Final Exam

Q1. What is the profitability index for the following set of cash flows if the relevant discount rates are 10 percent; 15 percent and 22 percent?

Year Cash Flow

0

1

2

3 -$27,500

15,800

13,600

83,00

Q.2 You are considering a new product launch. The project will cost $ 780,000, have four years life, and no salvage value; and depreciation is straight-line zero. Sales are projected at 180 units per year, price per unit will be $ 16,300, variable cost per unit will be $ 11,100, and fixed cost will be $ 535,000 per year. The required return on the project is 11 percent, and relevant tax rate is 35 percent.

a) Based on your knowledge, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to with in +/- 10 percent. What are best and worst cases for these projections? What is the base-case NPV? What are best -case and worst -case scenarios?

b) Evaluate the sensitivity of your base-case NPV to changes in fixed cost.

Q3. You find a certain stock that had returns 17 percent,-13 percent, 26 percent, and 8 percent for four of the last five years. If the average return of the stock over this period was 10 percent, what was the stock’s return for the missing year? What is standard deviation of the stock’s returns?

Q4 Stock J has a beta of 1.19 and an expected return of 12.95 percent, while the stock K has a beta of 0.84, and expected return of 10.40 percent. You want a portfolio with the same risk as the market. How much you will invest in each stock? What is expected return of your portfolio?

Q 5. An all equity firm is considering the following projects:

Project Beta IRR (Percent)

W

X

Y

Z ).80

0.90

1.10

1.35 9.3

10.6

11.4

14.1

The T-bill rate is 4 percent and the expected return on the market is 11 percent.

a) Which Projects have a higher expected return from the firm’s 11 percent cost of capital?

b) Which project should be accepted?

c) Which project will be incorrectly accepted or rejected if the firm’s over all cost of capital were used as a hurdle rate?