs of debt (financial distress, agency costs).

A) Pecking order

B) Tradeoff theory

C) Signaling theory

ANSWER IS B

5. The value of a resource in its next best alternative use.

A) Opportunity cost

B) Agency cost

C) Informational asymmetry

ANSWER IS A

6. Uses several macroeconomic factors to examine the impact of market surprises on returns

A) Arbitrage pricing theory.

B) Capital asset pricing model

C) Security market line

ANSWER IS A

7. If an investor is well-diversified, then they are concerned with

A) Market risk only

B) Unique risk only

C) Both market and unique risk

ANSWER IS A

8. A firm has an asset beta of 1 and a company cost of capital of 15%. A new project comes along with a beta of 2 and an expected return (IRR) of 23%. Putting the project’s beta into the CAPM gives the project a return of 25% based on project risk. The firm should

A) Reject the project because the IRR is greater than the company cost of capital. B) Reject the project because the CAPM return is greater than the IRR. C) Accept the project because the IRR is greater than the company cost of capital. D) Accept the project because the CAPM return is greater than the IRR.

ANSWER IS B

Problems:

Unless stated otherwise, interest is compounded annually and payments occur at the end of the period.

1. (10) Rand is considering a new project that requires an investment of $60 million in machinery. This is expected to produce sales of $94 million per year for 4 years and operating expenses of $71 million per year for 4 years. The machinery will be fully depreciated to a zero book value over 4 years using straight-line depreciation. There is no salvage value and working capital costs are negligible. The tax rate is 30%. The unlevered return on equity (ro) is 12%.

a) Calculate the base-case NPV.

b) The project will be financed with $20,000,000 in bonds. The bonds have a 4-year life, a coupon rate of 6% and a yield of 6%. Find the adjusted present value (APV

Base Case NPV = $34,481,800.00

APV = $140,166,666.67

SEE ATTACHED SPREADSHEET FO COMPLETE CALCULATION

2. (8) Stock X has an expected return of 36% and a variance of .08. Stock Y has an expected return of 48% and a variance of .18. Stocks X and Y have a correlation coefficient of .40. Calculate the expected return and variance of a portfolio consisting of $120,000 invested in stock X and $40,000 invested in stock Y.

Expected return of the portfolio = 39%

Variance = 0.1212

SEE ATTACHED...

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