Deck 15: Investment, Time, and Capital Markets

Question 1

When the interest rate is R, the formula for finding the value of a current amount $M one year from now is

A) M (1 + R/100).
B) M (1 + R).
C) M / (1 + R).
D) M / R.
E) M / (100R).

Answer 1

B

Question 2

Scenario 15.2:
Consider the payment streams listed below that are available from different capital projects for Furry Software. The firm must choose to implement just one out of the three possible projects.
Refer to Scenario 15.2. If the interest rate were 20%, Furry Software should

A) retool the offices.
B) rewire the network.
C) move to Southern California.
D) be indifferent between retooling and rewiring.
E) be indifferent between retooling and moving.

Answer 2

B

Question 3

If the interest rate is 10%, the present value of $1 next year is

A) $1.20.
B) $1.10
C) 91 cents.
D) 10 cents.
E) 9 cents.

Answer 3

C

Question 4

Scenario 15.1:
This year Jacob Verytall signs a "Fifty Million Dollar" contract with the Mission City Muckrakers, a new basketball team. He will be paid $10 million per year over the next 5 years beginning next year. The interest rate is 10%, and the Muckrakers have enough in the bank to generate the payment stream.
Refer to Scenario 15.1. If the interest rate falls,

A) the present value of this contract will fall.
B) the present value of this contract will be unaffected.
C) the present value of this contract will rise.
D) Jacob will be paid less than $10 million each year.
E) Jacob will be paid more than $10 million each year as he can invest the money.

Question 5

Scenario 15.1:
This year Jacob Verytall signs a "Fifty Million Dollar" contract with the Mission City Muckrakers, a new basketball team. He will be paid $10 million per year over the next 5 years beginning next year. The interest rate is 10%, and the Muckrakers have enough in the bank to generate the payment stream.
Refer to Scenario 15.1. In terms of this year's dollars, this "Fifty Million Dollar" contract is worth approximately

A) $45.4 million.
B) $37.9 million.
C) $10 million.
D) $9.4 million.
E) $7.5 million.

Question 6

A certain magazine offers its subscribers the opportunity to "Buy Now and Save." If at the time their subscription renewal is due they agree to pay for 2 years rather than 1, the renewal price will be $50 per year rather than the usual $60 per year. At what interest rate will the consumer, who is certain she will subscribe to the magazine for the next 2 years, decide to "Buy Now and Save"?

A) any interest rate under 50 percent
B) any interest rate over 1.5 percent
C) any interest rate over 150 percent
D) any interest rate under 5 percent
E) She will always take this offer if she is absolutely certain to buy the magazine for another 2 years.

Question 7

If a firm can earn a profit stream of $50,000 per year for 10 years, that profit stream is worth

A) more than $500,000 today.
B) $500,000 today.
C) less than $500,000 today, but a positive amount.
D) nothing today
E) some amount, but whether it is more, less or the same as $500,000 cannot be determined.

Question 8

The formula for finding the present value of an amount M that will be received one year from now, when the interest rate is R, is

A) M × (1 + R/100).
B) M × (1 + R).
C) M / (1 + R).
D) M / R.
E) M / (100R).

Question 9

When the interest rate is R, the formula for finding the future value of $M two years from now is

A) M (1 + R)².
B) M (1 + R²).
C) M / (1 + R)².
D) M / (1 + R²).

Question 10

If the interest rate is 5%, in one period the future value of $1 today is

A) $1.20.
B) $1.05.
C) 95 cents.
D) 20 cents.
E) 5 cents.

Question 11

Scenario 15.2:
Consider the payment streams listed below that are available from different capital projects for Furry Software. The firm must choose to implement just one out of the three possible projects.
Refer to Scenario 15.2. If the interest rate were 2%, Furry Software should

A) retool the offices.
B) rewire the network.
C) move to Southern California.
D) be indifferent between retooling and rewiring.
E) be indifferent between rewiring and moving.

Question 12

Which is a stock variable?

A) Labor
B) Profit
C) Income
D) Capital
E) Price

Question 13

Scenario 15.2:
Consider the payment streams listed below that are available from different capital projects for Furry Software. The firm must choose to implement just one out of the three possible projects.
Refer to Scenario 15.2. With no other information available, it is

A) clear Furry should retool the offices.
B) clear Furry should rewire the network.
C) clear Furry should move to Southern California.
D) clear Furry should either retool the offices or rewire the network.
E) not possible to tell which payment stream is most valuable to Furry.

Question 14

Which of the following statements correctly characterizes the problem with comparing production outcomes that are stocks and flows?

A) Labor usage is always a flow, which makes it difficult to compare with stock inputs like capital.
B) Most capital inputs are stocks, but the returns on these investments (profits) occur as a flow.
C) Most capital inputs are flows, but economists treat these expenditures as stocks by using the opportunity or economic costs associated with these inputs.
D) Business returns or profits may be equivalently viewed as stocks or flows, which makes it difficult to compare the returns with the input expenditures.

Question 15

Scenario 15.1:
This year Jacob Verytall signs a "Fifty Million Dollar" contract with the Mission City Muckrakers, a new basketball team. He will be paid $10 million per year over the next 5 years beginning next year. The interest rate is 10%, and the Muckrakers have enough in the bank to generate the payment stream.
Refer to Scenario 15.1. If the interest rate is expected to fall to 5% in years 4 and 5, in terms of current dollars the value of the Muckrakers payments will

A) rise.
B) stay the same.
C) fall.
D) change, but we cannot answer this question without further information.

Question 16

The marginal revenue product of capital inputs does not provide complete information about optimal use because capital is:

A) money.
B) not an input.
C) an output as well as an input.
D) durable.
E) all of the above

Question 17

The present value formula makes it apparent that:

A) a decline in the interest rate will cause a decision maker to weigh recent period returns relatively more heavily than before the decline.
B) an increase in the interest rate will cause a decision maker to weigh distant (or future) returns relatively more heavily than before the increase.
C) the present value of a fixed sum decreases as the time until it is to be paid increases.
D) all of the above
E) both A and C.

Question 18

You have won a contest and are allowed to choose between two prizes. One option is to receive $200 today and another $200 one year from now. The second option is $100 today and an additional $325 one year from now. At what interest rate (if any) is the present value of the two prizes identical?

A) 0 percent
B) 5 percent
C) 10 percent
D) 25 percent
E) none of the above

Question 19

Which of the following questions is addressed when hiring capital, but not addressed when hiring labor?

A) How much are future profits worth today?
B) How much are today's profits worth in the future?
C) How much are the future's profits worth in the future?
D) How much are today's profits worth today?
E) All questions present when capital is purchased are present when labor is purchased.

Question 20

To avoid the stock versus flow issue in production, some economists discuss capital usage in terms of rented capital. For example, your firm may not directly own some of the capital inputs to your production operation, and these capital inputs are employed on an hourly or daily basis. Which of the following inputs is a good example of a capital input that acts like a flow?

A) Land and buildings that are owned by the firm
B) A long-term licensing agreements that allow you to use a patented idea owned by another firm
C) A forklift that is rented on an hourly basis
D) all of the above

Question 21

If the payment stream of a bond remains the same and the price of the bond goes down, the

A) effective yield is unchanged.
B) effective yield rises.
C) effective yield decreases.
D) bond is reissued to reflect the higher interest rate.
E) bond is reissued to reflect the lower interest rate.

Question 22

A perpetuity for sale at $100,000 that promises a yearly payment of $5,000 has an effective yield of

A) 2%.
B) 5%.
C) 20%.
D) 50%.
E) 2,000%.

Question 23

Suppose you are an attorney, and you are defending a client in a wrongful death suit. The deceased was a pilot for an aerial acrobatics team, and the opposing attorney has prepared an an estimate of the value of lost income that includes the mortality rate for all pilots. You should argue that the attorney's estimate of lost earnings is too ________ because the mortality rate for aerial acrobats is ________ than for other types of pilots.

A) low, lower
B) low, higher
C) high, lower
D) high, higher

Question 24

Two corporations (TruBlu and FlyByNight) issue perpetuities that both pay $1,000 per year, but the market price of the FlyByNight bonds are much lower. The difference in the bond prices may reflect the belief that the bonds issued by FlyByNight are ________ risky when compared to the TruBlu bonds.

A) less
B) more
C) equally
D) none of the above

Question 25

You have won a contest and are allowed to choose between two prizes. One prize is $200 today and another $200 one year from now. The other prize is $100 today and an additional $325 one year from now. At what interest rate (if any) would you be indifferent between the two prizes?

Question 26

Your uncle wants to help you with your college expenses, and he promised to pay you $10,000 next year and $15,000 in two years. The current interest rate is 6%, and you expect that this interest rate will be the same for the next year and will increase to 8% in the year after. What is the formula that you should use to compute the present discounted value of your uncle's contribution to your education expenses?

A) 0 + 10,000 + 15,000
B) 10,000/(1.06) + 15,000/((1.06)^*(1.06))
C) 10,000/(1.06) + 15,000/((1.06)(1.08))
D) 10,000/(1.06) + 15,000/((1.08)(1.08))

Question 27

Use the following statements to answer this question:
I) The effective yield is generally easier to compute for a perpetuity than for a 10-year bond.
II) Two perpetuities that have the same annual payment must have the same price, even if the issuers of the bonds are different companies.

A) I and II are true.
B) I is true and II is false.
C) II is true and I is false.
D) I and II is false.

Question 28

A perpetual payment of $10,000, offered for sale at $125,000, is being offered at an effective yield of

A) 8%.
B) 9.2%
C) 12.5%.
D) 80%.
E) 92%.

Question 29

How would we compute the present discounted value of payments of $8,000 received three years in the future and $10,000 received four years in the future? The interest rate is expected to be 5 percent for the next four years.

A) 8,000/((1.05)³) + 10,000/((1.05)⁴)
B) 8,000/((1.5)³) + 10,000/((1.5)⁴)
C) 8,000/(1.05) + 10,000/(1.05)²)
D) 8,000/(1.03) + 10,000/(1.04)

Question 30

What is the approximate price of a $10,000 coupon bond that pays $1,000 in one year and $1,000 in two years at maturity? The effective yield on the bond is 6 percent.

A) $10,000
B) $10,730
C) $10,900
D) $12,000

Question 31

A bond has a current market value of $800. The holder of the bond will receive a single payment of $1,000 one year from now. The interest rate is 10 percent. The effective yield on the bond is:

A) $200.
B) 10 percent.
C) 25 percent.
D) negative.
E) The yield cannot be determined with the information provided.

Question 32

Scenario 15.3:
Consider the following information.
Melissa Qwerty was killed in a freak typewriter accident. Her family sued the typewriter company for the value of the income loss her death represented. The family demanded $X in compensation.
Refer to Scenario 15.3. $X would be higher if Ms. Querty's

A) income and the interest rate were higher.
B) income and the interest rate were lower.
C) income were higher and the interest rate were lower.
D) income were lower and the interest rate were higher.
E) mortality rate and growth in income were lower.

Question 33

Scenario 15.3:
Consider the following information.
Melissa Qwerty was killed in a freak typewriter accident. Her family sued the typewriter company for the value of the income loss her death represented. The family demanded $X in compensation.
Refer to Scenario 15.3. $X would be higher if

A) her income were higher and she were younger.
B) her income were higher and she were older.
C) her income and the mortality rates for someone of Ms. Qwerty's statistical profile were both lower.
D) her income and the mortality rates for someone of Ms. Qwerty's statistical profile were both higher.
E) she were older and the relevant mortality rate were lower.

Question 34

Two bonds of equal risk are for sale on the secondary bond market. The two bonds have the same face value, and both mature in 10 years. Bond A pays $10 per year and bond B pay $15 per year. Which bond will sell for a higher price?

A) Bond A
B) Bond B
C) They will sell for the same price.
D) The relative prices will depend on the expected interest rate over the next 10 years.

Question 35

The PDV of a perpetuity with a yearly payment of $500 at an interest rate of 5% is

A) $100.
B) $5,000.
C) $25,000.
D) $10,000.
E) $100,000.

Question 36

If a coupon bond has a "face value" of $1000, it means that

A) the original purchaser paid $1000 for it.
B) each purchaser must pay $1000 for it.
C) it was purchased for at least $1000 and perhaps more.
D) the holder will be paid $1000 when the bond matures.
E) the holder will be paid $1000 plus accumulated interest when the bond matures.

Question 37

As interest rates fall,

A) the values of bonds rise.
B) the values of bonds fall.
C) the values of bonds are unchanged.
D) the value of perpetuities are unchanged, but the value of other bonds change in value.
E) the value of all bonds except perpetuities change.

Question 38

Your 65-year-old father is going to retire next year. He would like to have an income of $20,000 per year for the remainder of his life. If he is expected to live for ten more years, write an algebraic expression to indicate the amount of money he needs today to pay him this sum of money if the interest rate is 10 percent.

Question 39

Scenario 15.3:
Consider the following information.
Melissa Qwerty was killed in a freak typewriter accident. Her family sued the typewriter company for the value of the income loss her death represented. The family demanded $X in compensation.
Refer to Scenario 15.3. Which of the following would raise $X?

A) Lower current income
B) Lower expected growth in income
C) Lower mortality rates
D) Lower interest rates
E) Higher age at time of death

Question 40

The authors provide an example that illustrates the calculation of the present discounted value for the lost wages from a deceased worker, and one component in this calculation is the worker's annual mortality rate (m). Suppose we conduct this computation in two different ways --- one calculation assumes m is constant for all future periods, and the other calculation allows m to decline over time due to improvements in medical technology. Which estimated PDV will be larger?

A) The PDV with constant m will be larger
B) The PDV with variable m will be larger
C) The two PDV's will be equal
D) The answer to this question depends on the assumed interest rate

Question 41

The Ampex Co. manufactures plastic fixtures for residential bathrooms. Currently, it has an opportunity to invest $1,000,000 in the equipment needed to produce other plastic fixtures for kitchen use. If the company decides to sell kitchen fixtures, it has reason to believe that it can generate the following profit stream during a six-year life cycle for kitchen fixtures.
End of Year Profit
1 $ 10,000
2 100,000
3 500,000
4 600,000
5 400,000
6 200,000
At the end of six years, the company can sell the capital used to make kitchen fixtures for $50,000. If the interest rate on money available to Ampex is 11% per year, should it invest in kitchen fixtures? Does it matter if the 11% per year is in nominal or real terms? Explain.

Question 42

A $130,000 investment in new equipment this year will increase your firm's profits by $50,000 in each of the next 3 years. What is the net present value of this investment if your firm's opportunity cost of capital is 10 percent?

A) -5,657
B) 5,657
C) 124,343
D) 128,850

Question 43

Your firm is evaluating a potential investment in new machinery, but the manager in charge of the project uses an opportunity cost of capital that is too large. How does this error affect the projected net present value of the firm's investment?

A) NPV is overstated
B) NPV is understated
C) NPV is unaffected
D) NPV changes from positive to negative

Question 44

The Vortex Corp. has an opportunity to invest $1,500,000 in investment A or in investment B. Investment A promises to pay $500,000 profit at the end of the first year, $550,000 at the end of two years, $600,000 at the end of three years, and $625,000 at the end of four years. Investment B promises to pay $25,000 profit at the end of the first year, $100,000 at the end of two years, $600,000 at the end of the third year, and $1,000,000 at the end of four years. Assume that nine percent per year is an appropriate discount rate for each investment. Also, assume a zero scrap value for each investment at the end of four years. Determine which investment promises to be the better of the two for the company.

Question 45

You have been offered the opportunity to purchase a bond that will pay $100 in interest at the end of each of the next three years, and a $1000 repayment of principal at the end of the third year. The current interest rate is 12%.
a. Calculate the selling price of the bond. (You may assume that 12% accurately reflects the risk of the bond.)
b. What would happen to the selling price of the bond if interest rates should fall?

Question 46

The first term in an NPV calculation is usually

A) positive, because firms consider only positive returns.
B) positive, because interest charges do not accrue until the second period.
C) zero, because interest charges do not accrue until the second period.
D) negative, because funds for the project have to be borrowed up front before it is begun.
E) negative, because the cost of the project is immediate, but revenue streams from the project come later.

Question 47

The real interest rate is

A) the nominal rate plus the rate of inflation.
B) the nominal rate minus the rate of inflation.
C) the nominal rate divided by the rate of inflation.
D) the nominal rate multiplied by the rate of inflation.
E) the nominal rate.

Question 48

You manage a new product development team for an electronics manufacturer, and your firm's policy is that all new projects must pay for themselves in the first five years. Your team has projected that the first year of the project requires an initial investment of $2 million with no revenue, the second year loss is $500,000, the net revenue for year 3 is zero, and you earn $1.8 million in both year 4 and year 5. If the opportunity cost of capital for your firm is 8%, should you go ahead with this project?

A) No, the expected NPV is negative
B) Yes, the expected NPV is roughly $290,000
C) Yes, the expected NPV is $1.1 million
D) We do not have enough information to answer this question.

Question 49

Firms that issue callable bonds have the option of repaying the principal to the bond buyers before the stated maturity date for the bonds. Firms may call their bonds before maturity in order to avoid making some of the coupon payments. Should we expect the price of a callable bond to be higher or lower than the price of a non-callable bond that has the same coupon payment, principal, and effective yield?

A) Price of the callable bond should be higher
B) Price of the bonds should be the same
C) Price of the callable bond should be lower
D) We need to know the year in which the bond is called in order to compare the prices

Question 50

The Clemson Manufacturing Corp. engineers have estimated that a new factory can be constructed for the manufacture of hydraulic valves and fittings. Two different technologies, A and B, have been considered in the manufacturing process. The costs of the factory and annual earnings are given below for both technologies.
Capital Costs Earnings
(in $millions) (in $millions)
End of the Year A B A B
0 $10 $15 $0 $0
1 10 10 -1 0
2 10 0 1 2
3 0 0 5 10
4 0 0 10 10
5 0 0 20 10
At the end of five years, technology A will have a scrap value of one million dollars, and technology B will have a scrap value of 5 million dollars. Assume that these two projects are equally risky and the appropriate discount rate is 10 percent per year. Calculate the net present value of each of these factories. Determine if either or both would be feasible. Does it matter whether or not real or nominal terms are used for capital costs, cash flows, and discount rate? Explain.

Question 51

For net present value calculations, the rate of return that one could earn by investing in another project with similar risk is known as the:

A) real interest rate.
B) nominal interest rate.
C) prime interest rate.
D) opportunity cost of capital.

Question 52

If the inflation rate falls and nominal interest rates are unchanged,

A) inflation will fall.
B) inflation will continue at the same rate.
C) real interest rates rise.
D) real interest rates are unaffected.
E) real interest rates fall.

Question 53

If an individual has $10,000 in a savings account paying 3% and the inflation rate is 2%, the nominal interest rate is

A) 3% and the real rate is 5%.
B) 5% and the real rate is 7%.
C) 5% and the real rate is 3%.
D) 3% and the real rate is 1%.
E) 5%.

Question 54

Thompson Industries produces packaging materials. Thompson is considering undertaking one or both of two investment projects. The first investment involves a new automated warehouse for the firm's foam and plastic inventory. The warehouse can be expected to have a useful life of ten years, after which it will be obsolete with no scrap value. The warehouse involves $3,000,000 in capital cost that must be paid immediately. The warehouse will lower the firm's cost $400,000 for each of the first five years, and $500,000 per year thereafter. The second project involves the acquisition of a computerized order system that would allow the firm's salespeople to link directly with the computer to place orders. The computerized network will require an initial capital cost of $1,000,000, but will save the firm $300,000 per year in support staff costs. Thompson's managers believe that the order system will be obsolete after five years. Cash flows for each project will be at year end. Thompson uses a 10% discount rate in evaluating the investment projects. interest rates and future cash flows are in real terms, net of all tax effects.
a. Calculate the net present value of each investment project. Which project(s) should the firm accept?
b. Comment on the impact of a change in the discount rate on the NPV. (Analyze both an increase and a decrease in the NPV.)

Question 55

The "NPV Criterion" is that a firm should invest in a new capital project if

A) the present value of the expected future cash flows is larger than the present value of the cost of the investment.
B) the future value of the expected future cash flows is larger than the cost of the investment.
C) financing can be secured on the basis of new bonds.
D) financing can be secured on the basis of new stocks.
E) financing is not necessary because there are enough liquid assets in the company's portfolio to afford the investment.

Question 56

The interest rate R in an NPV calculation should always

A) be the return that the firm could earn on a similar investment.
B) be the riskless interest rate (e.g., U.S. Treasury bills).
C) be the rate on corporate bonds.
D) be the rate of return available in the stock market.
E) be the interest rate at which the firm has to borrow.

Question 57

The real discount rate and the nominal discount rate differ in their treatment of

A) risk. .
B) market return.
C) inflation.
D) expected risk.

Question 58

Suppose you invest $100,000 in a new machine today, and you earn a $150,000 return in one year. What is the internal rate of return on this investment?

A) 10 percent
B) 25 percent
C) 50 percent
D) 100 percent

Question 59

You have been hired by an attorney to perform an economic analysis of lost wages in a wrongful death suit. The case involves an insurance agent, John Doe, who was killed in an auto accident a few days after his 59th birthday. Mr. Doe could have expected to earn $75,000 this year. Data suggest that the income of insurance agents has risen an average of 6% over the past 20 years. Mr. Doe's expected retirement age was 65, i.e., on his 65th birthday. Available data provide the mortality rates given below for individuals of Mr. Doe's sex and occupation at various ages. Ten percent appears to be the appropriate discount rate.

a. Calculate the present discounted value of Mr. Doe's expected earnings stream. (For simplicity, assume he receives all of his earnings for the preceding year on his birthday.)
b. The attorney has asked your advice regarding a minimum figure that should be accepted as an out-of-court settlement. What guidance can you give the attorney? Would additional information allow you to give the attorney a more precise estimate of the figure that should be accepted? Give an example of how more information would help.
c. You must be prepared for cross-examination by the defendant's attorney. Where would you expect the opposing attorney to attack your testimony?

Question 60

What is the relationship between interest rates and bond prices? Explain.

Question 61

A "risky" asset will earn a rate of return close to that of "riskless" assets if its risk is

A) nondiversifiable.
B) diversifiable.
C) nominal, as opposed to real.
D) related to the rate of inflation.
E) no greater than the risk of similar assets.

Question 62

The decision firms make about new capital projects is most like the decision consumers make when they decide

A) whether to take a new job.
B) which of two new jobs to take.
C) what brand of coffee to buy.
D) whether to buy a new house.
E) whether to go on vacation.

Question 63

An asset's beta can be used to compute its discount rate for an NPV calculation because the discount rate is equal to

A) r_f + b(r_m + r_f).
B) r_f - b(r_m + r_f).
C) r_f - b(r_m - r_f).
D) r_f + b(r_m - r_f).
E) beta itself.

Question 64

Another name for diversifiable risk is

A) systematic risk.
B) nonsystematic risk.
C) nominal risk.
D) portfolio risk.
E) meta-portfolio risk.

Question 65

Suppose a firm's stock valuation is worth three times its outstanding debt. The firm's stock earns an annual return of 6 percent and pays 8 percent on the outstanding debt. What is the firm's company cost of capital?

A) 4.5 percent
B) 6 percent
C) 6.5 percent
D) 8 percent

Question 66

If an asset's beta is high, its

A) diversifiable risk and expected return are high.
B) nondiversifiable risk and expected return are high.
C) diversifiable risk is high; its expected return is low.
D) nondiversifiable risk is high; its expected return is low.
E) total risk is high; its return could be any amount.

Question 67

The "Capital Asset Pricing Model" measures the risk premium for a capital investment by comparing the expected return on that investment with the

A) average return on other investments of similar risk.
B) average return on the past several years' investments made by the firm.
C) expected return on the entire stock market.
D) expected return on the government bond market.
E) expected return on the corporate bond market.

Question 68

Of the following endeavors of Happy Home Insurance Company of California, which involves the most nondiversifiable risk?

A) Fire insurance
B) Home burglary insurance
C) Earthquake insurance
D) Personal accident insurance
E) Home office insurance

Question 69

Some universities now offer "tuition bonds." Parents can purchase a bond at the time their child is born. The bond is redeemable in 18 years for an amount of money equal to the cost of the university's tuition at that time. Which of the following would reduce the market price of these bonds?

A) An increase in the rate of interest
B) A decrease in the rate of interest
C) The passage of legislation limiting increases in college tuition to the rate of inflation
D) both A and C
E) both B and C

Question 70

If the rate of return on the stock market is r_m and the rate of return on a risk-free asset is r_f, then

A) r_m - r_f measures the risk, all of it nondiversifiable, one has to accept in the stock market.
B) r_m - r_f measures the risk, all of it diversifiable, one has to accept in the stock market.
C) r_m + r_f measures the risk, all of it nondiversifiable, one has to accept in the stock market.
D) r_m + r_f measures the risk, all of it diversifiable, one has to accept in the stock market.
E) r_m r_f measures the stock market's total risk.

Question 71

You have been given an opportunity to invest in a stock. Recent trends suggest that a one percent rise in the stock market leads to approximately a two and one-half percent rise in the price of this stock. The real risk-free rate currently stands at 6% and stocks on average have provided 12% returns. Using the capital asset pricing model, determine the appropriate discount rate for the stock in question.

Question 72

The higher the beta,

A) the smaller the diversifiable risk.
B) the smaller the nondiversifiable risk.
C) the larger the diversifiable risk.
D) the larger the nondiversifiable risk.

Question 73

The beta for General Motors (GM) is 0.5, the risk-free rate is 4%, and the market return is 9%. What is GM's risk-adjusted discount rate?

A) 4%
B) 4.5%
C) 6.5%
D) 9%

Question 74

If a project's only risk is diversifiable,

A) only half the risk premium should be added to the discount rate.
B) only half the risk premium should be subtracted from the discount rate.
C) the risk premium should be added to the discount rate.
D) the risk premium should be subtracted from the discount rate.
E) no risk premium should be attached to the discount rate.

Question 75

Which kind of risk affects the opportunity cost of capital?

A) Nondiversifiable risk
B) Diversifiable risk
C) Both nondiversifiable and diversifiable risk
D) The risk inherent in "riskless" assets such as U.S. Treasury bills
E) The risk inherent in "riskless" portfolios such as broad stock market holdings

Question 76

The Ampex Corp. manufactures brass fittings for the plumbing industry. It has an opportunity to produce and sell brass components for residential electric fixtures. If it does produce components for electrical fixtures, it will have to spend $500,000 initially. It expects to get a nominal net cash flow of $200,000 in each of the five years life of the project. If the real interest rate is 8 percent per year and the inflation rate is 4 percent per year, what will the NPV of the project be?

Question 77

Which is the best example of a nondiversifiable risk for Stalwart Shoes?

A) A project to open a new store in Texas
B) A project to open a new factory in Texas
C) A project to move into the sock market
D) The state of the economy in Texas
E) The state of the U.S. economy

Question 78

The asset beta in the Capital Asset Pricing Model is a moderate number that measures

A) how sensitive the asset's return is to market movements.
B) how sensitive the asset's discount rate is to changes in inflation.
C) the risk premium on the stock market.
D) the risk premium on an individual stock.

Question 79

The weighted average of a firm's expected return on its stock and the interest rate that it pays for debt is known as the:

A) internal rate of return.
B) opportunity cost of capital.
C) risk-free rate of return.
D) company cost of capital.

Question 80

Use the following statements to answer this question:
I) The company cost of capital is identical to the risk-adjusted rate of return.
II) The company cost of capital does not depend on beta but does depend on the firm's interest rate on debt obligations.

A) I and II are true.
B) I is true and II is false.
C) II is true and I is false.
D) I and II are false.