c13 risk in capital budgeting

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Capital Budgeting and risk

– measure of dispersion or variability around the expected value – larger the standard deviation greater the risk
Coefficient of Variation
– equal to standard deviation / expected value – larger the coefficient of variation greater the risk
6c-11
Issues to Consider in Multinational Capital Budgeting
• A variety of factors may affect the capital budgeting analysis : 1. Exchange rate fluctuations
3. Financing arrangement
– Many foreign projects are partially financed by foreign subsidiaries.
6c-12
Issues to Consider in Multinational Capital Budgeting
Year
1 2 3 4 5
Investment B (10% discount rate)
$1,500 2,000 2,500 5,000 5,000 x x x x x 0.909 0.826 0.751 0.683 0.621 = $1,364 = 1,652 = 1,878 = 3,415 = 3,105 $11,414
Although both projects are acceptable, if they are mutually exclusive, only B would be undertaken.

Risk & capital Budgeting

2.
3.
12
Accounting for Taxes in Finding WACC
We have thus far assumed away taxes, which are often important in financing decisions.
• Tax deductibility of interest payments favors use of debt.
An example.... S.D. Williams Total value = $50 million 1 million common shares; $50/share; re = 15%. 200,000 preferred shares, 8% coupon, $80/share, 10% rate of return, $16 million value. $47.1 million (par value) long term debt, fixed rate notes with 8% coupon rate, but 7% YTM. Notes sell at premium and worth $49 million.
$0 $100 million $20 million $0 $20 million 20 ÷ 100 = 20% $5 million
$100 million
$50 million $50 million $20 million $4 million $16 million 16 ÷ 50 = 32% $5 million
• The opportunity to deduct interest payments reduces the after-tax cost of debt and changes the WACC formula:

Capital Budgeting Decision

Group Assignment 2Capital Budgeting DecisionDec.19.2013BE1108Group Members: 刘茹冰蔡熤A/Q1：Payback period in capital budgeting refers to the period of time required torecoup the funds expended in an investment, or to reach the break-even point. For example, a $1000 investment which returned $500 per year would have a two-year payback period. Payback period intuitively measures how long something takes to "pay for itself." All else being equal, shorter payback periods are preferable to longer payback periods. Payback period is popular due to its ease of use.Net present value In finance, the net present value (NPV) or net presentworth (NPW)of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity.In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV).NPV can be described as the “difference amount” between the sums of disco unted: cash inflows and cash outflows. It compares the present value of money today to the present value of money in the future, taking inflation and returns into account.Profitability index (PI), also known as profit investment ratio (PIR) and valueinvestment ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for ranking projects because it allows you to quantify the amount of value created per unit of investment.The internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value (NPV as NET*1/(1+IRR)^year) of all cash flows (both positive and negative) from a particular investment equal to zero. It can also be defined as the discount rate at which the present value of all future cash flow is equal to the initial investment or in other words the rate at which an investment breaks even.In more specific terms, the IRR of an investment is the discount rate at which the net present value of costs (negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the investment.IRR calculations are commonly used to evaluate the desirability of investments orprojects. The higher a project's IRR, the more desirable it is to undertake the project.Assuming all projects require the same amount of up-front investment, the project with the highest IRR would be considered the best and undertaken first.A firm (or individual) should, in theory, undertake all projects or investments available with IRRs that exceed the cost of capital. Investment may be limited by availability of funds to the firm and/or by the firm's capacity or ability to manage numerous projects.The Modified Internal Rate of Return (MIRR) is a financial measure of an investment's attractiveness.[1][2] It is used in capital budgeting to rank alternative investments of equal size. As the name implies, MIRR is a modification of the internal rate of return (IRR) and as such aims to resolve some problems with the IRR.While there are several problems with the IRR, MIRR resolves two of them.Firstly, IRR assumes that interim positive cash flows are reinvested at the same rate of return as that of the project that generated them.[3] This is usually an unrealistic scenario and a more likely situation is that the funds will be reinvested at a rate closer to the firm's cost of capital. The IRR therefore often gives an unduly optimistic picture of the projects under study. Generally for comparing projects more fairly, the weighted average cost of capital should be used for reinvesting the interim cash flows.Secondly, more than one IRR can be found for projects with alternating positive and negative cash flows, which leads to confusion and ambiguity. MIRR finds only one value.A/Q2：Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. When used carefully or to compare similar investments, it can be quite useful. As a stand-alone tool to compare an investment to "doing nothing," payback period has no explicit criteria for decision-making (except, perhaps, that the payback period should be less than infinity). The time value of money is not taken into account.The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not account for the time value of money, risk, financing, or other important considerations, such as the opportunity cost. Whilst the time value of money can be rectified by applying a weighted average cost of capital discount, it is generally agreed that this tool for investment decisions should not be used in isolation. Alternative measures of "return" preferred by economists are net present value and internal rate of return. An implicit assumption in the use of payback period is that returns to the investment continue after the payback period. Payback period does not specify any required comparison to other investments or even to not making an investment.NPV is a central tool in discounted cash flow (DCF) analysis and is a standardmethod for using the time value of money to appraise long-term projects. Used for capital budgeting and widely used throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, above the cost of funds.If... It means...Then...NPV > 0 the investment wouldadd value to the firmthe project may be acceptedNPV < 0 the investment wouldsubtract value fromthe firmthe project should be rejectedNPV = 0 the investment wouldneither gain nor losevalue for the firmWe should be indifferent in the decision whether to accept orreject the project. This project adds no monetary value.Decision should be based on other criteria, e.g., strategicpositioning or other factors not explicitly included in thecalculation.Rules for selection or rejection of a project:If PI > 1 then accept the projectIf PI < 1 then reject the projectBecause the internal rate of return is a rate quantity, it is an indicator of the efficiency, quality, or yield of an investment. This is in contrast with the net present value, which is an indicator of the value or magnitude of an investment.An investment is considered acceptable if its internal rate of return is greater than an established minimum acceptable rate of return or cost of capital. In a scenario where an investment is considered by a firm that has equity holders, this minimum rate is the cost of capital of the investment (which may be determined by the risk-adjusted cost of capital of alternative investments). This ensures that the investment is supported by equity holders since, in general, an investment whose IRR exceeds its cost of capital adds value for the company (i.e., it is economically profitable).The rate of return that equates the present value of a project’s cash inflows with the present value of its cash outflows i.e. it sets out the net present value equal to zero. Internal rate of return is basically used to measure the efficiency of capital investment. Internal rate of return is generally required low cost of capital to accept the project.Given a collection of pairs (time, cash flow) involved in a project, the internal rate of return follows from the net present value as a function of the rate of return.A rate of return for which this function is zero is an internal rate of return.The period is usually given in years, but the calculation may be made simplerif is calculated using the period in which the majority of the problem is defined(e.g., using months if most of the cash flows occur at monthly intervals) andconverted to a yearly period thereafter.Any fixed time can be used in place of the present (e.g., the end of one interval of an annuity); the value obtained is zero if and only if the NPV is zero.In the case that the cash flows are random variables, such as in the case of a life annuity, the expected values are put into the above formula.Often, the value of cannot be found analytically. In this case, numericalmethods or graphical methods must be used.Like the internal rate of return, the modified internal rate of return cannot be validly used to rank-order projects of different sizes, because a larger project with a smaller modified internal rate of return may have a higher present value.However, there exist variants of the modified internal rate of return which can be used for such comparisons.Page 299Q1:Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine. A:year 1=-500000000+6000000=-440000000Year 2=-440000000++90000000=-350000000Year 3=-350000000+170000000=-180000000Year 4=-180000000+230000000=500000005000000-80000000=-30000000Year 5=-30000000+205000000=175000000Payback period is 4.15 years.Internal rate of return :-500000000+60000000/(1+r)+90000000/(1+r)^2+170000000/ (1+r)^3+230000000/(1+r)^4+205000000/(1+r)^5+140000000/(1+r)^6+110000000/(1 +r)^7+70000000/(1+r)^8-80000000/(1+r)^9=0Irr=18.87percentModified internal rate of return=14.748％,Finance rate=.12Reinvest rate=.12Npv=115109801.56Q2:Based on your analysis, should the company open the mine? A:payback period=4.85Irr=.1887>.12Mirr=.14748Npv is positiveIt should open the mine.。

风险,资本,成本和资本预算讲义(英文)--woshishenmaa

• Assume a risk-free rate of 5% and a market risk premium of 10%.
• What is the appropriate discount rate for an expansion of this firm?
RRFβi(RMRF)
R5%2.51% 0 R30%
• Operating leverage refers to the sensitivity to the firm’s fixed costs of production.
• Financial leverage is the sensitivity to a firm’s fixed costs of financing.
• This chapter discusses the appropriate discount rate when cash flows are risky.
12.1 The Cost of Equity Capital
Firm with excess cash
Pay cash dividend
The Cost of Equity Capital
• From the firm’s perspective, the expected return is the Cost of Equity Capital: Ri RFβi(RMRF)
• To estimate a firm’s cost of equity capital, we need to know three things:
• Operating leverage magnifies the effect of cyclicality on beta.

罗斯-公司理财-英文练习题-附带答案-第九章

罗斯-公司理财-英⽂练习题-附带答案-第九章CHAPTER 9Risk Analysis, Real Options, and Capital Budgeting Multiple Choice Questions:I. DEFINITIONSSCENARIO ANALYSISb 1. An analysis of what happens to the estimate of the net present value when you examinea number of different likely situations is called _____ analysis.a. forecastingb. scenarioc. sensitivityd. simulatione. break-evenDifficulty level: EasySENSITIVITY ANALYSISc 2. An analysis of what happens to the estimate of net present value when only onevariable is changed is called _____ analysis.a. forecastingb. scenarioc. sensitivityd. simulatione. break-evenDifficulty level: EasySIMULATION ANALYSISd 3. An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.a. forecastingb. scenarioc. sensitivityd. simulatione. break-evenDifficulty level: EasyBREAK-EVEN ANALYSISe 4. An analysis of the relationship between the sales volume and various measures ofprofitability is called _____ analysis.a. forecastingb. scenarioc. sensitivityd. simulatione. break-evenDifficulty level: EasyVARIABLE COSTSa 5. Variable costs:a. change in direct relationship to the quantity of output produced.b. are constant in the short-run regardless of the quantity of output produced.c. reflect the change in a variable when one more unit of output is produced.d. are subtracted from fixed costs to compute the contribution margin.e. form the basis that is used to determine the degree of operating leverage employed by a firm.Difficulty level: EasyFIXED COSTSb 6. Fixed costs:a. change as the quantity of output produced changes.b. are constant over the short-run regardless of the quantity of output produced.c. reflect the change in a variable when one more unit of output is produced.d. are subtracted from sales to compute the contribution margin.e. can be ignored in scenario analysis since they are constant over the life of a project. Difficulty level: EasyACCOUNTING BREAK-EVENc 7. The sales level that results in a project’s net income exactly equaling zero is called the_____ break-even.a. operationalb. leveragedc. accountingd. cashe. present valueDifficulty level: EasyPRESENT VALUE BREAK-EVENe 8. The sales level that results in a project’s net present value exactly equaling zero is called the _____ break-even.a. operationalb. leveragedc. accountingd. cashe. present valueDifficulty level: EasyII. CONCEPTSSCENARIO ANALYSISb 9. Conducting scenario analysis helps managers see the:a. impact of an individual variable on the outcome of a project.b. potential range of outcomes from a proposed project.c. changes in long-term debt over the course of a proposed project.d. possible range of market prices for their stock over the life of a project.e. allocation distribution of funds for capital projects under conditions of hard rationing. Difficulty level: EasySENSITIVITY ANALYSISb 10. Sensitivity analysis helps you determine the:a. range of possible outcomes given possible ranges for every variable.b. degree to which the net present value reacts to changes in a single variable.c. net present value given the best and the worst possible situations.d. degree to which a project is reliant upon the fixed costs.e. level of variable costs in relation to the fixed costs of a project.Difficulty level: EasySENSITIVITY ANALYSISc 11. As the degree of sensitivity of a project to a single variable rises, the:a. lower the forecasting risk of the project.b. smaller the range of possible outcomes given a pre-defined range of values for the input.c. more attention management should place on accurately forecasting the future value of that variable.d. lower the maximum potential value of the project.e. lower the maximum potential loss of the project.Difficulty level: MediumSENSITIVITY ANALYSISc 12. Sensitivity analysis is conducted by:a. holding all variables at their base level and changing the required rate of return assigned to a project.b. changing the value of two variables to determine their interdependency.c. changing the value of a single variable and computing the resulting change in the current value of a project.d. assigning either the best or the worst possible value to each variable and comparing the results to those achieved by the base case.e. managers after a project has been implemented to determine how each variable relates to the level of output realized.Difficulty level: MediumSENSITIVITY ANALYSISd 13. To ascertain whether the accuracy of the variable cost estimate for a project will havemuch effect on the final outcome of the project, you should probably conduct _____ analysis.a. leverageb. scenarioc. break-evend. sensitivitye. cash flowDifficulty level: EasySIMULATIONd 14. Simulation analysis is based on assigning a _____ and analyzing the results.a. narrow range of values to a single variableb. narrow range of values to multiple variables simultaneouslyc. wide range of values to a single variabled. wide range of values to multiple variables simultaneouslye. single value to each of the variablesDifficulty level: MediumSIMULATIONe 15. The type of analysis that is most dependent upon the use of a computer is _____ analysis.a. scenariob. break-evenc. sensitivityd. degree of operating leveragee. simulationDifficulty level: EasyVARIABLE COSTSd 16. Which one of the following is most likely a variable cost?a. office rentb. property taxesc. property insuranced. direct labor costse. management salariesDifficulty level: EasyVARIABLE COSTSa 17. Which of the following statements concerning variable costs is (are) correct?I. Variable costs minus fixed costs equal marginal costs.II. Variable costs are equal to zero when production is equal to zero.III. An increase in variable costs increases the operating cash flow.a. II onlyb. III onlyc. I and III onlyd. II and III onlye. I and II onlyDifficulty level: MediumVARIABLE COSTSa 18. All else constant, as the variable cost per unit increases, the:a. contribution margin decreases.b. sensitivity to fixed costs decreases.c. degree of operating leverage decreases.d. operating cash flow increases.e. net profit increases.Difficulty level: MediumFIXED COSTSc 19. Fixed costs:I. are variable over long periods of time.II. must be paid even if production is halted.III. are generally affected by the amount of fixed assets owned by a firm.IV. per unit remain constant over a given range of production output.a. I and III onlyb. II and IV onlyc. I, II, and III onlyd. I, II, and IV onlye. I, II, III, and IVDifficulty level: MediumCONTRIBUTION MARGINc 20. The contribution margin must increase as:a. both the sales price and variable cost per unit increase.b. the fixed cost per unit declines.c. the gap between the sales price and the variable cost per unit widens.d. sales price per unit declines.e. the sales price minus the fixed cost per unit increases.Difficulty level: MediumACCOUNTING BREAK-EVENa 21. Which of the following statements are correct concerning the accounting break-evenpoint?I. The net income is equal to zero at the accounting break-even point.II. The net present value is equal to zero at the accounting break-even point.III. The quantity sold at the accounting break-even point is equal to the total fixed costs plus depreciation divided by the contribution margin.IV. The quantity sold at the accounting break-even point is equal to the total fixed costs divided by the contribution margin.a. I and III onlyb. I and IV onlyd. II and IV onlye. I, II, and IV onlyDifficulty level: MediumACCOUNTING BREAK-EVENb 22. All else constant, the accounting break-even level of sales will decrease when the:a. fixed costs increase.b. depreciation expense decreases.c. contribution margin decreases.d. variable costs per unit increase.e. selling price per unit decreases.Difficulty level: MediumPRESENT VALUE BREAK-EVENd 23. The point where a project produces a rate of return equal to the required return isknown as the:a. point of zero operating leverage.b. internal break-even point.c. accounting break-even point.d. present value break-even point.e. internal break-even point.Difficulty level: EasyPRESENT VALUE BREAK-EVENb 24. Which of the following statements are correct concerning the present value break-even point of a project?I. The present value of the cash inflows equals the amount of the initial investment.II. The payback period of the project is equal to the life of the project.III. The operating cash flow is at a level that produces a net present value of zero.IV. The project never pays back on a discounted basis.a. I and II onlyb. I and III onlyc. II and IV onlyd. III and IV onlyDifficulty level: MediumINVESTMENT TIMING DECISIONb 25. The investment timing decision relates to:a. how long the cash flows last once a project is implemented.b. the decision as to when a project should be started.c. how frequently the cash flows of a project occur.d. how frequently the interest on the debt incurred to finance a project is compounded.e. the decision to either finance a project over time or pay out the initial cost in cash.Difficulty level: MediumOPTION TO WAITe 26. The timing option that gives the option to wait:I. may be of minimal value if the project relates to a rapidly changing technology.II. is partially dependent upon the discount rate applied to the project being evaluated.III. is defined as the situation where operations are shut down for a period of time.IV. has a value equal to the net present value of the project if it is started today versus the net present value if it is started at some later date.a. I and III onlyb. II and IV onlyc. I and II onlyd. II, III, and IV onlye. I, II, and IV onlyDifficulty level: ChallengeOPTION TO EXPANDb 27. Last month you introduced a new product to the market. Consumer demand has beenoverwhelming and appears that strong demand will exist over the long-term. Given thissituation, management should consider the option to:a. suspend.b. expand.c. abandon.d. contract.e. withdraw.Difficulty level: EasyOPTION TO EXPANDc 28. Including the option to expand in your project analysis will tend to:a. extend the duration of a project but not affect the project’s net present value.b. incre ase the cash flows of a project but decrease the project’s net present value.c. increase the net present value of a project.d. decrease the net present value of a project.e. have no effect on either a project’s cash flows or its net present value.Difficulty level: MediumSENSITIVITY AND SENARIO ANALYSISd 29. Theoretically, the NPV is the most appropriate method to determine the acceptabilityof a project. A false sense of security can be overwhelm the decision-maker when the procedure is applied properly and the positive NPV results are accepted blindly. Sensitivity and scenario analysis aid in the process bya. changing the underlying assumptions on which the decision is based.b. highlights the areas where more and better data are needed.c. providing a picture of how an event can affect the calculations.d. All of the above.e. None of the above.Difficulty level: MediumDECSION TREEa 30. In order to make a decision with a decision treea. one starts farthest out in time to make the first decision.b. one must begin at time 0.c. any path can be taken to get to the end.d. any path can be taken to get back to the beginning.e. None of the above.Difficulty level: MediumDECISION TREEc 31. In a decision tree, the NPV to make the yes/no decision is dependent ona. only the cash flows from successful path.b. on the path where the probabilities add up to one.c. all cash flows and probabilities.d. only the cash flows and probabilities of the successful path.e. None of the above.Difficulty level: MediumDECISION TREEe 32. In a decision tree, caution should be used in analysis becausea. early stage decisions are probably riskier and should not likely use the same discount rate.b. if a negative NPV is actually occurring, management should opt out of the project and minimize their loss.c. decision trees are only used for planning, not actually daily management.d. Both A and C.e. Both A and B.Difficulty level: MediumSENSITIVITY ANALYSISd 33. Sensitivity analysis evaluates the NPV with respect toa. changes in the underlying assumptions.b. one variable changing while holding the others constant.c. different economic conditions.d. All of the above.e. None of the above.Difficulty level: MediumSENSITIVITY ANALYSISd 34. Sensitivity analysis provides information ona. whether the NPV should be trusted, it may provide a false sense of security if all NPVs are positive.b. the need for additional information as it tests each variable in isolation.c. the degree of difficulty in changing multiple variables together.d. Both A and B.e. Both A and C.Difficulty level: MediumFIXED COSTSb 35. Fixed production costs area. directly related to labor costs.b. measured as cost per unit of time.c. measured as cost per unit of output.d. dependent on the amount of goods or services produced.e. None of the above.Difficulty level: MediumVARIABLE COSTSd 36. Variable costsa. change as the quantity of output changes.b. are zero when production is zero.c. are exemplified by direct labor and raw materials.d. All of the above.e. None of the above.Difficulty level: EasySENSITIVITY ANALYSISb 37. An investigation of the degree to which NPV depends on assumptions made about any singular critical variable is called a(n)a. operating analysis.b. sensitivity analysis.c. marginal benefit analysis.d. decision tree analysis.e. None of the above.Difficulty level: EasySENSITIVITY AND SCENARIOS ANALYSISb 38. Scenario analysis is different than sensitivity analysisa. as no economic forecasts are changed.b. as several variables are changed together.c. because scenario analysis deals with actual data versus sensitivity analysis which deals with a forecast.d. because it is short and simple.e. because it is 'by the seat of the pants' technique.Difficulty level: MediumEQUIVALENT ANNUAL COSTc 39. In the present-value break-even the EAC is used toa. determine the opportunity cost of investment.b. allocate depreciation over the life of the project.c. allocate the initial investment at its opportunity cost over the life of the project.d. determine the contribution margin to fixed costs.e. None of the above.Difficulty level: MediumBREAK-EVENb 40. The present value break-even point is superior to the accounting break-even point becausea. present value break-even is more complicated to calculate.b. present value break-even covers the economic opportunity costs of the investment.c. present value break-even is the same as sensitivity analysis.d. present value break-even covers the fixed costs of production, which the accounting break-even does not.e. present value break-even covers the variable costs of production, which the accounting break-even does not.Difficulty level: EasyABANDONMENTd 41. The potential decision to abandon a project has option value becausea. abandonment can occur at any future point in time.b. a project may be worth more dead than alive.c. management is not locked into a negative outcome.d. All of the above.e. None of the above.Difficulty level: EasyTYPES OF BREAK-EVEN ANALYSISd 42. Which of the following are types of break-even analysis?a. present value break-evenb. accounting profit break-evenc. market value break-evend. Both A and B.e. Both A and C.Difficulty level: EasyMONTE CARLO SIMULATIONc 43. The approach that further attempts to model real word uncertainty by analyzingprojects the way one might analyze gambling strategies is calleda. gamblers approach.b. blackjack approach.c. Monte Carlo simulation.d. scenario analysis.e. sensitivity analysis.Difficulty level: MediumMONTE CARLO SIMULATIONc 44. Monte Carlo simulation isa. the most widely used by executives.b. a very simple formula.c. provides a more complete analysis that sensitivity or scenario.d. the oldest capital budgeting technique.e. None of the above.Difficulty level: EasyOPTIONS IN CAPITAL BUDGETINGd 45. Which of the following are hidden options in capital budgeting?a. option to expand.b. timing option.c. option to abandon.d. All of the above.e. None of the above.Difficulty level: EasyIII. PROBLEMSUse this information to answer questions 46 through 50.The Adept Co. is analyzing a proposed project. The company expects to sell 2,500units, give or take 10 percent. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5 percent range. The depreciation expense is $4,000. The saleprice is estimated at $16 aunit, give or take 2 percent. The company bases their sensitivity analysis on the expected case scenario. SCENARIO ANALYSISd 46. What is the sales revenue under the optimistic case scenario?a. $40,000b. $43,120c. $44,000d. $44,880e. $48,400Difficulty level: MediumSCENARIO ANALYSISd 47. What is the contribution margin under the expected case scenario?a. $2.67b. $3.00c. $7.92d. $8.00e. $8.72Difficulty level: MediumSCENARIO ANALYSISc 48. What is the amount of the fixed cost per unit under the pessimistic case scenario?a. $4.55b. $5.00c. $5.83d. $6.02e. $6.55Difficulty level: MediumSENSITIVITY ANALYSISb 49. The company is conducting a sensitivity analysis on the sales price using a salesprice estimate of $17. Using this value, the earnings before interest and taxes will be:a. $4,000b. $6,000c. $8,500d. $10,000e. $18,500Difficulty level: MediumSENSITIVITY ANALYSISb 50. The company conducts a sensitivity analysis using a variable cost of $9. The totalvariable cost estimate will be:a. $21,375b. $22,500c. $23,625d. $24,125e. $24,750Difficulty level: MediumUse this information to answer questions 51 through 55.The Can-Do Co. is analyzing a proposed project. The company expects to sell 12,000units, give or take 4 percent. The expected variable cost per unit is $7 and the expectedfixed cost is $36,000. The fixed and variable cost estimates are considered accuratewithin a plus or minus 6 percent range. The depreciation expense is $30,000. The tax rate is 34 percent. The sale price is estimated at $14 a unit, give or take 5 percent. Thecompany bases their sensitivity analysis on the expected case scenario.SCENARIO ANALYSISa 51. What is the earnings before interest and taxes under the expected case scenario?a. $18,000b. $24,000c. $36,000d. $48,000e. $54,000Difficulty level: MediumSCENARIO ANALYSISc 52. What is the earnings before interest and taxes under anoptimistic case scenario?a. $22,694.40b. $24,854.40c. $37,497.60d. $52,694.40Difficulty level: ChallengeSCENARIO ANALYSISb 53. What is the earnings before interest and taxes under the pessimistic case scenario?b. -$422.40c. -$278.78d. $3,554.50e. $5,385.60Difficulty level: ChallengeSENSITIVITY ANALYSISd 54. What is the operating cash flow for a sensitivity analysis using total fixed costs of$32,000?a. $14,520b. $16,520c. $22,000d. $44,520e. $52,000Difficulty level: MediumSENSITIVITY ANALYSISd 55. What is the contribution margin for a sensitivity analysis using a variable cost per unitof $8?a. $3b. $4c. $5d. $6e. $7Difficulty level: MediumVARIABLE COSTc 56. A firm is reviewing a project with labor cost of $8.90 per unit, raw materials cost of $21.63 a unit, and fixed costs of $8,000 a month. Sales are projected at 10,000 units over the three-month life of the project. What are the total variable costs of the project?a. $216,300c. $305,300d. $313,300e. $329,300Difficulty level: MediumVARIABLE COSTd 57. A project has earnings before interest and taxes of $5,750, fixed costs of $50,000, aselling price of $13 a unit, and a sales quantity of 11,500 units. Depreciation is $7,500. What is the variable cost per unit?a. $6.75c. $7.25d. $7.50e. $7.75Difficulty level: MediumFIXED COSTb 58. At a production level of 5,600 units a project has total costs of $89,000. The variable cost per unit is $11.20. What is the amount of the total fixed costs?a. $24,126b. $26,280c. $27,090d. $27,820e. $28,626Difficulty level: MediumFIXED COSTe 59. At a production level of 6,000 units a project has total costs of $120,000. The variablecost per unit is $14.50. What is the amount of the total fixed costs?a. $25,165b. $28,200c. $30,570d. $32,000e. $33,000Difficulty level: MediumCONTRIBUTION MARGINc 60. Wilson’s Meats has computed their fixed costs to be $.60 for every pound of meatthey sell given an average daily sales level of 500 pounds. They charge $3.89 per pound of top-grade ground beef. The variable cost per pound is $2.99. What is the contribution margin per pound of ground beef sold?a. $.30b. $.60c. $.90d. $2.99e. $3.89Difficulty level: MediumCONTRIBUTION MARGINe 61. Ralph and Emma’s is considering a project with total sales of $17,500, total variablecosts of $9,800, total fixed costs of $3,500, and estimated production of 400 units. The depreciation expense is $2,400 a year. What is the contribution margin per unit?a. $4.50b. $10.50d. $19.09e. $19.25Difficulty level: MediumACCOUNTING BREAK-EVENa 62. You are considering a new project. The project has projected depreciation of $720, fixed costs of $6,000, and total sales of $11,760. The variable cost per unit is$4.20. What is the accounting break-even level of production?a. 1,200 unitsb. 1,334 unitsc. 1,372 unitsd. 1,889 unitse. 1,910 unitsDifficulty level: MediumACCOUNTING BREAK-EVENb 63. The accounting break-even production quantity for a project is 5,425 units. The fixed costs are $31,600 and the contribution margin is $6. What is the projected depreciation expense?a. $700b. $950c. $1,025d. $1,053e. $1,100Difficulty level: MediumACCOUNTING BREAK-EVENd 64. A project has an accounting break-even point of 2,000 units. The fixed costs are$4,200 and the depreciation expense is $400. The projected variable cost per unit is $23.10. What is the projected sales price?a. $20.80b. $21.00c. $21.20d. $25.40e. $25.60Difficulty level: MediumACCOUNTING BREAK-EVENa 65. A proposed project has fixed costs of $3,600, depreciation expense of $1,500, and a sales quantity of 1,300 units. What is the contribution margin if the projected level of sales is the accounting break-even point?a. $3.92c. $4.50d. $4.80e. $5.00Difficulty level: MediumPRESENT VALUE BREAK-EVENc 66. A project has a contribution margin of $5, projected fixed costs of $12,000, projectedvariable cost per unit of $12, and a projected present value break-even point of 5,000 units. What is the operating cash flow at this level of output?a. $1,000b. $12,000c. $13,000d. $68,000e. $73,000Difficulty level: MediumPRESENT VALUE BREAK-EVENa 67. Thompson & Son have been busy analyzing a new product. They have determined that an operating cash flow of $16,700 will result in a zero net present value, which is a company requirement for project acceptance. The fixed costs are $12,378 and the contribution margin is $6.20. The company feels that they can realistically capture10 percent of the 50,000 unit market for this product. Should the company develop thenew product? Why or why not?a. yes; because 5,000 units of sales exceeds the quantity required for a zero net present valueb. yes; because the internal break-even point is less than 5,000 unitsc. no; because the firm can not generate sufficient sales to obtain at least a zero net present valued. no; because the project has an expected internal rate of return of negative 100percente. no; because the project will not pay back on a discounted basisDifficulty level: ChallengePRESENT VALUE BREAK-EVENe 68. Kurt Neal and Son is considering a project with a discounted payback just equal to the project’s life. The projections include a sales price of $11, variable cost per unit of$8.50, and fixed costs of $4,500. The operating cash flow is $6,200. What is the break-even quantity?a. 1,800 unitsb. 2,480 unitsc. 3,057 unitsd. 3,750 unitse. 4,280 unitsDifficulty level: MediumDECISION TREE NET PRESENT VALUEb 69. At stage 2 of the decision tree it shows that if a project is successful, the payoff will be $53,000 with a 2/3 chance of occurrence. There is also the 1/3 chance of a $-24,000payoff. The cost of getting to stage 2 (1 year out) is $44,000. The cost of capital is15%. What is the NPV of the project at stage 1?a. $-13,275b. $-20,232c. $ 2,087d. $ 7,536e. Can not be calculated without the exact timing of future cash flows.Difficulty level: MediumUse the following to answer questions 70-71:The Quick-Start Company has the following pattern of potential cash flows with their planned investment in a new cold weather starting system for fuel injected cars.DECISION TREEa 70. If the company has a discount rate of 17%, what is the value closest to time 1 netpresent value?a. $ 48.6 millionb. $ 80.9 millionc. $108.2 milliond. $181.4 millione. None of the above.Difficulty level: ChallengeDECISION TREEb 71. If the company has a discount rate of 17%, should they decide to invest?a. yes, NPV = $ 2.2 millionb. yes, NPV = $ 21.6 millionc. no, NPV = $-1.9 milliond. yes, NPV = $ 8.6 millione. No, since more than one branch is NPV = 0 or negative you must reject.Difficulty level: ChallengeACCOUNTING BREAK-EVENe 72. The Mini-Max Company has the following cost information on their new prospectiveproject. Calculate the accounting break-even point.Initial investment: $700。

Chapter 12 Risk, cost of capital, and capital budgeting

Cost of capital

For corporate capital budgeting purpose, we often discount a project’s free cash flows (to the firm) by its cost of capital. Free cash flows (FCFs): the cash flows available to the firm’s suppliers of capital, including debt and equity, after all operating expenses (including taxes) have been paid and investments in working capital and fixed assets have been made. Firm = debt + equity.
WACC, II

WACC = we × re + wd × rd × (1 – corporate tax rate). re is the cost of equity (via the CAPM or other pricing models). rd is the cost of debt; if the firm uses corporate bonds to finance all of its long-term debt, we can use YTM as an estimate of the cost of debt.
The cost of equity

In Chapter 11, we learned that the CAPM provides an estimate of the required (expected) return from stock market (equity) investors’ perspective. We learned that this required return can be used to estimate the cost of equity. The cost of equity is a positive function of beta.

风险资本成本和资本预算

03
CATALOGUE
风险资本成本与资本预算的关系
风险资本成本在资本预算中的作用
评估投资项目的风险
风险资本成本是评估投资项目风险的重要指标，通过比较不同项目的风险资本成本，企业可以优先选择风险较低、收益较高的项目。
确定投资项目的折现率
风险资本成本可以作为投资项目的折现率，用于将未来的现金流折现到现值，从而更准确地评估项目的经济价值。
在计算风险资本成本时，由于数据不完整或数据质量不高，导致难以准确评估风险。
风险评估难度大
风险资本成本涉及多个因素，如市场风险、信用风险等，准确评估这些风险具有较大难度。
资本预算不准确
由于风险评估的不确定性，可能导致资本预算不准确，从而影响企业的投资决策。
解决方案和数据质量和完整性，为准确评
风险资本成本和资本预算
CATALOGUE
目录
• 风险资本成本 • 资本预算 • 风险资本成本与资本预算的关系 • 实际应用中的挑战与解决方案
01
CATALOGUE
风险资本成本
风险资本成本的定义
01
风险资本成本是指投资者因承担企业风险而要求的额外收益，以补偿其承担的风险。
02
它反映了投资者对企业未来收益和风险的预期，是企业筹资和投资决策的重要依据。
无风险利率
无风险利率是指投资者可以无风险地获取的回报率。无风险利率是投资者要求的最低回报率，因此它也是确定风险资本成本的重要因素。
企业特定风险
企业特定风险是指企业特有的经营风险、财务风险等。这些风险因素会影响投资者对企业的信心和预期回报率，从而影响风险资本成本。
通货膨胀率
通货膨胀率是指货币购买力的下降速度。通货膨胀率越高，投资者要求的回报率越高，因此风险资本成本也越高。

成本预算课程英文版

❖ Investment is the monetary value of the assets the organization gives up to acquire a long-term asset which are often called capital outlays.
❖ Return is the increased future cash inflows11-7 attributable to the long-term asset
❖ Capital assets create these capacityrelated costs
11-2
❖ NOregeandizatotioCnsohnavtreodleCvealoppeitdasl pAescisficets
tools to control the acquisition and use of long-term assets because:
❖ Capital budgeting has three phases:
Identifying potential investments, Choosing which investments to make, and Follow-up monitoring of the investments. 11-4
The amount of money committed to the acquisition of capital assets is usually quite large
The long-term nature of capital assets creates11-3 technological risk
We need an equivalent basis to compare the cash flows that occur at different points in time

Risk and Capital Budgeting

1-26
Portfolio Risk
• Changes in overall risk of a firm depends on its relationship with other investments
– Highly correlated investments - do not really diversify away risk
• The overall risk exposure of that firm might diminish • The investing firm could alter cyclical fluctuations
inherent in its business and reduce overall risk exposure • Thus, standard deviation for the entire company has been reduced
– Investments carrying greater than normal risk will be discounted at a higher rate and so on
• Risk is assumed to be measured by the coefficient of variation (V)
• Beta is a risk measure widely used with portfolios of common stock
• Beta measures the volatility of returns on an individual stock relative to the stock market index of returns

Capital Budgeting Part 1- Revision notes

✍ Capital budgeting is the process of evaluating and selecting long-term investments thatare consistent with the goal of shareholders (owners’) wealth maximization.✍ The process of planning significant outlays on projects that have long-term implicationsis known as Capital Budgeting.✍ Capital expenditure planning, evaluation, and control, sometimes called as the capitalbudgeting.✍ It involves long-term commitments of resources to realize future benefits. It reflects basiccompany’s objectives and has a significant, long-term effect on the economic well being of the firm.☞ It affects the profitability of a firm.☞ Its effect over a long time spans and inevitably affects the c ompany’s future coststructure.☞ Capital investment decision once made, are not easily reversible without much financialloss to the firm.☞ It involves costs and the majority of the firms have scarce (limited) capital resources.DIFFICULTIES☑The benefits from investments are received in some future period and the future is uncertain. (Risk Involvement)☑Cost incurred and benefits received from the capital budgeting decisions occur in different time periods. (Time value of Money)☑It is not often possible to calculate in strict quantitative terms all the benefits or the costs relating to a particular investment decision.Every decision is made either to1.Enhance the Revenue, or to2.Reduce the costTYPES OF CB DECISIONSAn entity may be deal with the three types of capital budgeting decisions:1.Accept-reject decision2.Mutually exclusive Projects decisions3.Capital Rationing decisionAccept-reject decisionIn this decision, all those proposals, which yield a rate of return greater than a certain required rate of return or cost of capital, are accepted and the rest are rejected. By applying this criterion, all independent projects are accepted. Independent projects are those projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.Mutually exclusive projects decisionMEP decisions are those which compete with other projects in such a way that the acceptance of one will exclude the others from further considerationCapital rationing decisionCapital rationing is a financial situation in which a firm has only fixed amount to allocate among competing capital expenditures.Not all cash flows are relevant in capital budgeting. The only relevant cash flows are the incremental cash flows after tax. Incremental cash flows means only those cash flows that affect a firm’s existing total cash flows should be considered.Here are some examples of what is relevant to project cash flows:1.Depreciation: Capital assets are subject to depreciation and we need to account fordepreciation twice in our calculations of cash flows. We deduct depreciation once to calculate the taxes we pay on project revenues and we add back depreciation to arrive at cash flows because depreciation is a non-cash item.2.Working Capital: Major investments may require increases to working capital. For example,new production facilities often require more inventories and higher salaries payable.Therefore, we need to consider the net change in working capital associated with our project.Changes in net working capital will sometimes release themselves at the end of the project.3.Overhead:Many capital projects can result in increases to allocated overheads, therefore,you need to assess the impact of your capital project on overhead and determine if these costs are relevant.4.Financing Costs: If we plan on financing a capital project, this will involve additional cashflows to investors. The best way to account for financing costs is to include them within our discount rate. This eliminates the possibility of double-counting the financing costs by deducting them in our cash flows and discounting at our cost of capital which also includes our financing costs.We also need to ignore costs that are sunk; i.e. costs that will not change if we invest in the project. For example, a new product line may require some preliminary marketing research. This research is done regardless of the project and thus, it is sunk. The concept of sunk costs and relevant costs applies to all types of financing decisions.CLASSIFICATION OF CASH FLOWS AFTER TAXFor systematic estimation of cash flows, we classify the expenses and benefits into three categories:1.Initial CF2.Operating CF3.Terminal CFInitial Cash FlowsThe initial investments are the one-time expenditures at the time of acquisition to the running condition of the assets. Examples: Accession of property, plant, equipment, installation, training cost. Initial cash flows may be occurred in the form of direct and indirect cash flows.Direct Cash Flows Indirect Cash flows- Capital Expenditure - After tax proceeds of old assets- Operating Expenditure - Change in net working capitalOperating Cash FlowThe cash flows generated by an asset are called operating cash flows, which do not depend on the amount of debt or interest payments being made by the company.In terms of incremental cash flows:Operating CF = (❒S –❒C –❒D) (1 – t) + ❒DWhere ❒S = Incremental sales❒C = Incremental expenditures❒D = Incremental depreciationt = tax rateTerminal Cash FlowsThe cash flows that are expected to occur at the point when project’s useful life ends are the terminal cash flows. Two types of cash inflows influence the capital budgeting decision:1.Salvage value of the asset(s)2.Recovery of the working capitalEVALUATING TECHNI QUES1.Traditional Technique2.Time-adjusted Technique1. TRADITIONAL TECHNIQUEo Payback Methodo Accounting rate of returnPayback period is the length of time that it takes for a project to fully recover its initial cost out ofthe cash receipts that it generates.Payback period= Expected number of years required to recover a project’s cost. MeritsSimple to calculate.Easy to understand.It saves time because if proposal does not provide the payback within specified period then there may be no need to consider it further.Useful in those industries where products become obsolete very rapidly.DemeritsIt is not a true measure of the profitability of an investment.Ignores the time value of money.Ignores cash flows occurring after the payback period.Decision CriteriaShortest payback period project will be preferred over the rest.ExampleFor uniform cash flowsYork Company needs a new milling machine. The company is considering two machines: Machine A costs RS.15000 and will reduce costs by Rs.5000 per year. While machine B costs only Rs.12000 but will reduce costs by Rs.5000 per year. Which company should purchase according to payback method?Solution:Machine A payback period = 15000 / 5000= 3 yearsMachine B payback period = 12000 / 5000= 2.4 yearsRecommendation: Machine B should be purchased because it has a shorter payback periodthan machine A.For un-even cash flowsConsider the two projects and recommend which project should be adopted according to payback method?Project LExpected Net Cash FlowYear Project L Project S0 1 2 3 (Rs.100)106080(Rs.100)704020Payback L= 2 + Rs.30/ Rs.80 years= 2.4 yearsPayback S = 1 + Rs.30 / Rs.40=1.75 yearsRecommendationProject S should be adopted because its payback period is shorter than that of project L.The rate of return on accounting profit which is generated by the investment is termed as accounting rate of return.It focuses on accounting profit rather than cash flows. It is computed as:Average NetIncome is determined by addingall profit after taxes and dividing it by number of years. In the case of annuity, the average net income is equal to the any year’s profit.Average investment is determined by dividing the investment by 2.If Salvage value is zero, then,Avg. Investment = Total Investment / 2If Salvage value is greater than zero, thenValue Salvage Value SalvageInvestment Investment Avg .2..+⎥⎦⎤⎢⎡-=If cost reduction project is involved thenInitial investment should be reduce by any salvage value from the sale of old equipmentMeritsSimple to calculateEasy to understand.Used for demonstration purposes.DemeritsIgnores the time value of money.It focuses on accounting profit rather than cash flows.It may be desirable in some years and undesirable in the other years because of variationin accounting profit over the life of the project.Decision CriteriaIf ARR > RRR Accept If ARR < RRRRejectExampleRaak Amusement Corporation is investigating the purchase of a new electronic game called IGI-4. The manufacturer will sell 20 games to Raak Amusements for Rs.180000. Raak Amusement has determined the following additional information:i. The game life would have 5 years with no salvage value. (Straight line Depreciation)ii. The game would replace other unpopular games. These games would be sold for Rs.30000. iii. It is estimated that IGI-4 would generate incremental revenues of Rs.200000 per year.Incremental out of pocket costs each year would be in total: maintenance Rs.50000; and insurance Rs.10000. In addition, would have to pay a 40% commission & other outlets to the supermarkets.Required : Compute the ARR. Will the game be purchased if Raak Amusement accepts the project with ARR greater than 1?SolutionIncome Statement Rs. Sales 200000 Commission 80000 Contribution Margin 120000Fixed Expenses Maintenance 50000 Insurance 10000 Depreciation 36000 Total Fixed Expenses 96000 Net Operating IncomeDepreciation: 180000/5 = Rs.36000ipment ueofOldEqu SalvageVal estment InitialInv ingIncomelNetOperat Incrementa ARR -=30000180********-=ARRRecommendationBecause the return exceeds the 14% therefore, it should be accepted to purchase the games.ARR 16% > RRR 14%------- Accept the project2. TIME-ADJUSTED TECHNIQUEUnlike accounting, financial management is concerned with the values of assets today; i.e. present values. Since capital projects provide benefits into the future and since we want to determine the present value of the project, we will discount the future cash flows of a project to the present.Discounting refers to taking a future amount and finding its value today. Future values differ from present values because of the time value of money. Financial management recognizes the time value of money because:Inflation reduces values over time; i.e. Rs. 1,000 today will have less value five years from now due to rising prices (inflation).Uncertainty in the future; i.e. we think we will receivers Rs. 1,000 five years from now, but a lot can happen over the next five years.Opportunity Costs of money; Rs. 1,000 today is worth more to us than Rs. 1,000 five years from now because we can invest Rs. 1,000 today and earn a return.Following are the time adjusted technique to evaluate the projects:✆Discounted Payback period Method✆Net Present Value Method✆Internal Rate of Return (IRR) Method✆Modified IRR Method✆Profitability Index MethodDiscounted payback period is the length of time that it takes for a project to fully recover its initial cost out of the present value of cash receipts that it generates.Decision CriteriaShortest payback period project will be preferred over the rest.ExampleExamine the following example and recommend the company about the acceptance of the project. The required payback period is 5 years.Year CashFlowPVFactor@10%PV of CFRECOVERY PaybackYearsNeeded Balance0 -10000 -10000 10000 10000 11 3000 0.909 2727 10000 7273 12 2500 0.826 2065 7273 5208 13 2000 0.751 1502 5208 3706 14 2000 0.683 1366 3706 2340 15 2000 0.621 1242 2340 1098 16 2500 0.564 1410 1098 - 0.78Discounted Payback PeriodRecommendationBecause discounted payback period is more than the required, the company should not to accept that project.Present value of cash inflows minus present value of cash outflows is termed as Net PresentValueNPT = PV of Cash Inflows – PV of Cash OutflowsProcedureFind the PV of each cash flow, including both inflows and outflows, discounted at the project’s cost of capital.Match the discounted cash inflows with the discounted cash outflows, the result will be the NPV of the project.FormulaeFor discounting the Future value to the Present Value:For Un-even Cash flows (Single)For Annuity (Same Size)WhereR = Annuity (Amount of any 1 year)i = Interest raten = Number of periodsMeritsIt recognizes the time value of money.It considers the total benefit arising out of the project over its life time.It is particularly useful for the selection of mutually exclusive projects.This method of asset selection is instrumental in achieving the objective of the financial management.DemeritsIt is difficult to calculate and understand.Difficult to use in comparison with the payback method and ARR method.It involves the calculation of discount rate of return to discount the cash flows. Decision CriteriaIf NPV is +ve Accept the ProjectIf NPV is –ve Reject the ProjectExampleConsider the two projects Project L and Project R. Initial Investments of both are Rs.100.Recommendation✍If the projects are independent, accept both✍If the projects are mutually exclusive, accept Project L since NPV S > NPV LDefinitionAn asset’s internal rate of return (time adjusted rate of return) is the true economic return earnedby the asset over its life.IRR is that discounted rate which forces the PV of a project’s expected cash inflows to equal thepresent value of the project’s expected costs.MeritsIt considers the time value of moneyIt takes into account the total cash outflows and inflowsIt is easier to understand. Business executives and non-technical peoples can understand it more easily as compare to NPV.It does not use the concept of RRR rather it itself provides a rate which is indicative of the profitability of the proposal.DemeritsIt generally involves complicated and boring calculations.It produces multiple rates which can be confusing.In evaluating mutually exclusive proposals, the project with the highest IRR would be picked up to the exclusion of all others which are more consistent with the goal.It is based on the assumption that all cash inflows are reinvested at the IRRDecision CriteriaIf IRR >= Hurdle Rate (RRR) Accept the ProposalIf IRR < Hurdle Rate (RRR) Reject the ProposalExampleFollowing data is related to the two machines A and B. Assuming cost of capital is 12%. Calculate the IRR.Years MachineA MachineB 0 -56125 -56125 1 14000 22000 2 16000 20000 3 18000 18000 4 20000 16000 52500017000SolutionBy Trial & Error Method:Years PV Factor @ 17% Machine A PV Factor @20% Machine B CFAT PV of CFAT CFAT PV of CFAT 0 1 -56125 -56125 1 -56125 -56125 1 0.855 14000 11970 0.833 22000 18326 2 0.731 16000 11696 0.694 20000 13880 3 0.624 18000 11232 0.579 18000 10422 4 0.534 20000 10680 0.482 16000 7712 5 0.456 25000 11400 0.402 17000 68348531049NPV of both machine are positive so increase the discount rate and try again.Years PV Factor @ 18% Machine A PV Factor @21% Machine BPV of0 1 -56125 -56125 1 -56125 -56125 1 0.847 14000 11858 0.826 22000 18172 2 0.718 16000 11488 0.683 20000 13660 3 0.609 18000 10962 0.564 18000 10152 4 0.516 20000 10320 0.467 16000 7472 5 0.437 25000 10925 0.386 17000 6562InterpolationMachine A⎥⎦⎤⎢⎣⎡--+=)572{853853%17IRR %598.0%17+=IRRMachine B⎥⎦⎤⎢⎣⎡--+=)107{10491049%20IRR %9.0%17+=IRRRecommendationBecause, Machine B IRR is greater than Machine A IRR, so firm should accept the proposal of Machine B.The discount rate at which the PV of a project’s cost is equal to the PV of its terminal value.PV costs = PV terminal valueIRR based on reinvestment rate assumption. In order to eliminate the reinvestment rate assumption, we will modify the Internal Rate of Return so that the reinvestment rate is our cost of capital or the rate which is expected to earn on investment. This will give a more accurate IRR for our project.Decision CriteriaIf MIRR >= Hurdle Rate (RRR) Accept the Proposal If MIRR< Hurdle Rate (RRR)Reject the Proposal ORPV of Sum of Terminal Value > PV of Cash Outflows Accept the Proposal PV of Sum of Terminal Value < PV of Cash OutflowsReject the ProposalSelection among various alternatives, the one with highest rate of return is preferable.ExampleConsider a project which original outlay Rs.10000 and the Life is 5 years. Cash inflows Rs.4000 for each year and cost of capital is 10%.Expected Rate of Return at which cash inflows will be re-invested: For 1 and 2 year 6% For 3 to 5 year 8%Year Cash Inflows Rate Years of Investment Compounding FactorTotalCompounded14000 6 41.262 5048 2 4000 6 3 1.191 4764 3 4000 8 2 1.166 4664 4 4000 8 1 1.08 4320 5 4000 8 0 1 400022796PV of Cash Outflows-10000 PV of Cash Inflows 22796@0.621 14156.3 Net Present ValueTo achieve NPV = Zero, apply 17% discount RatePV of Cash Outflows-10000 PV of Cash Inflows (17%) 22796@0.4561 10397.25 Net Present Value397.25To achieve NPV = Zero, now apply 18% discount RatePV of Cash Outflows-10000 PV of Cash Inflows (18%) 22796@0.4371 9964.13 Net Present ValueInterpolation⎥⎦⎤⎢⎣⎡-+=)87.35{25.39725.397%17MIRR %917.0%17+=MIRRRecommendationBecause MIRR > Cost of Capital so, accept the project. 17.917% > 10% --------------- Accept the ProjectComparison between IRR and MIRRThe modified IRR has a significant advantage over the regular IRR. Modified IRR assumes the cash flows from all projects are reinvested at the cost of capital, whereas regular IRR assumes that cash flows from each project are reinvested at theproject’s own IRR. Its mean different projects have different IRR and hence at the same time they are reinvested at the different rate, which is illogical. Therefore reinvestment at k is generally more l ogical and correct, that’s why M IRR is a better indicator of a project’s true profitabilit y. Profitability index measures the present value of returns per rupee invested.FormulaDecision Criteria✆ If PI > 1Accept (NPV +Ve)✆ If PI < 1 Reject (NPV –Ve) ✆ When PI = 1Remains indifferent (NPV Zero)ExampleConsider two Machines A & B. Present value of cash inflows Rs.68645 & Rs.71521 of A & B respectively and present value of cash outflows of both machines Rs.56215.SolutionMachine AtflowsPVofCashOu flowsPVofCashIn PI =5612568645=PIMachine BtflowsPVofCashOu flowsPVofCashIn PI =5612571521=PIRecommendationSince the PI of both the machines is greater than 1, both the machines are acceptable. However, Machine B PI is greater than Machine A, therefore Machine B is preferable.Capital Budgeting Continue----wait for next part。

国际金融资本预算以货币风险

国际金融资本预算以货币风险International FinanceTodayCapital Budgeting (international style)Financing (international style)TopicsExchange ratesCurrency riskManaging Currency RiskCapital Budgeting w/ currency riskFinancing w/currency riskExchange RatesSpot RateThe price of a currency for immediate delivery (i1>.e. today’s exchange rate)Forward RateThe price of a currency on a specified future date (i.e. a forward contract in which the exercise price is the exchange rate)Futures - Same as forward (w/secondary markets)Options - on exchange rates & Future KsExchange RatesExampleGerman mark spot price is M1.4457 per $1German mark 6 mt forward price is M1.4282 per $1The Mark is selling at a Forward PremiumThe Dollar is selling at a Forward DiscountThis means that the market expects the dollar to get weaker, relative to the markExample (premium? discount?)The Japanese Yen spot price is 101.18 per $1The Japanese 6mt fwd price is 103.52 per $1Exchange RatesExampleWhat is the Mark premium (annualized)?Exchange RatesExampleWhat is the Mark premium (annualized)?Mark Premium = 2 x ( 1.4457 - 1.4282) = 2.45%1.4282Dollar Discount = 2.45%Exchange RatesExampleWhat is the Mark premium (annualized)?Mark Premium = 2 x ( 1.4457 - 1.4282) = 2.45%1.4282Dollar Discount = 2.45%ExampleWhat is the Yen discount (annualized)?Exchange RatesExampleWhat is the Mark premium (annualized)?Mark Premium = 2 x ( 1.4457 - 1.4282) = 2.45%1.4282Dollar Discount = 2.45%ExampleWhat is the Yen discount (annualized)?Yen Discount = 2 x ( 103.52 - 101.18) = 4.26%103.52Dollar Premium = 4.26%Exchange Rates1) Interest Rate Parity Theory1 + rf = Ff/$1 + r$ Sf/$The difference between the risk free interest rates in two different countries is equal to the difference between the forward and spot rates Exchange RatesExampleYou are doing a project in Germany which has an initial cost of $100,000. All other things being equal, you have the opprtunity to obtain a 1 year German loan (in marks) @ 8.0% or a 1 year US loan (in dollars) @ 10%. The spot rate is 1.4457dm:$1 The 1 year forward rate is 1.4194dm:$1 Which loan will you prefer and why?Ignore transaction costsExchange RatesExampleYou are doing a project in Germany which has an initial cost of $100,000. All other things being equal, you have the opprtunity to obtain a 1 year German loan (in marks) @ 8.0% or a 1 year US loan (in dollars) @ 10%. The spot rate is 1.4457dm:$1 The 1 year forward rate is 1.4194dm:$1 Which loan will you prefer and why? Ignore transaction costsCost of US loan = $100,000 x 1.10 = $110,000Exchange RatesExampleYou are doing a project in Germany which has an initial cost of $100,000. All other things being equal, you have the opprtunity to obtain a 1 year German loan (in marks) @ 8.0% or a 1 year US loan (in dollars) @ 10%. The spot rate is 1.4457dm:$1 The 1 year forward rate is 1.4194dm:$1 Which loan will you prefer and why? Ignore transaction costsCost of US loan = $100,000 x 1.10 = $110,000Cost of German Loan = $100,000 x 1.4457 = 144,570 dm exchangeExchange RatesExampleYou are doing a project in Germany which has an initial cost of $100,000. All other things being equal, you have the opprtunity to obtain a 1 year German loan (in marks) @ 8.0% or a 1 year US loan (in dollars) @ 10%. The spot rate is 1.4457dm:$1 The 1 year forward rate is 1.4194dm:$1 Which loan will you prefer and why? Ignore transaction costsCost of US loan = $100,000 x 1.10 = $110,000Cost of German Loan = $100,000 x 1.4457 = 144,570 dm exchange 144,570 dm x 1.08 = 156,135 dm loan pmtExchange RatesExampleYou are doing a project in Germany which has an initial cost of $100,000. All other things being equal, you have the opprtunity to obtain a 1 year German loan (in marks) @ 8.0% or a 1 year US loan (in dollars) @ 10%. The spot rate is 1.4457dm:$1 The 1 year forward rate is 1.4194dm:$1 Which loan will you prefer and why? Ignore transaction costsCost of US loan = $100,000 x 1.10 = $110,000Cost of German Loan = $100,000 x 1.4457 = 144,570 dm exchange 144,570 dm x 1.08 =156,135 dm loan pmt156,135 dm / 1.4194 = $110,000 exchangeIf the two loans created a different result, arbitrage exists!Exchange Rates2) Expectations Theory of Forward RatesFf/$ = E (Sf/$)Sf/$ Sf/$The difference between the forward & spot rates equals the expected change in the spot rate.Exchange Rates3) Law of One Price (Purchasing Power Parity)E (Sf/$) = E ( 1 + if )Sf/$ E ( 1 + i$ )The expected change in the spot rate equals the expected difference in inflation between the two countries.Exchange RatesExampleGiven a spot rate of dm:$ 1.4457:$1Given a 1yr fwd rate of 1.4194:$1If inflation in the US is forecasted at 4.5% this year,what do we knowabout the forecasted inflation rate in Germany?Exchange RatesExampleGiven a spot rate of dm:$ 1.4457:$1Given a 1yr fwd rate of 1.4194:$1If inflation in the US is forecasted at 4.5% this year,what do we know about the forecasted inflation rate in Germany?E (Sf/$) = E ( 1 + if )Sf/$ E ( 1 + i$ )Exchange RatesExampleGiven a spot rate of dm:$ 1.4457:$1Given a 1yr fwd rate of 1.4194:$1If inflation in the US is forecasted at 4.5% this year,what do we know about the forecasted inflation rate in Germany?E (Sf/$) = E ( 1 + if )Sf/$ E ( 1 + i$ )1.4194 = E( 1 + i)1.4457 1 + .045Exchange RatesExampleGiven a spot rate of dm:$ 1.4457:$1Given a 1yr fwd rate of 1.4194:$1If inflation in the US is forecasted at 4.5% this year,what do we know about the forecasted inflation rate in Germany?E (Sf/$) = E ( 1 + if )Sf/$ E ( 1 + i$ )solve for i1.4194 = E( 1 + i) i = .026 or2.6%1.4457 1 + .045Exchange Rates4) Capital Market EquilibriumE ( 1 + if ) = 1 + rfE ( 1 + i$ ) 1 + r$The expected difference in inflation rates equals the difference in current interest rates.Also called common real interest ratesExchange RatesExampleIn the previous examples, show the equilibrium of interest rates and inflation rates1 + rf = 1.08 = .98181 + r$ 1.10Exchange RatesExampleIn the previous examples, show the equilibrium of interest rates and inflation rates1 + rf = 1.08 = .98181 + r$ 1.10E ( 1 + if ) = 1.026 = .9818E ( 1 + i$ ) 1.045Exchange RatesApplicationsQ: What does it mean to a business if the dollar is trading at a forward premium?Exchange RatesApplicationsQ: What does it mean to a business if the dollar is trading at a forward premium?A: Stronger purchasing powerExchange RatesExampleHonda builds a new car in Japan for a cost + profit of 1,715,000 yen. At an exchange rate of 101.18:$1 the car sells for $16,950 in Baltimore. If the dollar rises in value, against the yen, to an exchange rate of 105:$1, what will be the price of the car?Exchange RatesExampleHonda builds a new car in Japan for a cost + profit of 1,715,000 yen. At an exchange rate of 101.18:$1 the car sells for $16,950 in Baltimore. If the dollar rises in value, against the yen, to an exchange rate of 105:$1, what will be the price of the car?1,715,000 = $16,333105Exchange RatesExampleHonda builds a new car in Japan for a cost + profit of 1,715,000 yen. At an exchange rate of 101.18:$1 the car sells for $16,950 in Baltimore. If the dollar rises in value, against the yen, to an exchange rate of 105:$1, what will be the price of the car?1,715,000 = $16,333105Conversely, if the yen is trading at a forward discount, Japan will experience a decrease in purchasing power.Exchange RatesExampleHarley Davidson builds a motorcycle for a cost plus profit fo $12,000. At an exchange rate of 101.18:$1, the motorcycle sells for 1,214,160 yen in Japan. If the dollar rises in value and the exchange rate is 105:$1, what will the motorcycle cost in Japan?Exchange RatesExampleHarley Davidson builds a motorcycle for a cost plus profit fo $12,000. At an exchange rate of 101.18:$1, the motorcycle sells for 1,214,160 yen in Japan. If the dollar rises in value and the exchange rate is 105:$1, what will the motorcycle cost in Japan?$12,000 x 105 = 1,260,000 yen (3.78% rise)Currency RiskCurrency Risk can be reduced by using various financial instrumentsCurrency forward contracts, futures contracts, and even options on these contracts are available to control the riskCurrency RiskExampleYour US company is building a plant in Germany. Your cost will becurrency risk. The spot rate is 1.4397dm:$1 and the 6 mt forward rate is 1.4350dm:$1. How can you eliminate the currency risk? How does this help in evaluating the project?Currency RiskExampleYour US company is building a plant in Germany. Your cost will be 2,000,000 dm, with full payment due in 6 months. You are concerned about currency risk. The spot rate is 1.4397dm:$1 and the 6 mt forward rate is 1.4350dm:$1. How can you eliminate the currency risk? How does this help in evaluating the project?Since you are long in dollars, you should short dm contractsCurrency RiskExampleYour US company is building a plant in Germany. Your cost will be 2,000,000 dm, with full payment due in 6 months. You are concerned about currency risk. The spot rate is 1.4397dm:$1 and the 6 mt forward rate is 1.4350dm:$1. How can you eliminate the currency risk? How does this help in evaluating the project?Since you are long in dollars, you should short dm contracts2,000,000dm / 1.4350 = $1,393,728 worth of 6mt dm Ks.Currency RiskExampleYour US company is building a plant in Germany. Your cost will becurrency risk. The spot rate is 1.4397dm:$1 and the 6 mt forward rate is 1.4350dm:$1. How can you eliminate the currency risk? How does this help in evaluating the project?Since you are long in dollars, you should short dm contracts2,000,000dm / 1.4350 = $1,393,728 worth of 6mt dm Ks.This will lock in your Co cash flow at $1,393,728Currency RiskExampleYour US company is building a plant in Germany. Your cost will be 2,000,000 dm, with full payment due in 6 months. You are concerned about currency risk. The spot rate is 1.4397dm:$1 and the 6 mt forward rate is 1.4350dm:$1. How can you eliminate the currency risk? How does this help in evaluating the project?Since you are long in dollars, you should short dm contracts2,000,000dm / 1.4350 = $1,393,728 worth of 6mt dm Ks.This will lock in your Co cash flow at $1,393,728The forward premium paid is 0.33% (using capital market equilibrium, this premium probably equals the inflation rate.Capital BudgetingTechniques1) Exchange to $ and analyze2) Discount and then exchange3) Choose a currency standard ($) and hedge all non dollar CFExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: What are the 1, 2, 3, 4, 5 year forward rates?ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: What are the 1, 2, 3, 4, 5 year forward rates?A: E (Sf/$) = E ( 1 + if )t solve for E(S)Sf/$ E ( 1 + i$ )tExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: What are the 1, 2, 3, 4, 5 year forward rates?A: E (Sf/$) = E ( 1 + if )t solve for E(S)Sf/$ E ( 1 + i$ )tE(S) 2.02 2.04 2.06 2.08 2.10ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: Convert the CF to $ using the forward rates.1 2 3 4 5CFg 400 450 510 575 650ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: Convert the CF to $ using the forward rates.1 2 3 4 5CFg 400 450 510 575 650E(S) 2.02 2.04 2.06 2.08 2.10ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650Q: Convert the CF to $ using the forward rates.1 2 3 4 5CFg 400 450 510 575 650E(S) 2.02 2.04 2.06 2.08 2.10CF$ 198 221 248 276 310ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650What is the PV of the project in dollars at a risk premium of 7.4%?ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650What is the PV of the project in dollars at a risk premium of 7.4%?$ discount rate = 1.08 x 1.074 = 1.16PV = $794,000ExampleOutland Corporation is building a plant in Holland to produce reindeerrepelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650What is the PV of the project in guilders at a risk premium of 7.4%? Convert to dollars.ExampleOutland Corporation is building a plant in Holland to produce reindeer repelant to sell in that country. The plant is expected to produce a cash flow (in guilders ,000s) as follows. The US risk free rate is 8%, the Dutch rate is 9%. US inflation is forecasted at 5% per year and the current spot rate is 2.0g:$1.year 1 2 3 4 5400 450 510 575 650What is the PV of the project in guilders at a risk premium of 7.4%? Convert to dollars.$ discount rate = 1.09 x 1.074 = 1.171PV = 1,588,000 guildersexchanged at 2.0:$1 = $794,000Misc ItemsTax Comparisons between countriesPolitical RiskMisc ItemsTax Comparisons between countriesPolitical RiskCorporate Financial Theory- Go over Final- Answer questions for final - in normal class room What We KnowNet Present ValueCapital Asset Pricing Model (CAPM)Efficient Capital MarketsValue Additivity & ConservationOption TheoryAgency TheoryWhat We Do Not KnowHow major decions are madeWhat determines the risk & PV ?CAPM shortfallsWhy are some markets inefficient?Is management a liability?Why do IPOs succeed & new markets emerge?Why is capital structure not optimized?Dividend policy - Answer?Liquidity value?Why do mergers come in waves?What We Do Not KnowReview for FinalIn normal class room TopicsFormatDifficultyBonus Points******************* * * * * * * * * * * * * * * * * * * * * * * ** * * * * * * * * *。

(完整word版)投资学第7版Test Bank答案09

Multiple Choice Questions1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of riskisA) unique risk.B) beta.C) standard deviation of returns.D) variance of returns.E) none of the above.Answer: B Difficulty: EasyRationale: Once, a portfolio is diversified, the only risk remaining is systematic risk,which is measured by beta.2. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rateof return is a function ofA) market riskB) unsystematic riskC) unique risk.D) reinvestment risk.E) none of the above.Answer: A Difficulty: EasyRationale: With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences return according to the CAPM.3. The market portfolio has a beta ofA) 0.B) 1.C) -1.D) 0.5.E) none of the aboveAnswer: B Difficulty: EasyRationale: By definition, the beta of the market portfolio is 1.4. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively.According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal toA) 0.06.B) 0.144.C) 0.12.D) 0.132E) 0.18Answer: D Difficulty: EasyRationale: E(R) = 6% + 1.2(12 - 6) = 13.2%.5. The risk-free rate and the expected market rate of return are 0.056 and 0.125,respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal toA) 0.1225B) 0.144.C) 0.153.D) 0.134E) 0.117Answer: A Difficulty: EasyRationale: E(R) = 5.6% + 1.25(12.5 - 5.6) = 14.225%.6. Which statement is not true regarding the market portfolio?A) It includes all publicly traded financial assets.B) It lies on the efficient frontier.C) All securities in the market portfolio are held in proportion to their market values.D) It is the tangency point between the capital market line and the indifference curve.E) All of the above are true.Answer: D Difficulty: ModerateRationale: The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.7. Which statement is not true regarding the Capital Market Line (CML)?A) The CML is the line from the risk-free rate through the market portfolio.B) The CML is the best attainable capital allocation line.C) The CML is also called the security market line.D) The CML always has a positive slope.E) The risk measure for the CML is standard deviation.Answer: C Difficulty: ModerateRationale: Both the Capital Market Line and the Security Market Line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus C is not true; the other statements are true).8. The market risk, beta, of a security is equal toA) the covariance between the security's return and the market return divided by thevariance of the market's returns.B) the covariance between the security and market returns divided by the standarddeviation of the market's returns.C) the variance of the security's returns divided by the covariance between the securityand market returns.D) the variance of the security's returns divided by the variance of the market's returns.E) none of the above.Answer: A Difficulty: ModerateRationale: Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.9. According to the Capital Asset Pricing Model (CAPM), the expected rate of return onany security is equal toA) R f+ β [E(R M)].B) R f + β [E(R M) - R f].C) β [E(R M) - R f].D) E(R M) + R f.E) none of the above.Answer: B Difficulty: ModerateRationale: The expected rate of return on any security is equal to the risk free rate plus the systematic risk of the security (beta) times the market risk premium, E(R M - R f).10. The Security Market Line (SML) isA) the line that describes the expected return-beta relationship for well-diversifiedportfolios only.B) also called the Capital Allocation Line.C) the line that is tangent to the efficient frontier of all risky assets.D) the line that represents the expected return-beta relationship.E) the line that represents the relationship between an individual security's return andthe market's return.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return per unit of risk, where risk isdefined as beta (systematic risk).11. According to the Capital Asset Pricing Model (CAPM), fairly priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: B Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).12. According to the Capital Asset Pricing Model (CAPM), under priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: D Difficulty: Moderate13. According to the Capital Asset Pricing Model (CAPM), over priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: C Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).14. According to the Capital Asset Pricing Model (CAPM),A) a security with a positive alpha is considered overpriced.B) a security with a zero alpha is considered to be a good buy.C) a security with a negative alpha is considered to be a good buy.D) a security with a positive alpha is considered to be underpriced.E) none of the above.Answer: D Difficulty: ModerateRationale: A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the perceived risk of the security, and thus isunderpriced.15. According to the Capital Asset Pricing Model (CAPM), which one of the followingstatements is false?A) The expected rate of return on a security decreases in direct proportion to a decreasein the risk-free rate.B) The expected rate of return on a security increases as its beta increases.C) A fairly priced security has an alpha of zero.D) In equilibrium, all securities lie on the security market line.E) All of the above statements are true.Answer: A Difficulty: ModerateRationale: Statements B, C, and D are true, but statement A is false.16. In a well diversified portfolioA) market risk is negligible.B) systematic risk is negligible.C) unsystematic risk is negligible.D) nondiversifiable risk is negligible.E) none of the above.Answer: C Difficulty: ModerateRationale: Market, or systematic, or nondiversifiable, risk is present in a diversified portfolio; the unsystematic risk has been eliminated.17. Empirical results regarding betas estimated from historical data indicate thatA) betas are constant over time.B) betas of all securities are always greater than one.C) betas are always near zero.D) betas appear to regress toward one over time.E) betas are always positive.Answer: D Difficulty: ModerateRationale: Betas vary over time, betas may be negative or less than one, betas are not always near zero; however, betas do appear to regress toward one over time.18. Your personal opinion is that a security has an expected rate of return of 0.11. It has abeta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09.According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.19. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If youexpect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you shouldA) buy the stock because it is overpriced.B) sell short the stock because it is overpriced.C) sell the stock short because it is underpriced.D) buy the stock because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.20. You invest $600 in a security with a beta of 1.2 and $400 in another security with a betaof 0.90. The beta of the resulting portfolio isA) 1.40B) 1.00C) 0.36D) 1.08E) 0.80Answer: D Difficulty: ModerateRationale: 0.6(1.2) + 0.4(0.90) = 1.08.21. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expectedrate of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock isA) 1.7%.B) -1.7%.C) 8.3%.D) 5.5%.E) none of the above.Answer: A Difficulty: ModerateRationale: 10% - [5% +1.1(8% - 5%)] = 1.7%.22. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: B Difficulty: ModerateRationale: 11.5% - 4% + 1.3(11.5% - 4%) = -2.25%; therefore, the security isoverpriced.23. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 13.75% - 4% + 1.3(11.5% - 4%) = 0.0%; therefore, the security is fairlypriced.24. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 15% - 4% + 1.3(11.5% - 4%) = 1.25%; therefore, the security is under priced.25. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 11.2% - 4% + 0.92(10% - 4%) = 1.68%; therefore, the security is underpriced.26. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10.According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 9.52% - 4% + 0.92(10% - 4%) = 0.0%; therefore, the security is fairly priced.27. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 8.0% - 4% + 0.92(10% - 4%) = -1.52%; therefore, the security is overpriced.28. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 10% < 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is overpriced andshould be shorted.29. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 11 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: E Difficulty: ModerateRationale: 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is fairly priced. 30. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 13 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: D Difficulty: ModerateRationale: 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is under priced. 31. You invest 55% of your money in security A with a beta of 1.4 and the rest of yourmoney in security B with a beta of 0.9. The beta of the resulting portfolio isA) 1.466B) 1.157C) 0.968D) 1.082E) 1.175Answer: E Difficulty: ModerateRationale: 0.55(1.4) + 0.45(0.90) = 1.175.32. Given the following two stocks A and BIf the expected market rate of return is 0.09 and the risk-free rate is 0.05, which security would be considered the better buy and why?A) A because it offers an expected excess return of 1.2%.B) B because it offers an expected excess return of 1.8%.C) A because it offers an expected excess return of 2.2%.D) B because it offers an expected return of 14%.E) B because it has a higher beta.Answer: C Difficulty: ModerateRationale: A's excess return is expected to be 12% - [5% + 1.2(9% - 5%)] = 2.2%. B's excess return is expected to be 14% - [5% + 1.8(9% - 5%)] = 1.8%.33. Capital Asset Pricing Theory asserts that portfolio returns are best explained by:A) economic factors.B) specific risk.C) systematic risk.D) diversification.E) none of the above.Answer: C Difficulty: EasyRationale: The risk remaining in diversified portfolios is systematic risk; thus, portfolio returns are commensurate with systematic risk.34. According to the CAPM, the risk premium an investor expects to receive on any stockor portfolio increases:A) directly with alpha.B) inversely with alpha.C) directly with beta.D) inversely with beta.E) in proportion to its standard deviation.Answer: C Difficulty: EasyRationale: The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or portfolio varies directly with beta.35. What is the expected return of a zero-beta security?A) The market rate of return.B) Zero rate of return.C) A negative rate of return.D) The risk-free rate.E) None of the above.Answer: D Difficulty: ModerateRationale: E(R S) = r f + 0(R M - r f) = r f.36. Standard deviation and beta both measure risk, but they are different in thatA) beta measures both systematic and unsystematic risk.B) beta measures only systematic risk while standard deviation is a measure of totalrisk.C) beta measures only unsystematic risk while standard deviation is a measure of totalrisk.D) beta measures both systematic and unsystematic risk while standard deviationmeasures only systematic risk.E) beta measures total risk while standard deviation measures only nonsystematic risk.Answer: B Difficulty: EasyRationale: B is the only true statement.37. The expected return-beta relationshipA) is the most familiar expression of the CAPM to practitioners.B) refers to the way in which the covariance between the returns on a stock and returnson the market measures the contribution of the stock to the variance of the marketportfolio, which is beta.C) assumes that investors hold well-diversified portfolios.D) all of the above are true.E) none of the above is true.Answer: D Difficulty: ModerateRationale: Statements A, B and C all describe the expected return-beta relationship.38. The security market line (SML)A) can be portrayed graphically as the expected return-beta relationship.B) can be portrayed graphically as the expected return-standard deviation of marketreturns relationship.C) provides a benchmark for evaluation of investment performance.D) A and C.E) B and C.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return-beta (the CML is a measure of expected return-standard deviation of market returns). The SML provides the expected return-beta relationship for "fairly priced" securities; thus if a portfolio manager selects securities that are underpriced and produces a portfolio with a positive alpha, thisportfolio manager would receive a positive evaluation.39. Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficientpricing factor by suggesting that managers should use beta to estimateA) long-term returns but not short-term returns.B) short-term returns but not long-term returns.C) both long- and short-term returns.D) book-to-market ratios.E) None of the above was suggested by Stein.Answer: A Difficulty: Difficult40. Studies of liquidity spreads in security markets have shown thatA) liquid stocks earn higher returns than illiquid stocks.B) illiquid stocks earn higher returns than liquid stocks.C) both liquid and illiquid stocks earn the same returns.D) illiquid stocks are good investments for frequent, short-term traders.E) None of the above is true.Answer: B Difficulty: Difficult41. An underpriced security will plotA) on the Security Market Line.B) below the Security Market Line.C) above the Security Market Line.D) either above or below the Security Market Line depending on its covariance withthe market.E) either above or below the Security Market Line depending on its standard deviation.Answer: C Difficulty: EasyRationale: An underpriced security will have a higher expected return than the SML would predict; therefore it will plot above the SML.42. The risk premium on the market portfolio will be proportional toA) the average degree of risk aversion of the investor population.B) the risk of the market portfolio as measured by its variance.C) the risk of the market portfolio as measured by its beta.D) both A and B are true.E) both A and C are true.Answer: D Difficulty: ModerateRationale: The risk premium on the market portfolio is proportional to the averagedegree of risk aversion of the investor population and the risk of the market portfolio measured by its variance.43. In equilibrium, the marginal price of risk for a risky security must beA) equal to the marginal price of risk for the market portfolio.B) greater than the marginal price of risk for the market portfolio.C) less than the marginal price of risk for the market portfolio.D) adjusted by its degree of nonsystematic risk.E) none of the above is true.Answer: A Difficulty: ModerateRationale: In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the market. If not, investors will buy or sell the security until they are equal.44. The capital asset pricing model assumesA) all investors are price takers.B) all investors have the same holding period.C) investors pay taxes on capital gains.D) both A and B are true.E) A, B and C are all true.Answer: D Difficulty: EasyRationale: The CAPM assumes that investors are price-takers with the same single holding period and that there are no taxes or transaction costs.45. If investors do not know their investment horizons for certainA) the CAPM is no longer valid.B) the CAPM underlying assumptions are not violated.C) the implications of the CAPM are not violated as long as investors' liquidity needsare not priced.D) the implications of the CAPM are no longer useful.E) none of the above is true.Answer: C Difficulty: ModerateRationale: This is discussed in the chapter's section about extensions to the CAPM. It examines what the consequences are when the assumptions are removed.46. The value of the market portfolio equalsA) the sum of the values of all equity securities.B) the sum of the values of all equity and fixed income securities.C) the sum the values of all equity, fixed income, and derivative securities.D) the sum of the values of all equity, fixed income, and derivative securities plus thevalue of all mutual funds.E) the entire wealth of the economy.Answer: E Difficulty: ModerateRationale: The market portfolio includes all assets in existence.47. The amount that an investor allocates to the market portfolio is negatively related toI)the expected return on the market portfolio.II)the investor's risk aversion coefficient.III)the risk-free rate of return.IV)the variance of the market portfolioA) I and IIB) II and IIIC) II and IVD) II, III, and IVE) I, III, and IVAnswer: D Difficulty: ModerateRationale: The optimal proportion is given by y = (E(R M)-r f)/(.01xAσ2M). This amount will decrease as r f, A, and σ2M decrease.48. One of the assumptions of the CAPM is that investors exhibit myopic behavior. Whatdoes this mean?A) They plan for one identical holding period.B) They are price-takers who can't affect market prices through their trades.C) They are mean-variance optimizers.D) They have the same economic view of the world.E) They pay no taxes or transactions costs.Answer: A Difficulty: ModerateRationale: Myopic behavior is shortsighted, with no concern for medium-term orlong-term implications.49. The CAPM applies toA) portfolios of securities only.B) individual securities only.C) efficient portfolios of securities only.D) efficient portfolios and efficient individual securities only.E) all portfolios and individual securities.Answer: E Difficulty: ModerateRationale: The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient and the risk premium on the market portfolio.50. Which of the following statements about the mutual fund theorem is true?I)It is similar to the separation property.II)It implies that a passive investment strategy can be efficient.III)It implies that efficient portfolios can be formed only through active strategies.IV)It means that professional managers have superior security selection strategies.A) I and IVB) I, II, and IVC) I and IID) III and IVE) II and IVAnswer: C Difficulty: ModerateRationale: The mutual fund theorem is similar to the separation property. The technical task of creating mutual funds can be delegated to professional managers; thenindividuals combine the mutual funds with risk-free assets according to theirpreferences. The passive strategy of investing in a market index fund is efficient.51. The expected return -- beta relationship of the CAPM is graphically represented byA) the security market line.B) the capital market line.C) the capital allocation line.D) the efficient frontier with a risk-free asset.E) the efficient frontier without a risk-free asset.Answer: A Difficulty: EasyRationale: The security market line shows expected return on the vertical axis and beta on the horizontal axis. It has an intercept of r f and a slope of E(R M) - r f.52. A “fairly priced” asset liesA) above the security market line.B) on the security market line.C) on the capital market line.D) above the capital market line.E) below the security market line.Answer: B Difficulty: EasyRationale: Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.53. For the CAPM that examines illiquidity premiums, if there is correlation among assetsdue to common systematic risk factors, the illiquidity premium on asset i is a function ofA) the market's volatility.B) asset i's volatility.C) the trading costs of security i.D) the risk-free rate.E) the money supply.Answer: C Difficulty: ModerateRationale: The formula for this extension to the CAPM relaxes the assumption thattrading is costless.54. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of1.5. The risk-free rate is 0.04 and the market expected rate of return is 0.11. Accordingto the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 14.5% = 4% + 1.5(11% - 4%) = 14.5%; therefore, the security is fairlypriced.55. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of1.1. The risk-free rate is 0.04 and the market expected rate of return is 0.10. Accordingto the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.56. The risk-free rate is 4 percent. The expected market rate of return is 12 percent. If youexpect stock X with a beta of 1.0 to offer a rate of return of 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 10% < 4% + 1.0(12% - 4%) = 12.0%; therefore, stock is overpriced and should be shorted.57. The risk-free rate is 5 percent. The expected market rate of return is 11 percent. If youexpect stock X with a beta of 2.1 to offer a rate of return of 15 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 15% < 5% + 2.1(11% - 5%) = 17.6%; therefore, stock is overpriced and should be shorted.58. You invest 50% of your money in security A with a beta of 1.6 and the rest of yourmoney in security B with a beta of 0.7. The beta of the resulting portfolio isA) 1.40B) 1.15C) 0.36D) 1.08E) 0.80Answer: B Difficulty: ModerateRationale: 0.5(1.6) + 0.5(0.70) = 1.15.。

Capital Budgeting

CAPITAL BUDGETINGCapital budgeting process:1.Identify the potential investments2.Estimate the potential net cash inflows from each investment3.Analyze the investments through different capital budgeting methodsa.Capital budgeting method without incorporating the time value of moneyb.Capital budgeting method that incorporates the time value of money4.Choose among the alternatives of capital investments due to the limited available resources (through capital rationing)5.Perform post audits on the chosen investment(s)Four Methods of Capital Budgeting Analysis1.Payback Period= Amount Invested (For Equal Net Cash Inflows) Expected Annual Net Cash InflowsORTotal Net Cash inflows until the amount invested is recovered (For Unequal Net Cash Inflows)Advantages:*Easy to use and focuses on how long it will take to recover the cost of investmentDisadvantages:*Ignores the profitability*Ignores time value of money* Ignores cash flows earned after the payback period achieved2.Accounting Rate of Return (ARR)= Average Annual Operating Income from an Asset (For both Equal and Unequal Net Cash Inflows) Average Amount Invested in an AssetAverage Annual Operating Income from an Asset = Total Operating Income during the life of the AssetAsset’s LifeAverage Amount Invested in an Asset = Beginning cost of Investment + Residual Value2Advantages:*Measures profitability of the asset*Shows effect on operating incomeDisadvantages:*Ignores the time value of money*Ignores net cash inflows Present Value (NPV)= (Equal Net Cash Inflows X Annuity PV) – Cost of Investment (For Equal Net Cash Inflows)OR= Sum of Present Value of each Net Cash Inflows – Cost of Investment (For Unequal Net Cash Inflows)(For Unequal Net Cash Inflows, we use the PV of $1 Table)Advantages:*Recognizes time value of money*Shows Asset’s ability to fulfill the company’s minimum required rate of returnDisadvantages:*More computations to rank alternatives of investments4.Internal Rate of Return (IRR)-Determine the rate of return when the cost of the investment is equal to the Present Value of the investment Equal Net Cash Inflows-Cost of Investment = (Equal Net Cash Inflows X Annuity PV) (For Equal Net Cash Inflows) Annuity PV = Cost of InvestmentEqual Net Cash Inflows-Use trial and error for Unequal Net Cash InflowsAdvantages:*Recognizes the time value of money*Directly computes specific rate of return of the investment。

CapitalBudgetingRisk英文版

• Expand CAPM to include CS
R = rf + B ( rm - rf )
becomes
Requity = rf + B ( rm - rf )
Capital Structure
COC = rportfolio = rassets
Capital Structure
COC = rportfolio = rassets
100(.2)
410(.8) 364
180(.2)
220(.4) 148
100(.6)
Decision Trees
Turboprop
NPV=888.18
+150(.6)
-550
NPV= ?
+30(.4)
NPV=444.55
*450
812 1.10
1N5P0V=5508.0808+1.0108(.6)
364
+50(.4)
148
NPV=184.55
100(.6)
Decision Trees
Turboprop -550
NPV=96.12
Piston -250
NPV=117.00
NPV=888.18
+150(.6)
710.73
+30(.4)
NPV=444.55
*450 -150
NPV=550.00
+100(.6) or
Capital Structure
COC = rportfolio = rassets
rassets = WACC = rdebt (D) + requity (E)
(V)

CapitalBudgeting1

Required: Something that will convert future cash flows to present values, taking into account timing and risk.
7
Therefore, we need future cash flows, the timing of each future cash flow and the required rate of return per period. NPV means net of the outlay required, ie.,
“profit” also includes some cash items which are non-operating, such as interest payments on borrowed funds.
13
Problem areas • Financial charges:
- should be excluded from the cash flows - the required rate of return covers interest and returns to equity. - numerator - operating cash flows - denominator - investors‟ rate of return • Sunk costs:
Note: NPV is one of several “discounting cash flows” (DCF) methods -- another is internal rate of return (IRR) method.
5
(i) The Capital Expenditure Process Capital expenditure: cash outlays now in the expectation of benefits (net cash flows) later. Four stages:

罗斯公司理财题库全集

Chapter 13 Risk, Cost of Capital, and Capital Budgeting Answer KeyMultiple Choice Questions1. The weighted average of the firm's costs of equity, preferred stock, and after tax debt is the:A.reward to risk ratio for the firm.B.expected capital gains yield for the stock.C.expected capital gains yield for the firm.D.portfolio beta for the firm.E.weighted average cost of capital (WACC).Difficulty level: EasyTopic: WACCType: DEFINITIONS2. If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the:A.return on the stock minus the risk-free rate.B.difference between the return on the market and the risk-free rate.C.beta times the market risk premium.D.beta times the risk-free rate.E.market rate of return.Difficulty level: EasyTopic: CAPMType: DEFINITIONS3. The best fit line of a pairwise plot of the returns of the security against the market index returns is called the:A.Security Market Line.B.Capital Market Line.C.characteristic line.D.risk line.E.None of the above.Difficulty level: MediumTopic: CHARACTERISTIC LINEType: DEFINITIONS4. The use of debt is called:A.operating leverage.B.production leverage.C.financial leverage.D.total asset turnover risk.E.business risk.Difficulty level: MediumTopic: USE OF DEBTType: DEFINITIONS5. The weighted average cost of capital for a firm is the:A.discount rate which the firm should apply to all of the projects it undertakes.B.overall rate which the firm must earn on its existing assets to maintain the value of its stock.C.rate the firm should expect to pay on its next bond issue.D.maximum rate which the firm should require on any projects it undertakes.E.rate of return that the firm's preferred stockholders should expect to earn over the long term.Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: DEFINITIONS6. The WACC is used to _______ the expected cash flows when the firm has____________.A.discount; debt and equity in the capital structureB.discount; short term financing on the balance sheetC.increase; debt and equity in the capital structureD.decrease; short term financing on the balance sheetE.None of the above.Difficulty level: MediumTopic: WACCType: CONCEPTS7. Using the CAPM to calculate the cost of capital for a risky project assumes that:ing the firm's beta is the same measure of risk as the project.B.the firm is all-equity financed.C.the financial risk is equal to business risk.D.Both A and B.E.Both A and C.Difficulty level: MediumTopic: CAPMType: CONCEPTS8. The use of WACC to select investments is acceptable when the:A.correlation of all new projects are equal.B.NPV is positive when discounted by the WACC.C.risk of the projects are equal to the risk of the firm.D.firm is well diversified and the unsystematic risk is negligible.E.None of the above.Difficulty level: EasyTopic: WACCType: CONCEPTS9. If the risk of an investment project is different than the firm's risk then:A.you must adjust the discount rate for the project based on the firm's risk.B.you must adjust the discount rate for the project based on the project risk.C.you must exercise risk aversion and use the market rate.D.an average rate across prior projects is acceptable because estimates contain errors.E.one must have the actual data to determine any differences in the calculations.Difficulty level: EasyTopic: DISCOUNT RATEType: CONCEPTS10. If the project beta and IRR coordinates plot above the SML the project should be:A.accepted.B.rejected.C.It is impossible to tell.D.It will depend on the NPV.E.None of the above.Difficulty level: MediumTopic: SECURITY MARKET LINEType: CONCEPTS11. The beta of a security provides an:A.estimate of the market risk premium.B.estimate of the slope of the Capital Market Line.C.estimate of the slope of the Security Market Line.D.estimate of the systematic risk of the security.E.None of the above.Difficulty level: EasyTopic: BETAType: CONCEPTS12. Regression analysis can be used to estimate:A.beta.B.the risk-free rate.C.standard deviation.D.variance.E.expected return.Difficulty level: EasyTopic: BETA ESTIMATIONType: CONCEPTS13. Beta measures depend highly on the:A.direction of the market variance.B.overall cycle of the market.C.variance of the market and asset, but not their co-movement.D.covariance of the security with the market and how they are correlated.E.All of the above.Difficulty level: MediumTopic: BETAType: CONCEPTS14. The formula for calculating beta is given by the dividing the ___________ of the stock with the market portfolio by the ___________ of the market portfolio.A.variance; covarianceB.covariance; varianceC.standard deviation; varianceD.expected return; varianceE.expected return; covarianceDifficulty level: MediumTopic: BETAType: CONCEPTS15. The slope of the characteristic line is the estimated:A.intercept.B.beta.C.unsystematic risk.D.market variance.E.market risk premium.Difficulty level: MediumTopic: BETA AND CHARACTERISTIC LINEType: CONCEPTS16. Companies that have highly cyclical sales will have a:A.low beta if sales are highly dependent on the market cycle.B.high beta if sales are highly dependent on the market cycle.C.high beta if sales are independent of the market cycle.D.All of the above.E.None of the above.Difficulty level: MediumTopic: CYCLICAL BUSINESS AND BETAType: CONCEPTS17. Betas may vary substantially across an industry. The decision to use the industry or firm beta to estimate the cost of capital depends on:A.how small the estimation errors are of all betas across industries.B.how similar the firm's operations are to the operations of all other firms in the industry.C.whether the company is a leader or follower.D.the size of the company's public float.E.None of the above.Difficulty level: MediumTopic: INDUSTRY OR FIRM BETAType: CONCEPTS18. Beta is useful in the calculation of the:pany's variance.pany's discount rate.pany's standard deviation.D.unsystematic risk.pany's market rate.Difficulty level: MediumTopic: BETAType: CONCEPTS19. For a multi-product firm, if a project's beta is different from that of the overall firm, then the:A.CAPM can no longer be used.B.project should be discounted using the overall firm's beta.C.project should be discounted at a rate commensurate with its own beta.D.project should be discounted at the market rate.E.project should be discounted at the T-bill rate.Difficulty level: MediumTopic: PROJECT AND FIRM BETAType: CONCEPTS20. The problem of using the overall firm's beta in discounting projects of different risk is the:A.firm would accept too many high-risk projects.B.firm would reject too many low risk projects.C.firm would reject too many high-risk projects.D.firm would accept too many low risk projects.E.Both A and B.Difficulty level: MediumTopic: FIRM'S BETAType: CONCEPTS21. The asset beta of a levered firm is generally:A.equal to the equity beta.B.different from the equity beta.C.different from the debt beta.D.the simple average of the equity beta and debt beta.E.Both B and C.Difficulty level: MediumTopic: ASSET BETAType: CONCEPTS22. Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ____________ than the beta of the common stock of an unlevered firm.A.equal toB.significantly lessC.slightly lessD.greaterE.None of the above.Difficulty level: MediumTopic: LEVERED VS. UNLEVERED BETAType: CONCEPTS23. The beta of a firm is determined by which of the following firm characteristicsA.Cycles in revenuesB.Operating leverageC.Financial leverageD.All of the above.E.None of the above.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS24. The beta of a firm is more likely to be high under what two conditionsA.High cyclical business activity and low operating leverageB.High cyclical business activity and high operating leverageC.Low cyclical business activity and low financial leverageD.Low cyclical business activity and low operating leverageE.None of the above.Difficulty level: MediumTopic: FACTORS AFFECTING BETAType: CONCEPTS25. A firm with cyclical earnings is characterized by:A.revenue patterns that vary with the business cycle.B.high levels of debt in its capital structure.C.high fixed costs.D.high price per unit.E.low contribution margins.Difficulty level: MediumTopic: CYCLICAL EARNINGSType: CONCEPTS26. A firm with high operating leverage has:A.low fixed costs in its production process.B.high variable costs in its production process.C.high fixed costs in its production process.D.high price per unit.E.low price per unit.Difficulty level: MediumTopic: OPERATING LEVERAGEType: CONCEPTS27. If a firm has low fixed costs relative to all other firms in the same industry,a large change in sales volume (either up or down) would have:A. a smaller change in EBIT for the firm versus the other firms.B.no effect in any way on the firms as volume does not effect fixed costs.C. a decreasing effect on the cyclical nature of the business.D. a larger change in EBIT for the firm versus the other firms.E.None of the above.Difficulty level: MediumTopic: OPERATING LEVERAGEType: CONCEPTS28. A firm with high operating leverage is characterized by __________ while one with high financial leverage is characterized by __________.A.low fixed cost of production; low fixed financial costsB.high variable cost of production; high variable financial costsC.high fixed costs of production; high fixed financial costsD.low costs of production; high fixed financial costsE.high fixed costs of production; low variable financial costsDifficulty level: MediumTopic: OPERATING AND FINANCIAL LEVERAGEType: CONCEPTS29. Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to have:A.low betas.B.high betas.C.zero betas.D.negative betas.E.None of the above.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS30. An industry is likely to have a low beta if the:A.stream of revenues is stable and less volatile than the market.B.economy is in a recession.C.market for its goods is unaffected by the market cycle.D.Both A and B.E.Both A and C.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS31. For the levered firm the equity beta is __________ the asset beta.A.greater thanB.less thanC.equal toD.sometimes greater than and sometimes less thanE.None of the above.Difficulty level: MediumTopic: ASSET AND EQUITY BETASType: CONCEPTS32. All else equal, a more liquid stock will have a lower ________.A.betaB.market premiumC.cost of capitalD.Both A and B.E.Both A and C.Difficulty level: ChallengeTopic: LIQUIDITYType: CONCEPTS33. Two stock market based costs of liquidity that affects the cost of capital are the:A.bid-ask spread and the specialist spread.B.market impact cost and the brokerage costs.C.investor opportunity cost and the brokerage costs.D.bid-ask spread and the market impact costs.E.None of the above.Difficulty level: MediumTopic: LIQUIDITYType: CONCEPTS34. When a specialist is caught in the middle of a trade between informed and uniformed traders, which effectively eliminates the spread or causes a loss, is subject to:A.market impact costs.B.adverse selection.C.broker's quotation bias.D.increasing the number of uninformed traders.E.None of the above.Difficulty level: ChallengeTopic: ADVERSE SELECTIONType: CONCEPTS35. All else equal, new shareholders will ____ the capital gains of existing shareholders.A.diluteB.hold constantC.increaseD.All of the aboveE.It is impossible to tell.Difficulty level: MediumTopic: CAPITAL GAINSType: CONCEPTS36. The following are methods to estimate the market risk premium:e historical data to estimate future risk premium.e the dividend discount model to estimate risk premium.e the bond valuation model to estimate growth in bond prices with different costs of capital.D. A and B.E. A and C.Difficulty level: MediumTopic: MARKET RISK PREMIUMType: CONCEPTS37. Beta is the slope of the:A.efficient frontier.B.market portfolio.C.security market line.D.characteristic line.E.None of the above.Difficulty level: MediumTopic: BETAType: CONCEPTS38. Two stocks that have the same beta ____ have the same correlation because _______:A.may; because correlation measures the sensitivity of the S&P to the market portfolio.B.will; because correlation measures the tightness of fit around the regression line.C.may not; because correlation measures the tightness of fit around the regression line.D.may not; because correlation measures the sensitivity to change.E.None of the above.Difficulty level: MediumTopic: BETA AND CORRELATIONType: CONCEPTS39. When using the cost of debt, the relevant number is the:A.pre-tax cost of debt since most corporations pay taxes at the same tax rate.B.pre-tax cost of debt since it is the actual rate the firm is paying bondholders.C.post-tax cost of debt since dividends are tax deductible.D.post-tax cost of debt since interest is tax deductible.E.None of the above.Difficulty level: MediumTopic: COST OF DEBTType: CONCEPTS40. Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding %. The company also has 4 million shares of common stock outstanding. The stock has a beta of and sells for $40 a share. The . Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capitalA.%B.%C.%D.%E.%= .04 + .08) = .128ReDebt: 80,000 $1,000 = $80mCommon: 4m $40 = $160mTotal = $80m + $160m = $240mDifficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS41. Peter's Audio Shop has a cost of debt of 7%, a cost of equity of 11%, anda cost of preferred stock of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What is the weighted average cost of capital for Peter's Audio ShopA.%B.%C.%D.%E.%Debt: $500,000 = $.51mPreferred: 40,000 $34 = $Common: 104,000 $20 = $Total = $.51m + $ + $ = $Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS42. Phil's Carvings, Inc. wants to have a weighted average cost of capital of 9%. The firm has an after-tax cost of debt of 5% and a cost of equity of 11%. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capitalA..33B..40C..50D..60E..67.09 = [We .11] + [(1 - We) .05) = .11We+ .05 - .05We; .04 = .06We; We= %;W d = 1 - We= 100% - % = %; Debt - equity ratio = % % = .50Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITAL Type: PROBLEMS43. Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of $36 a share. Last month, Jake's paid an annual dividend in the amount of $ per share. The dividend growth rate is 4%. Jake's also has 6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon, pay interest annually, and mature in years. The bonds are selling at 99% of face value. The company's tax rate is 34%. What is Jake's weighted average cost of capitalA.%B.%C.%D.%E.%Debt: 6,000 $1,000 .99 = $Common: 210,000 $36 = $Total = $ + $ = $= [($ $36] + .04 = .08602ReDifficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS44. The Consolidated Transfer Co. is an all-equity financed firm. The beta is .75, the market risk premium is 8% and the risk-free rate is 4%. What is the expected return of ConsolidatedA.7%B.8%C.9%D.10%E.13%.04 + (.08) = .10 = 10%Difficulty level: EasyTopic: CAPMType: PROBLEMS45. Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if the firm's equity has a beta of , the risk-free rate of return is 2%, the expected return on the market is 9%, and the return to the company's debt is 7%A.%B.%C.%D.%E.None of the above.Rs = Rf + (Rm - Rf) = .02 + (.09 - .02) = .104 = %Difficulty level: MediumTopic: CAPMType: PROBLEMS46. The cost of equity for Ryan Corporation is %. If the expected return on the market is 10% and the risk-free rate is 5%, then the equity beta is ___. A.B.C.D.E.Impossible to calculate with information given.Rs = Rf + (Rm - Rf); .084 = .05 + (.10 - .05); = .68Difficulty level: MediumTopic: EQUITY BETAType: PROBLEMS47. Suppose that the Simmons Corporation's common stock has a beta of . If the risk-free rate is 5% and the market risk premium is 4%, the expected return on Simmons' common stock is:A.%.B.%.C.%.D.%.E.%.Rs = Rf + (Rm - Rf) = .05 + (.04) = .114 = %Difficulty level: EasyTopic: CAPMType: PROBLEMS48. Suppose the Barges Corporation's common stock has an expected return of 12%. Assume that the risk-free rate is 5%, and the market risk premium is 6%. If no unsystematic influence affected Barges' return, the beta for Barges is ______.A.B.C.D.E.It is impossible to calculate with the information given.Rs = Rf + (Rm - Rf); .12 = .05 + (.06); = .07/.06 =Difficulty level: MediumTopic: CALCULATING BETAType: PROBLEMS49. Slippery Slope Roof Contracting has an equity beta of , capital structure with 2/3 debt, and a zero tax rate. What is its asset betaA.B.C.D.E.None of the aboveA = (E/(D + E.) E = (1/3) = .40Difficulty level: MediumTopic: ASSET BETAType: PROBLEMS50. The Template Corporation has an equity beta of and a debt beta of .8. The firm's market value debt to equity ratio is .6. Template has a zero tax rate. What is the asset betaA.B.C.D.E..8(.6/ + (1/ =Difficulty level: MediumTopic: ASSET BETAType: PROBLEMS51. The NuPress Valet Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $ million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. The appropriate discount rate, assuming average risk, is:A.%B.9%C.%D.%E.13%WACC = .09(1 - .34)(.5) + .13(.5) = .0297 + .065 = .0947 = %Difficulty level: EasyTopic: WACCType: PROBLEMSEssay Questions。

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13.2 Methods for incorporating risk into the required rate of return 2. Risk-adjusted return on capital RiskABC Company is considering a new project with an expected life of five years. The initial outlay is $100,000. The discount rate is 10%. The expected cash inflows and certainty-equivalent certaintycoefficients are as follows:
n
ACFt=the annual cash flow in period t IO=the initial cash outlay i*=the risk-adjusted discount rate riskN=the project’s life
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Financial Management; Tianjin Commercial University
Chapter 13 Risk in capital budgeting (资本预算风险) 资本预算风险)
2011-122011-12-26
Financial Management; Tianjin Commercial University
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13.1 Risk and the investment decision 1. What measure of risk is relevant in capital budgeting (1) Project stand-alone risk stand(2) Project’s contribution-to-firm risk contribution-to(3) Systematic risk 2. Measuring risk for capital-budgeting purposes and a capitaldose of reality – is systematic risk all there is?
certain flow in period t αt = riky cash flow in period t
NPV = ∑
t =1 n
α t ACFt
(1 + k rf )
t
− IO
2011-122011-12-26
Financial Management; Tianjin Commercial University
Financial Management; Tianjin Commercial University
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13.3 Risk-adjusted discount rate and measurement of a Riskproject’s systematic risk CAPM:
R j = R f + β j (R m − R f )
Management; Tianjin Commercial University
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13.2 Methods for incorporating risk into the required rate of return 2. Risk-adjusted return on capital RiskCertainCertain-equivalent coefficient (确定性相等系数, α) (确定性相等系数确定性相等系数,
Financial Management; Tianjin Commercial University
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13.5 Other approaches to evaluating risk in capital budgeting 1. Simulation (仿真) (仿真仿真) 2. Sensitivity analysis (敏感性分析) (敏感性分析敏感性分析) 3. Probability trees (概率树) (概率树概率树)
Year 1 2 3 4 5 ACFt $10,000 20,000 40,000 80,000 80,000 αt 0.95 0.90 0.85 0.75 0.65 Αt*ACFt $9,500 18,000 34,000 60,000 52,000
NPV=NPV=-100000+9500/1.1+18000/1.12+34000/1.13 +60000/1.14+52000/1.15 =$22325.82 2011-122011-12-26
• Beta estimation using accounting data Historical regression method 2. The pure play method (单纯业务法) for estimating a (单纯业务法单纯业务法) project’s beta
2011-122011-12-26
2011-122011-12-26
Financial Management; Tianjin Commercial University
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13.2 Methods for incorporating risk into the required rate of return 1. Risk-adjusted discount rate RiskThe NPV using the risk-adjusted discount rate becomes riskACFt NPV = ∑ − IO * t t =1 (1 + i )