Practice MC - Exam PDF

Junjie Liu – Econ 282 Practice Multiple Choice
Introduction
1. Present value of $121,000 expected to be received one year from today at an interest rate
(discount rate) of 10% per year is:
a. $121,000
b. $100,000
C. $110,000
d. None of the above
2. One year discount factor at a discount rate of 25% per year is:
a. 1.25
b. 1.0
C. 0.8
3. The one-year discount factor at an interest rate of 100% per year is:
a. 1.5
B. 0.5
c. 0.25
4. Present Value of $100,000 that is, expected, to be received at the end of one year at a
discount rate of 25% per year is:
A. $80,000
b. $125,000
c. $100,000
5. If the one-year discount factor is 0.8333, what is the discount rate (interest rate) per year?
a. 10%
B. 20%
c. 30%
6. If the present value of $480 to be paid at the end of one year is $400, what is the one-year
discount factor?
A. 0.8333
b. 1.20
c. 0.20
7. If the present value of $250 expected to be received one year from today is $200, what is the
discount rate?
a. 10%
b. 20%
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C. 25%
8. If the one-year discount factor is 0.90, what is the present value of $120 to be received one
year from today?
a. $100
b. $96
C. $108
9. If the present value of $600 expected to be received one year from today is $400, what is the
one-year discount rate?
a. 15%
b. 20%
c. 25%
D. 50%
10. The present value formula for one period cash flow is:
a. PV = C 1 (1 + r)
B. PV = C 1 /(1 + r)
c. PV = C 1 /r
11. The net present value formula for one period is: I) NPV = C 0 + [C 1 /(1 + r)]; II) NPV = PV -
required investment; and III) NPV = C 0 /C 1
a. I only
B. I and II only
c. III only
12. An initial investment of $400,000 will produce an end of year cash flow of $480,000. What
is the NPV of the project at a discount rate of 20%?
a. $176,000
b. $80,000
C. $0 (zero)
13. If the present value of a cash flow generated by an initial investment of $200,000 is
$250,000, what is the NPV of the project?
a. $250,000
B. $50,000
c. $200,000
14. Which of the following statements about risk are (is) true:
a. A safe dollar is worth the same as a risky one
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b. A safe dollar is worth less than a risky one

C. A safe dollar is worth more than a risky one
d. None of the above statements are true
15. The following statements regarding the NPV rule and the rate of return rule are true except:
a. Accept a project if its NPV > 0
b. Reject a project if the NPV < 0
C. Accept a project if its rate of return > 0
d. Accept a project if its rate of return > opportunity cost of capital
16. An initial investment of $500 produces a cash flow $550 one year from today. Calculate the
rate of return on the project
A. 10%
b. 15%
c. 25%
17. According to the net present value rule, an investment in a project should be made if the:
a. Net present value is greater than the cost of investment
b. Net present value is greater than the present value of cash flows
C. Net present value is positive
d. Net present value is negative
18. Which of the following statements regarding the net present value rule and the rate of return
rule is not true?
A. Accept a project if NPV > cost of investment
b. Accept a project if NPV is positive
c. Accept a project if return on investment exceeds the rate of return on an equivalent
investment in the financial market
d. Reject a project if NPV is negative
19. The payoffs of an investment are dependent on the state of the economy. The economy can
have two states, recession or growth, with equal probability. If the payoff in the event of
growth is $140 and in the event of recession is $60, what is the expected payoff for the
investment?
A. $100
b. $110
c. $120
20. If the probability of a recession is 0.2, normal growth is 0.5 and a boom is 0.3, and the payoff
in the event of a recession is $100, normal growth is $400 and boom is $500, what is the
expected payoff?
a. $200
B. $330
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c. $400
21. Current price of Company X's stock is $90. The table below gives the data on end of the year
prices and probabilities dependent on the state of the economy. Calculate the expected return
for the stock.
a. 10%
b. 15%
C. 22.2%
22. The opportunity cost of capital for a risky project is

a. The expected rate of return on a government security having the same maturity as the
project
b. The expected rate of return on a well-diversified portfolio of common stocks
C. The expected rate of return on a portfolio of securities of similar risks as the project
23. Mr. Free has $100 dollars income this year and zero income next year. The market interest
rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,
what will be his consumption next year?
a. $50
b. $100
C. $77
d. $55
24. Mr. Bird has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Bird also has an investment opportunity in which he can invest $50 today
and receive $80 next year. Suppose Mr. Bird consumes $30 this year and invests in the
project. What will be his consumption next year?
a. $88
B. $102
c. $80
d. $100
25. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10% per
year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next year?
A. $154
b. $170
c. $120
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26. Mr. Thomas has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Thomas also has an investment opportunity in which he can invest $50
this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this year and invests
in the project. What will be his consumption next year?
a. $55
B. $80
c. $50
27. Mr. Dell has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Dell also has an investment opportunity in which he can invest $50 this
year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the
project. What is the NPV of the investment opportunity?
a. $5
B. $22.73
c. $0 (zero)
28. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest rate
is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her
consumption next year?
a. $60,000
b. $30,000
c. $70,000
D. $18,000
29. The line that connects the maximum that one can consume this year (now) and the maximum
one can consume next year:
a. Has a slope of (1 + r)
B. Has a slope of -(1 + r)
c. Has a slope of r
d. Has a slope of 1/r
30. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest rate
is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will be
her consumption this year?
a. $60,000
B. $40,000
c. $70,000
d. $19,000
31. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a
project that costs $30,000 this year, which generates an income of $36,000 next year. The
market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in
the project and consumes $50,000 this year?
a. $40,000
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B. $52,000
c. $60,000
32. The discount rate is used for calculating the NPV is:
A. Determined by the financial markets
b. Found by the government
c. Found by the CEO
33. The managers of a firm can maximize stockholder wealth by:

A. Taking all projects with positive NPVs
b. Taking all projects with NPVs greater than the cost of investment
c. Taking all projects with NPVs greater than present value of cash flow
d. All of the above
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Discounted Cash Flow Valuation
1. The present value of $100 expected in two years from today at a discount rate of 6% is:
a. $116.64
b. $108.00
c. $100.00
D. $89.00
2. Present Value is defined as:

A. Future cash flows discounted to the present at an appropriate discount rate
b. Inverse of future cash flows
c. Present cash flow compounded into the future
3. If the interest rate is 12%, what is the 2- year discount factor?

A. 0.7972
b. 0.8929
c. 1.2544
4. If the present value of the cash flow X is $240, and the present value cash flow Y $160, then
the present value of the combined cash flow is:
a. $240
b. $160
c. $80
D. $400
5. If the 2-year discount factor is 0.64, what is the rate of interest (in APR)?
a. 10%
B. 25%
c. 40%
6. What is the present value of the following cash flow at a discount rate of 9%?
A. $372,431.81
b. $450,000
c. $405,950.68
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7. At an interest rate of 10%, which of the following cash flows should you prefer?
Year 1 Year 2 Year 3
A. 500 300 100
b. 100 300 500
c. 300 300 300
d. Any of the above as they all add up to $900
8. What is the net present value of the following cash flow at a discount rate of 11%?
A. $69,108.03
b. $231,432.51
c. $80,000
9. What is the present value of the following cash flow at a discount rate of 16% APR?
A. $136,741.97
b. $122,948.87
c. $158,620.69
10. What is the net present value (NPV) of the following cash flows at a discount rate of 9%?
A. $122,431.81
b. $200,000
c. $155,950.68
11. A perpetuity is defined as:

a. Equal cash flows at equal intervals of time for a specific number of periods
B. Equal cash flows at equal intervals of time forever
c. Unequal cash flows at equal intervals of time forever
12. What is the present value of $10,000 per year perpetuity at an interest rate of 10%?
a. $10,000
B. $100,000
c. $200,000
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13. You would like to have enough money saved to receive $100,000 per year perpetuity after
retirement so that you and your family can lead a good life. How much would you need to
save in your retirement fund to achieve this goal (assume that the perpetuity payments start
one year from the date of your retirement. The interest rate is 12.5%)?
a. $1,000,000
b. $10,000,000
C. $800,000
14. You would like to have enough money saved to receive $80,000 per year perpetuity after
save in your retirement fund to achieve this goal (assume that the perpetuity payments start
one year from the date of your retirement. The interest rate is 8%)?
a. $7,500,000
b. $750,000
C. $1,000,000
15. You would like to have enough money saved to receive a $50,000 per year perpetuity after
save in your retirement fund to achieve this goal (assume that the perpetuity payments starts
on the day of retirement. The interest rate is 8%)?
a. $1,000,000
B. $675,000
c. $625,000
16. You would like to have enough money saved to receive an $80,000 per year perpetuity after
save in your retirement fund to achieve this goal (assume that the perpetuity payments starts
on the day of retirement. The interest rate is 10%)?
a. $1,500,000
B. $880,000
c. $800,000
17. An annuity is defined as

A. Equal cash flows at equal intervals of time for a specified period of time
b. Equal cash flows at equal intervals of time forever
c. Unequal cash flows at equal intervals of time forever
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18. If you receive $1,000 payment at the end each year for the next five years, what type of cash
flow do you have?
a. Uneven cash flow stream
B. An annuity
c. An annuity due
19. If the three-year present value annuity factor is 2.673 and two-year present value annuity
factor is 1.833, what is the present value of $1 received at the end of the 3 years?
a. $1.1905
B. $0.84
c. $0.89
20. If the five-year present value annuity factor is 3.60478 and four-year present value annuity
factor is 3.03735, what is the present value at the $1 received at the end of five years?
a. $0.63552
b. $1.76233
C. $0.56743
21. What is the present value annuity factor at a discount rate of 11% for 8 years?
a. 5.7122
b. 11.8594
C. 5.1461
22. What is the present value annuity factor at an interest rate of 9% for 6 years?
a. 7.5233
B. 4.4859
c. 1.6771
23. What is the present value of $1000 per year annuity for five years at an interest rate of 12%?
a. $6,352.85
B. $3,604.78
c. $567.43
24. What is the present value of $5000 per year annuity at a discount rate of 10% for 6 years?
a. $21,776.30
b. $3,371.91
C. $16,760.78
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25. After retirement, you expect to live for 25 years. You would like to have $75,000 income
each year. How much should you have saved in the retirement to receive this income, if the
interest is 9% per year (assume that the payments start on the day of retirement)?
a. $736,693.47
B. $802,995.88
c. $2,043,750
26. After retirement, you expect to live for 25 years. You would like to have $75,000 income
each year. How much should you have saved in the retirement to receive this income, if the
interest is 9% per year (assume that the payments start one years after the retirement)?
A. $736,693.47
b. $6,352,567.22
c. $1,875,000
27. For $10,000 you can purchase a 5-year annuity that will pay $2504.57 per year for five years.
The payments are made at the end of each year. Calculate the effective annual interest rate
implied by this arrangement: (approximately)
A. 8%
b. 9%
c. 10%
28. If the present value annuity factor for 10 years at 10% interest rate is 6.1446, what is the
present value annuity factor for an equivalent annuity due?
a. 6.1446
b. 7.38
C. 6.759
29. If the present annuity factor is 3.8896, what is the present value annuity factor for an
equivalent annuity due if the interest rate is 9%?
a. 3.5684
B. 4.2397
c. 3.8896
30. For $10,000 you can purchase a 5-year annuity that will pay $2358.65 per year for five years.
The payments are made at the beginning of each year. Calculate the effective annual interest
rate implied by this arrangement: (approximately)
a. 8%
B. 9%
c. 10%
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31. John House has taken a $250,000 mortgage on his house at an interest rate of 6% per year. If
the mortgage calls for twenty equal annual payments, what is the amount of each payment?
A. $21,796.14
b. $10,500.00
c. $16,882.43
32. John House has taken a 20-year, $250,000 mortgage on his house at an interest rate of 6%
per year. What is the value of the mortgage after the payment of the fifth annual installment?
a. $128,958.41
B. $211,689.53
c. $141,019.50
33. If the present value of $1.00 received n years from today at an interest rate of r is 0.3855,
then what is the future value of $1.00 invested today at an interest rate of r% for n years?
a. $1.3855
B. $2.594
c. $1.70
d. Not enough information to solve the problem
34. If the present value of $1.00 received n years from today at an interest rate of r is 0.621, then
what is the future value of $1.00 invested today at an interest rate of r% for n years?
a. $1.00
B. $1.61
c. $1. 621
d. Not enough information to solve the problem
35. If the future value of $1 invested today at an interest rate of r% for n years is 9.6463, what is
the present value of $1 to be received in n years at r% interest rate?
a. $9.6463
b. $1.00
C. $0.1037
36. If the future value annuity factor at 10% and 5 years is 6.1051, calculate the equivalent
present value annuity factor
a. 6.1051
B. 3.7908
c. 6.7156
d. None of the given ones
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37. If the present value annuity factor at 10% APR for 10 years is 6.1446, what is the equivalent
future value annuity factor?
a. 3.108
B. 15.9374
c. 2.5937
a. 2.0455
B. 6.3529
c. 1.7623
39. Which of the following statements is true?

a. Present value of an annuity due is always less than the present value of an equivalent
annuity factor for a given interest rate
B. The present value of an annuity approaches the present value of a perpetuity as n goes to
infinity for a given interest rate
c. Both A and B are true
d. Both A and B are false
a. 3.108
B. 14.487
c. 2.159
41. You are considering investing in a retirement fund that requires you to deposit $5,000 per
year, and you want to know how much the fund will be worth when you retire. What
financial technique should you use to calculate this value?
a. Future value of a single payment
B. Future value of an annuity
c. Present value of an annuity
42. Mr. Hopper is expected to retire in 25 years and he wishes accumulate $750,000 in his
retirement fund by that time. If the interest rate is 10% per year, how much should Mr.
Hopper put into the retirement fund each year in order to achieve this goal? [Assume that the
payments are made at the end of each year]
a. $4,559.44
b. $2,500
C. $7,626.05
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43. Mr. Hopper is expected to retire in 30 years and he wishes accumulate $1,000,000 in his
retirement fund by that time. If the interest rate is 12% per year, how much should Mr.
Hopper put into the retirement fund each year in order to achieve this goal?
A. $4,143.66
b. $8,287.32
c. $4,000

a. Present value of an annuity is always greater than the present value of equivalent annuity
due for a given interest rate
B. The future value of an annuity due is always greater than the future value of an equivalent
ordinary annuity at the same interest rate
c. Both A and B are true
d. Both A and B are false
45. You would like to have enough money saved to receive a growing perpetuity, growing at a
rate of 5% per year, the first payment being $50,000 after retirement, so that you and your
family can lead a good life. How much would you need to save in your retirement fund to
achieve this goal? (assume that the growing perpetuity payments start one year from the date
of your retirement. The interest rate is 10%)?
A. $1,000,000
b. $10,000,000
c. $2,000,000
46. You would like to have enough money saved to receive a growing perpetuity, growing at a
rate of 4% per year, the first payment being $60,000 after retirement, so that you and your
family can lead a good life. How much would you need to save in your retirement fund to
achieve this goal? (assume that the growing perpetuity payments start one year from the date
of your retirement. The interest rate is 10%)?
a. $1,500,000
B. $1,000,000
c. $600,000
47. You would like to have enough money saved to receive a growing annuity for 20 years,
growing at a rate of 5% per year, the first payment being $50,000 after retirement. That way,
you hope that you and your family can lead a good life after retirement. How much would
you need to save in your retirement fund to achieve this goal.(assume that the growing
annuity payments start one year from the date of your retirement. The interest rate is 10%)?
a. $1,000,000
b. $425,678.19
C. $605,604.20
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48. You would like to have enough money saved to receive a growing annuity for 25 years,
growing at a rate of 4% per year, the first payment being $60,000 after retirement, so that you
and your family can lead a good life. How much would you need to save in your retirement
fund to achieve this goal? (assume that the growing perpetuity payments start one year from
the date of your retirement. The interest rate is 12%)?
a. $1,500,000
B. $632,390
c. $452,165
49. In the growing annuity and growing perpetuity formulas; the most important assumption that
is needed for the formulas to work correctly is:
a. r < g
b. r = g
C. r > g
d. No assumption is needed
50. Which of the following statements regarding simple interest and compound interest are true?
a. Problems in finance generally use the simple interest concept
B. Problems in finance generally use the compound interest concept
c. It does not really matter whether you use simple interest or compound interest for solving
problems in finance
51. If you invest $100 at 12% APR for three years, how much would you have at the end of 3
years using simple interest?
A. $136
b. $140.49
c. $240.18
52. If you invest $100 at 12% APR for three years, how much would you have at the end of 3
years using compound interest?
a. $136
B. $140.49
c. $240.18

A. The process of discounting is the inverse of the process of compounding
b. Ending balances using simple interest is always greater than the ending balance using
compound interest at positive interest rates
c. Present value of an annuity due is always less than the present value of an equivalent
annuity at positive interest rates
d. All of the above are true
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54. The concept of compound interest is most appropriately described as:

a. Interest earned on an investment
b. The total amount of interest earned over the life of an investment
C. Interest earned on interest
55. Ms. Colonial has just taken out a $150,000 mortgage at an interest rate of 6% per year. If the
mortgage calls for equal monthly payments for twenty years, what is the amount of each
payment? (Assume monthly compounding or discounting.)
A. $1254.70
b. $1625.00
c. $1263.06
d. None of the above are true
56. An investment at 10.47% effective rate compounded monthly is equal to a nominal (annual)
rate of:
a. 10.99%
b. 9.57%
C. 10%
57. An investment at 12% nominal rate compounded monthly is equal to an annual rate of:
A. 12.68%
b. 12.36%
c. 12%
58. Mr. William expects to retire in 30 years and would like to accumulate $1 million in the
pension fund. If the annual interest rate is 12% per year, how much should Mr. Williams put
into the pension fund each month in order to achieve his goal? Assume that Mr. Williams
will deposit the same amount each month into his pension fund and also use monthly
compounding.
A. $286.13
b. $771.60
c. $345.30
59. An investment at 10% nominal rate compounded continuously is equal to an equivalent

annual rate of:
a. 10.250%
B. 10.517%
c. 10.381%
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60. The present value of a $100 per year perpetuity at 10% per year interest rate is $1000. What
would be the present value if the payments were compounded continuously?
a. $1000.00
B. $1049.21
c. $1024.40
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Valuing Bonds
1. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and
maturing in five years. The interest payments are made annually. Calculate the price of the
bond (in euros) if the yield to maturity is 3.5%.
a. 100
B. 106.77
c. 106.33
2. Generally, a bond can be valued as a package of: I) annuity, II) Perpetuity, III) single
payment
a. I and II only
b. II and III only
C. I and III only
3. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and
maturing in five years. The interest payments are made annually. Calculate the yield to
maturity of the bond (in euros) if the price of the bond is 106 euros.
a. 5.00%
B. 3.80%
c. 3.66%
4. If a bond is paying interest semi-annually, then:

a. Interest is paid once a year
B. Interest is paid every six months
c. Interest is paid every three months
5. A 3-year bond with 10% coupon rate and $1000 face value yields 8% APR. Assuming annual
coupon payment, calculate the price of the bond.
a. $857.96
b. $951.96
c. $1000.00
D. $1051.54
6. A 5-year treasury bond with a coupon rate of 8% has a face value of $1000. What is the
semi-annual interest payment?
a. $80
B. $40
c. $100
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7. A three-year bond has 8.0% coupon rate and face value of $1000. If the yield to maturity on
the bond is 10%, calculate the price of the bond assuming that the bond makes semi-annual
coupon interest payments.
a. $857.96
B. $949.24
c. $1057.54
d. $1000.00
8. A four-year bond has an 8% coupon rate and a face value of $1000. If the current price of the
bond is $878.31, calculate the yield to maturity of the bond (assuming annual interest
payments).
a. 8%
b. 10%
C. 12%
d. 6%
9. A 5-year bond with 10% coupon rate and $1000 face value is selling for $1123. Calculate the
yield to maturity on the bond assuming annual interest payments.
a. 10.0%
b. 8.9%
C. 7.0%
10. Which of the following statements about the relationship between interest rates and bond
prices is true? I) There is an inverse relationship between bond prices and interest rates II)
There is a direct relationship between bond prices and interest rates III) The price of short-
term bonds fluctuates more than the price of long-term bonds for a given change in interest
rates. (Assuming that coupon rate is the same for both) IV) The price of long-term bonds
fluctuates more than the price of short-term bonds for a given change in interest rates.
(Assuming that the coupon rate is the same for both)
A. I and IV only
b. I and III only
c. II and III only
d. None of the given statements are true
11. Consider a bond with a face value of $1,000, a coupon rate of 6%, a yield to maturity of 8%,
and ten years to maturity. This bond's duration is:
a. 8.7 years
B. 7.6 years
c. 0.1 years
d. 6.5 years
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12. A bond with a face value of $1,000 has coupon rate of 7%, yield to maturity of 10%, and
twenty years to maturity. The bond's duration is:
A. 10.0 years
b. 7.4 years
c. 20.0 years
d. 12.6 years
13. A bond with has face value of $1,000, coupon rate of 0%, yield to maturity of 9%, and ten
years to maturity. This bond's duration is:
a. 6.7 years
b. 7.5 years
c. 9.6 years
D. 10.0 years
14. A bond with duration of 10 years has yield to maturity of 10%. This bond's volatility is:
A. 9.09%
b. 6.8%
c. 14.6%
d. 6.0%
15. A bond with duration of 5.7 years has yield to maturity of 9%. The bond's volatility is:
a. 1.9 %
B. 5.2 %
c. 5.7 %
d. 9.0 %
16. If a bond's volatility is 10% and the interest rate goes down by 0.75% (points) then the price
of the bond:
a. Decreases by 10%
b. Decreases by 7.5%
C. Increases by 7.5%
d. Increases by 0.75%
17. If a bond's volatility is 5% and the interest rate changes by 0.5% (points) then the price of the
bond:
a. Changes by 5%
B. Changes by 2.5 %
c. Changes by 7.5%
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18. Volatility of a bond is given by: I) Duration/ (1+yield) II) Slope of the curve relating the
bond price to the interest rate III) Yield to maturity
a. I only
b. II only
c. III only
D. I and II only
19. The term structure of interest rates can be described as the:

a. Relationship between the spot interest rates and the bond prices
b. Relationship between spot interest rates and stock prices
C. Relationship between spot interest rates and maturity of a bond
20. Which of the following statements is true? I) The spot interest rate is a weighted average of
yields to maturity II) Yield to maturity is the weighted average of spot interest rates and
estimated forward rates III) The yield to maturity is always higher than the spot rates
a. I only
B. II only
c. III only
d. I and III only
21. A forward rate prevailing from period three through to period four can be: I) Readily
observed in the market place II) Extracted from spot interest rate with 3 and 4 years to
maturity III) Extracted from 1 and 2 year spot interest rates
a. I only
B. II only
c. III only
d. I and III only
22. If the 3-year spot rate is 10.5% and the 2-year spot rate is 10%, what is the one-year forward
rate of interest two years from now?
a. 3.7%
b. 9.5%
C. 11.5%
23. If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the one-year forward rate
of interest four years from now?
A. 14.1%
b. 9.5%
c. 1.0%
d. 11.0%
21
24. If the 4-year spot rate is 7% and the 3-year spot rate is 6%, what is the one-year forward rate
of interest three years from now?
A. 10.0%
b. 6.5%
c. 9.6%
25. How can one invest today at the 2-year forward rate of interest? I) By buying a 2-year bond
and selling a 1-year bond with the same coupon II) By buying a 1-year bond and selling a 2-
year bond with the same coupon III) By buying a 1-year bond and then after a year
reinvesting in a further 1-year bond
A. I only
b. II only
c. III only
d. II and III only
26. The expectations hypothesis states that the forward interest rate is the: I) Expected future spot
rate II) Always greater than the spot rate III) yield to maturity
A. I only
b. II only
c. III only
d. II and III only
27. If the nominal interest rate per year is 10% and the inflation rate is 4%, what is the real rate
of interest?
a. 10%
b. 4%
C. 5.8%
28. Mr. X invests $1000 at 10% nominal rate for one year. If the inflation rate is 4%, what is the
real value of the investment at the end of one year?
a. $1100
b. $1000
C. $1058
22
Stock Valuation
1. General Electric (GE) has about 10.3 billion shares outstanding and the stock price is $37.10.
The P/E ratio is about 18.3. Calculate the market capitalization for GE. (Approximately)
a. $679 billion
b. $188 billion
C. $382 billion
2. The Wall Street Journal quotation for a company has the following values: Div: $1.12, PE:
18.3, Close: $37.22. Calculate the dividend payout ratio for the company (Approximately).
a. 18%
B. 55%
c. 45%
3. If the Wall Street Journal Quotation for a company has the following values close: 55.14; Net
chg: = +1.04; then the closing price for the stock for the previous trading day was?
a. $56.18
B. $54.10
c. $55.66
4. Super Computer Company's stock is selling for $100 per share today. It is expected that this
stock will pay a dividend of 6 dollars per share, and then be sold for $114 per share at the end
of one year. Calculate the expected rate of return for the shareholders.
A. 20%
b. 15%
c. 10%
d. 25%
5. The value of a common stock today depends on:

a. Number of shares outstanding and the number of shareholders
B. The expected future dividends and the discount rate
c. The Wall Street analysts
d. Present value of the future earnings per share
6. CK Company stockholders expect to receive a year-end dividend of $5 per share and then be
sold for $115 dollars per share. If the required rate of return for the stock is 20%, what is the
current value of the stock?
A. $100
b. $122
c. $132
d. $110
23
7. Deluxe Company expects to pay a dividend of $2 per share at the end of year-1, $3 per share
at the end of year -2 and then be sold for $32 per share. If the required rate on the stock is
15%, what is the current value of the stock?
A. $28.20
b. $32.17
c. $32.00
d. None of the given answers
8. Casino Inc. is expected to pay a dividend of $3 per share at the end of year-1 (D1) and these
dividends are expected to grow at a constant rate of 6% per year forever. If the required rate
of return on the stock is 18%, what is current value of the stock today?
A. $25
b. $50
c. $100
d. $54
9. The constant dividend growth formula P0= Div1/ (r-g) assumes: I) the dividends are growing
at a constant rate g forever II) r > g III) g is never negative.
a. I only
b. II only
C. I and II only
d. III only
10. Will Co. is expected to pay a dividend of $2 per share at the end of year -1(D 1 ) and the
dividends are expected to grow at a constant rate of 4% forever. If the current price of the
stock is $20 per share calculate the expected return or the cost of equity capital for the firm:
a. 10%
b. 4%
C. 14%
11. World-Tour Co. has just now paid a dividend of $2.83 per share (D 0 ); the dividends are
expected to grow at a constant rate of 6% per year forever. If the required rate of return on
the stock is 16%, what is the current value on stock, after paying the dividend?
a. $30
b. $56
C. $70
d. $48
12. The expected rate of return or the cost of equity capital is estimated as follows:
a. Dividend yield - expected rate of growth in dividends
B. Dividend yield + expected rate of growth in dividends
c. Dividend yield / expected rate of growth in dividends
d. (Dividend yield) * (expected rate of growth in dividends)
24
13. Dividend growth rate for a stable firm can be estimated as:
a. Plow back rate / the return on equity (ROE)
B. Plow back rate * the return on equity (ROE)
c. Plow back rate + the return on equity (ROE)
d. Plow back rate - the return on equity (ROE)
14. MJ Co. pays out 60% of its earnings as dividends. Its return on equity is 15%. What is the
stable dividend growth rate for the firm?
a. 9%
b. 5%
C. 6%
d. 15%
15. Michigan Co. is currently paying a dividend of $2.00 per share. The dividends are expected
to grow at 20% per year for the next four years and then grow 6% per year thereafter.
Calculate the expected dividend in year 5.
a. $4.15
b. $2.95
C. $4.40
d. $3.81
16. Great Motor Company is currently paying a dividend of $1.40 per year. The dividends are
expected to grow at a rate of 18% for the next three years and then a constant rate of 5 %
thereafter. What is the expected dividend per share in year 5?
a. $2.35
B. $2.54
c. $2.91
d. $1.50
17. The In-Tech Co. has just paid a dividend of $1 per share. The dividends are expected to grow
at 25% per year for the next three years and at the rate of 5% per year thereafter. If the
required rate of return on the stock is 18%(APR), what is the current value of the stock?
A. $12.97
b. $11.93
c. $15.20
18. R&D Technology Corporation has just paid a dividend of $0.50 per share. The dividends are
expected to grow at 24% per year for the next two years and at 8% per year thereafter. If the
required rate of return in the stock is 16% (APR), calculate the current value of the stock.
a. $1.11
b. $7.71
C. $8.82
25
19. Ocean Co. has paid a dividend $2 per share out of earnings of $4 per share. If the book value
per share is $25, what is the expected growth rate in dividends (g)?
a. 16%
b. 12%
C. 8%
d. 4%
20. Seven-Seas Co. has paid a dividend $3 per share out of earnings of $5 per share. If the book
value per share is $40 and the market price is 52.50 per share, calculate the required rate of
return on the stock.
a. 12%
B. 11%
c. 5%
d. 6%
21. River Co. has paid a dividend $2 per share out of earnings of $4 per share. If the book value
per share is $25 and is currently selling for $40 per share, calculate the required rate of return
on the stock.
a. 15.2%
b. 7.2%
c. 14.7%
D. 13.4%
22. Lake Co. has paid a dividend $3 per share out of earnings of $5 per share. If the book value
per share is $40, what is the expected growth rate in dividends?
a. 7.5%
b. 8%
c. 12.5%
D. 5%
23. The growth rate in dividends is a function of two ratios. They are:
a. ROA and ROE
b. Dividend yield and growth rate in dividends
C. ROE and the Retention Ratio
d. Book value per share and EPS
24. Company X has a P/E ratio of 10 and a stock price of $50 per share. Calculate earnings per
share of the company.
a. $6 per share
b. $10 per share
c. $0.20 per share
D. $5 per share
26
25. Which of the following formulas regarding earnings to price ratio is true:
a. EPS/Po = r[1 + (PVGO/Po]
B. EPS/Po = r[1 - (PVGO/Po)]
c. EPS/Po = [r + (PVGO/Po)]
d. EPS/Po =[r + (1+(PVGO/Po)]/r
26. Generally high growth stocks pay:

A. Low or no dividends
b. High dividends
c. Erratic dividends
d. Both A and C
27. A high proportion of the value a growth stock comes from:

a. Past dividend payments
b. Past earnings
C. PVGO (Present Value of the Growth Opportunities)
d. Both A and B
28. Summer Co. is expected to pay a dividend or $4.00 per share out of earnings of $7.50 per
share. If the required rate of return on the stock is 15% and dividends are growing at a
current rate of 10% per year, calculate the present value of the growth opportunity for the
stock (PVGO).
a. $80
B. $30
c. $50
d. $26
29. Parcel Corporation is expected to pay a dividend of $5 per share next year, and the dividends
pay out ratio is 50%. If the dividends are expected to grow at a constant rate of 8% forever
and the required rate of return on the stock is 13%, calculate the present value of the growth
opportunity.
a. $100
b. $76.92
C. $23.08
30. Universal Air is a no growth firm and has two million shares outstanding. It is expected to
earn a constant 20 million per year on its assets. If all earnings are paid out as dividends and
the cost of capital is 10%, calculate the current price per share for the stock.
a. $200
b. $150
C. $100
d. $50
27
Net Present Value and Other Investment Criteria
1. Which of the following investment rules does not use the time value of the money concept?
a. Net present value
b. Internal rate of return
C. The payback period
d. All of the above use the time value concept
2. Suppose a firm has a $100 million in excess cash. It could:

a. Invest the funds in projects with positive NPVs
b. Pay high dividends to the shareholders
c. Buy another firm
D. All of the above
3. The following are measures used by firms when making capital budgeting decisions except:
a. Payback period
b. Internal rate of return
C. P/E ratio
d. Net present value
4. The survey of CFOs indicates that NPV method is always, or almost always, used for
evaluating investment projects by:
a. 12% of firms
b. 20% of firms
c. 57% of firms
D. 75% of firms
5. The survey of CFOs indicates that IRR method is used for evaluating investment projects
by:
a. 12% of firms
b. 20% of firms
C. 76% of firms
d. 57% of firms
6. Which of the following investment rules has value adding-up property?

a. The payback period method
B. Net present value method
c. The book rate of return method
d. The internal rate of return method
28
7. If the net present value (NPV) of project A is +$100, and that of project B is +$60, then the
net present value of the combined project is:
a. +$100
b. +$60
C. +$160
8. If the NPV of project A is +$30 and that of project B is -$60, then the NPV of the combined
project is:
a. +$30
b. -$60
C. -$30
9. You are given a job to make a decision on project X, which is composed of three independent
projects A, B, and C which have NPVs of +$70, -$40 and +$100, respectively. How would
you go about making the decision about whether to accept or reject the project?
a. Accept the firm's joint project as it has a positive NPV
b. Reject the joint project
C. Break up the project into its components: accept A and C and reject B
10. If the NPV of project A is +$120, and that of project B is -$40 and that of project C is +$40,
what is the NPV of the combined project?
a. +$100
b. -$40
c. +$70
D. +$120
11. The net present value of a project depends upon:

a. Company's choice of accounting method
b. Manager's tastes and preferences
C. Project's cash flows and opportunity cost of capital
d. All of the above
12. Which of the following investment rules may not use all possible cash flows in its
calculations?
a. NPV
B. Payback period
c. IRR
d. All of the above
29
13. The payback period rule:

a. Varies the cut-off point with the interest rate
b. Determines a cut-off point so that all projects accepted by the NPV rule will be accepted
by the payback period rule
C. Requires an arbitrary choice of a cut-off point
d. Both A and C
14. The payback period rule accepts all projects for which the payback period is:
a. Greater than the cut-off value
B. Less than the cut-off value
c. Is positive
d. An integer
15. The main advantage of the payback rule is:

a. Adjustment for uncertainty of early cash flows
B. It is simple to use
c. Does not discount cash flows
d. Both A and C
16. The following are disadvantages of using the payback rule except:
a. The payback rule ignores all cash flow after the cutoff date
b. The payback rule does not use the time value of money
C. The payback period is easy to calculate and use
d. The payback rule does not have the value additive property
17. Which of the following statements regarding the discounted payback period rule is true?
A. The discounted payback rule uses the time value of money concept
b. The discounted payback rule is better than the NPV rule
c. The discounted payback rule considers all cash flows
d. The discounted payback rule exhibits the value additive property
18. Given the following cash flows for project A: C 0 = -1000, C 1 = +600, C 2 = +400, and C 3 =
+1500, calculate the payback period.
a. One year
B. Two years
c. Three years
19. The cost of a new machine is $250,000. The machine has a 3-year life and no salvage value.
If the cash flow each year is equal to 40% of the cost of the machine, calculate the payback
period for the project:
a. 2 years
B. 2.5 years
c. 3 years
d. Cannot be determined because of insufficient data
30
20. Given the following cash flows for project Z: C 0 = -1,000, C 1 = 600, C 2 = 720 and C 3 = 2000,
calculate the discounted payback period for the project at a discount rate of 20%.
a. 1 year
B. 2 years
c. 3 years
21. Internal rate of return (IRR) method is also called:

a. Discounted payback period method
B. Discounted cash-flow (DCF) rate of return method
c. Modified internal rate of return (MIRR) method
22. The quickest way to calculate the internal rate of return (IRR) of a project is by:
a. Trial and error method
b. Using the graphical method
C. Using a financial calculator
d. Guessing the IRR
23. If an investment project (normal project) has IRR equal to the cost of capital, the NPV for
that project is:
a. Positive
b. Negative
c. Zero
D. Unable to determine
24. Given the following cash flows for Project M: C 0 = -1,000, C 1 = +200, C 2 = +700, C 3 = +698,
calculate the IRR for the project.
A. 23%
b. 21%
c. 19%
25. The IRR is defined as:

A. The discount rate that makes the NPV equal to zero
b. The difference between the cost of capital and the present value of the cash flows
c. The discount rate used in the NPV method
d. The discount rate used in the discounted payback period method
31
26. Which of the following methods of evaluating capital investment projects incorporates the
time value of money concept? I) Payback Period, II) Discounted Payback Period, III) Net
Present Value (NPV), IV) Internal Rate of Return
a. I, II, and III only
B. II, III, and IV only
c. III and IV only
d. I, II, III, and IV
27. Driscoll Company is considering investing in a new project. The project will need an initial
investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years.
Calculate the IRR for the project.
a. 14.5%
b. 18.6%
c. 20.2%
D. 23.4%
28. The following are some of the shortcomings of the IRR method except:
A. IRR is conceptually easy to communicate
b. Projects can have multiple IRRs
c. IRR method cannot distinguish between a borrowing project and a lending project
d. It is very cumbersome to evaluate mutually exclusive projects using the IRR method
29. Project X has the following cash flows: C 0 = +2000, C 1 = -1,300 and C 2 = -1,500. If the IRR
of the project is 25% and if the cost of capital is 18%, you would:
a. Accept the project
B. Reject the project
30. Project X has the following cash flows: C 0 = +2000, C 1 = -1,150 and C 2 = -1,150. If the IRR
of the project is 9.85% and if the cost of capital is 12%, you would:
A. Accept the project
b. Reject the project
31. If the sign of the cash flows for a project changes two times then the project has:
a. One IRR
B. Two IRRs
c. Three IRRs
32. Project Y has following cash flows: C 0 = -800; C 1 = +5,000; C 2 = -5,000; Calculate the IRRs
for the project:
A. 25% & 400%
b. 125% & 500%
c. -44% & 11.6%
32
33. Music Company is considering investing in a new project. The project will need an initial
investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years.
Calculate the NPV for the project if the cost of capital is 15%.
a. $169, 935
b. $1,200,000
C. $339,870
d. $125,846
34. Muscle Company is investing in a giant crane. It is expected to cost 6.5 million in initial
investment and it is expected to generate an end of year cash flow of 3.0 million each year
for three years. Calculate the IRR approximately.
a. 14.6 %
b. 16.4 %
C. 18.2 %
d. 22.1%
35. A project will have only one internal rate of return if:
a. The net present value is positive
b. The net present value is negative
c. The cash flows decline over the life of the project
D. There is a one sign change in the cash flows
36. Story Company is investing in a giant crane. It is expected to cost 6.0 million in initial
for three years. Calculate the NPV at 12% (approximately).
a. 2.4 million
B. 1.2 million
c. 0.80 million
d. 0.20 million
37. Dry-Sand Company is considering investing in a new project. The project will need an initial
investment of $1,200,000 and will generate $600,000 (after-tax) cash flows for three years.
Calculate the MIRR (modified internal rate of return) for the project if the cost of capital is
15%.
a. 14.5%
b. 18.6%
C. 20.2%
d. 23.4%
33
38. Mass Company is investing in a giant crane. It is expected to cost 6.6 million in initial
for three years. Calculate the MIRR for the project if the cost of capital is 12% APR.
a. 17.3%
B. 15.3%
c. 23.8%
d. 22.1%
39. Given the following cash flow for project A: C 0 = -3,000, C 1 = +500, C 2 = +1,500 and C 3 =
+5,000, calculate the NPV of the project using a 15% discount rate.
a. $5,000
b. $2,352
c. $3,201
D. $1,857
40. Profitability index is useful under:

A. Capital rationing
b. Mutually exclusive projects
c. Non-normal projects
41. The following table gives the available projects for a firm.
If the firm has a limit of 210 million to invest, what is the maximum NPV the company can
obtain?
a. 200
b. 283
C. 307
34
42. The following table gives the available projects for a firm
The firm has only twenty million to invest. What is the maximum NPV that the company can
obtain?
a. 3.5
b. 4.0
C. 4.5
43. Benefit-cost ratio is defined as the ratio of:

a. Net present value cash flow to initial investment
B. Present value of cash flow to initial investment
c. Net present value of cash flow to IRR
d. Present value of cash flow to IRR
35
Making Investment Decisions
1. Preferably, cash flows for a project are estimated as:

a. Cash flows before taxes
B. Cash flows after taxes
c. Accounting profits before taxes
d. Accounting profits after taxes
2. When a firm has the opportunity to add a project that will utilize excess factory capacity (that
is currently not being used), which costs should be used to determine if the added project
should be undertaken?
a. Opportunity cost
b. Sunk cost
C. Incremental costs
3. The cost of a resource that may be relevant to an investment decision even when no cash
changes hand is called a (an):
a. Sunk cost
B. Opportunity cost
c. Working capital
4. Net Working Capital is the: I) Short-term assets II) Short term liabilities III) Long-term
assets IV) Long term liabilities
a. I only
B. (I - II)
c. (III - I)
d. (III - IV)
5. Investment in net working capital is not depreciated because:

a. It is not a cash flow
B. It is recovered during or at the end of the project and is not a depreciating asset
c. It is a sunk cost
d. All of the above
6. Net Working Capital should be considered in project cash flows because:

A. Firms must invest cash in short-term assets to produce finished goods
b. They are sunk costs
c. Firms need positive NPV projects for investment
36
7. Investment in inventories includes investment in: I) Raw material II) Work-in-progress III)
Finished goods
a. I only
b. I and II only
C. I, II, and III
d. III only
8. For example, in case of an electric car project, the following cash flows should be treated as
incremental flows when deciding whether to go ahead with the project except:
a. The consequent reduction in sales of the company's existing gasoline models (i.e.:
incidental effects)
B. Interest payment on debt
c. The value of tools that can be transferred from the company's existing plants
d. The expenditure on new plants and equipment
9. The principal short-term assets are: I) Cash, II) Accounts receivable, III) Inventories and IV)
Accounts Payable
a. I only
b. I and IV only
C. I, II, and III
d. IV only
10. The value of a previously purchased machine to be used by a proposed project is an example
of:
a. Sunk cost
B. Opportunity cost
c. Fixed cost
11. Money that a firm has already spent or committed to spend regardless of whether a project is
taken is called:
a. Fixed cost
b. Opportunity cost
C. Sunk cost
12. The cost that is incurred as a result of past, irrevocable decisions and is irrelevant to future
decisions is called:
a. Opportunity cost
B. Sunk cost
c. Incremental cost
37
13. For example, in the case of an electric car project, which of the following cash flows should
be treated as incremental flows when deciding whether to go ahead with the project?
a. The cost of research and development undertaken for developing the electric car in the past
three years
b. The annual depreciation charge
C. Tax savings resulting from the depreciation charges
d. Dividend payments
14. In the case of freely traded resources, opportunity cost is the:

a. Book value
B. Market value
c. Historical value
15. If the discount rate is stated in nominal terms, then in order to calculate the NPV in a
consistent manner requires that project: I) cash flows be estimated in nominal terms II) cash
flows be estimated in real terms III) accounting income be used
A. I only
b. II only
c. III only
16. If the discount rate is stated in real terms, then in order to calculate the NPV in a consistent
manner requires that project: I) cash flows be estimated in nominal terms II) cash flows be
estimated in real terms III) accounting income be used
a. I only
B. II only
c. III only
17. A firm owns a building with a book value of $150,000 and a market value of $250,000. If the
building is utilized for a project, then the opportunity cost ignoring taxes is:
a. $100,000
b. $150,000
C. $250,000
18. The real interest rate is 3% and the inflation rate is 5%. What is the nominal interest rate?
a. 3%
b. 5%
C. 8.15%
d. 2%
38
19. If the nominal interest rate is 7. 5% and the inflation rate is 4%, what is the real interest rate?
a. 4%
b. 9.5%
C. 3.4%
20. A cash flow received in two years is expected to be $10,816 in nominal terms. If the real rate
of interest is 2% and the inflation rate is 4%, what is the real cash flow for year-2?
a. $11,236
b. $10,816
C. $10,000
d. $9,246
21. Given the following data for Project M:
Real discount rate = 5%

Nominal discount rate = 10%
Calculate the NPV of the project:
A. $51.70
b. $35.54
c. $45.21
22. Given the following data for Project M:
Real discount rate = 5%

Nominal discount rate = 10%
Calculate the NPV of the project:
a. $25.85
B. $17.77
c. $22.65
23. The real rate of interest is 3% and the inflation is 4%. What is the nominal rate of interest?
a. 3%
b. 4%
C. 7.12%
d. 1%
39
24. The NPV value obtained by discounting nominal cash flows using the nominal discount rate
is the: I) same as the NPV value obtained by discounting real cash flows using the real
discount rate II) same as the NPV value obtained by discounting real cash flows using the
nominal discount rate III) same as the NPV value obtained by discounting nominal cash
flows using the real discount rate
A. I only
b. II only
c. III only
d. II and III only
25. Real cash flow occurring in year-2 is $60,000. If the inflation rate is 5% per year, the real
rate of interest is 2%, calculate the cash flow for the year-2
a. $60,000
b. $55,422
C. $66,150
26. Proper treatment of inflation in the NPV calculation involves: I) Discounting nominal cash
flows using the nominal discount rate II) Discounting real cash flows using the real discount
rate III) Discounting nominal cash flows using the real discount rates
a. I only
b. II only
c. III only
D. I and II only
27. A firm has a general-purpose machine, which has a book value of $300,000 and is sold for
$500,000 in the market. If the tax rate is 35%, what is the opportunity cost of using the
machine in a project?
a. $500,000
B. $430,000
c. $300,000
28. Capital equipment costing $250,000 today has 50,000 salvage value at the end of 5 years. If
the straight line depreciation method is used, what is the book value of the equipment at the
end of two years?
a. $200,000
B. $170,000
c. $140,000
d. $50,000
40
29. A capital equipment costing $400,000 today has no (zero) salvage value at the end of 5 years.
If straight-line depreciation is used, what is the book value of the equipment at the end of
three years?
a. $120,000
b. $80,000
C. $160,000
d. $240,000
30. For project Z, year - 5 inventories increase by $6,000, accounts receivables by $4,000 and
accounts payables by $3,000. Calculate the increase or decrease in working capital for year-
5.
a. Increases by $6,000
b. Decreases by $4,000
C. Increases by $7,000
d. Decreases by $7,000
31. For project A in year-2, inventories increase by $12,000 and accounts payable by $2,000.
Calculate the increase or decrease in net working capital for year-2.
a. Decreases by $14,000
b. Increases by $14,000
c. Decreases by $10,000
D. Increases by $10,000
32. Working capital is one of the most common causes of misunderstanding in estimating project
cash flows. The following are the most common errors: I) forgetting about working capital
entirely II) forgetting that working capital may change during the life of the project III)
forgetting that working capital is recovered at the end of the project IV) forgetting to
depreciate the working capital
a. I and II only
B. I, II, and III only
c. II, III and IV only
d. I, II and IV only
33. If the depreciation amount is 600,000 and the marginal tax rate is 35%, then the tax shield
due to depreciation is:
a. $210,000
b. $600,000
C. $390,000
41
34. If the depreciation amount is $100,000 and the marginal tax rate is 35%, then the tax shield
due to depreciation is:
A. $35,000
b. $100,000
c. $65,000
35. If the depreciable investment is $600,000 and the MACRS 5-Year class schedule is: Year-1:
20%; Year-2: 32%; Year-3: 19.2%; Year-4: 11.5%; Year-5: 11.5% and Year-6: 5.8%
Calculate the depreciation for Year-2.
a. $120,000
B. $192,000
c. $96,000
d. $115,200
36. If the depreciable investment is $1,000,000 and the MACRS 5-Year class schedule is: Year-
1: 20%; Year-2: 32%; Year-3: 19.2%; Year-4: 11.5%; Year-5: 11.5% and Year-6: 5.8%
Calculate the depreciation tax shield for Year-2 using a tax rate of 30%:
a. $224,000
b. $60,000
C. $96,000
d. $300,000
37. A project requires an initial investment of $200,000 and is expected to produce a cash flow
before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t = 2].
The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year
schedule:(t = 1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is
such that it can make use of all applicable tax shields. The opportunity cost of capital is 12%.
Assume that the asset can be sold for book value. Calculate the NPV of the project:
(Approximately)
a. $22,463
B. $19,315
c. $16,244
42
38. A project requires an initial investment of $200,000 and is expected to produce a cash flow
before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t = 2].
The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year
schedule: (t = 1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is
such that it can make use of all applicable tax shields. The opportunity cost of capital is 11%.
Assume that the asset can be sold for book value. Calculate the IRR for the project:
(approximately)
a. 12.00%
b. 11.00%
C. 17.73%
39. You have been asked to evaluate a project with infinite life. Sales and costs are projected to
be $1000 and $500 respectively. There is no depreciation and the tax rate is 30%. The real
required rate of return is 10%. The inflation rate is 4% and is expected to be 4% forever.
Sales and costs will increase at the rate of inflation. If the project costs $3000, what is the
NPV?
a. $500.00
b. $1629.62
C. $365.38
40. A project requires an investment of $900 today. It has sales of $1,100 per year forever. Costs
will be $600 the first year and increase by 20% per year. Ignoring taxes calculate the NPV of
the project at 12% discount rate.
a. $65.00
B. $57.51
c. $100.00
d. Cannot be calculated as g > r
41. Two machines, A and B, which perform the same functions, have the following costs and
lives.
Which machine would you choose? The two machines are mutually exclusive and the cost of
capital is 15%.
A. Machine A as the EAC is $1789.89
b. Machine B as the EAC is $1922.88
c. Don't buy either machine
d. Accept both A and B
43
42. Two mutually exclusive projects have the following NPVs and project lives.
If the cost of capital is 15%, which project would you accept?

A. A
b. B
c. Both A and B
d. Reject both A and B
43. OM Construction Company must choose between two types of cranes. Crane A costs
$600,000, will last for 5 years, and will require $60,000 in maintenance each year. Crane B
costs $750,000 and will last for seven years and will require $30,000 in maintenance each
year. Maintenance costs for cranes A and B are incurred at the end of each year. The
appropriate discount rate is 12% per year. Which machine should OM Construction
purchase?
a. Crane A as EAC is $226,444
B. Crane B as EAC is $194,336
c. Crane A as the PV is $816,286
d. Cannot be calculated as the revenues for the project are not given
44. You are considering the purchase of one of two machines required in your production
process. Machine A has a life of two years. Machine A costs $50 initially and then $70 per
year in maintenance. Machine B has an initial cost of $90. It requires $40 in maintenance for
each year of its 3 year life. Either machine must be replaced at the end of its life. Which is
the better machine for the firm? The discount rate is 15% and the tax rate is zero.
a. Machine A as EAC for Machine A is $100.76
B. Machine B as EAC for Machine B is $79.42
c. Machine A as PV of costs for Machine A is $163.80
d. Machine B as PV of costs for Machine B is $181.33
44
Project Analysis and Evaluation
1. You are given the following data for year-1. Revenue = $43; Total costs = $30; Depreciation
= $3; Tax rate = 30%. Calculate the operating cash flow for the project for year-1.
a. $7
B. $10
c. $13
2. A project has an initial investment of 100. You have come up with the following estimates of
the projects with cash flows.
If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity
analysis of NPV (no taxes) show?
A. -50, 20, +100
b. -100, -50, +80
c. -50, +50, +70
3. You are given the following data for year-1: Revenues = 100, Fixed costs = 30; Total
variable costs = 50; Depreciation = $10; Tax rate = 30%. Calculate the after tax cash flow for
the project for year-1.
A. $17
b. $7
c. $10
4. A project has the following cash flows: C 0 = -100,000; C 1 = 50,000; C 2 = 150,000; C 3 =

100,000. If the discount rate changes from 12% to 15%, what is the change in the NPV of the
project (approximately)?
a. 12,750 increase
B. 12,750 decrease
c. 122,650 increase
d. 135,400 decrease
45
5. You have come up with the following estimates of project cash flows:
The cash flows are perpetuities and the cost of capital is 8%. What does a sensitivity analysis
of NPV (without taxes) show?
A. 25, +232.50, +440
b. 100, +500, +800
c. 90, -55, -20
d. One of the above
6. A project has an initial investment of $150. You have come up with the following estimates
of revenues and costs. Calculate the NPV assuming that cash flow and perpetuities. (No
taxes.) (Cost of capital =10%)
a. 50, -100, +400

b. 50, +300, +500
C. 100, +150, +350
d. One of the above
7. A project requires an initial investment in equipment of $90,000 and then requires an

investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end
of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and
the cost of capital is 15%. Cash flows from the project are:
a. CF 0 : -90,000; CF 1 : 12,600; CF 2 : 12,600; CF 3 : 29,600
B. CF 0 : -100,000; CF 1 : 42,600; CF 2 : 42,600; CF 3 : 59,600
c. CF 0 : -100,000; CF 1 : 42,600; CF 2 : 42,600; CF 3 : 42,600

the cost of capital is 15%. Calculate the NPV of the project:
a. 3840
B. 8443
c. -2735
46

the cost of capital is 12%. Calculate the NPV of the project:
A. 14,418
b. 8443
c. -2735
the cost of capital is 15%.What would the NPV of the project be if the revenues were higher
by 10% and the costs were 65% of the revenues?
a. $8443
b. $964
C. $5566
the cost of capital is 15%.What would the NPV if the discount rate were higher by 10%?
A. $5648
b. $3840
c. -$2735
12. The following are drawbacks of sensitivity analysis except:

a. It provides ambiguous results
b. Underlying variables are likely to be interrelated
C. It provides additional information about the project that is useful
d. All of the above statements are drawbacks of sensitivity analysis
13. Which of the following statements most appropriately describes "Scenario Analysis"
a. It looks at the project by changing one variable at a time
b. It provides the break-even level of sales for the project
C. It looks at different but consistent combination of variables
d. Each of the above statements describes "Scenario Analysis" correctly
47
14. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the break-even level (i.e. NPV = 0) of annual rates? (Approximately)
(Assume no taxes.)
a. 150,000 units
b. 342,290 units
C. 381,777 units
15. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is12%, what is the approximate
break-even level (i.e. NPV = 0) of annual sales? (Assume no taxes.) (Approximately)
a. $133,333 units
B. $272,117 units
c. $227,533 units
16. Firms often calculate a project's break-even sales using book earnings. Generally, break-even
sales based on NPV is:
A. Higher than the one calculated using book earnings
b. Lower than the one calculated using book earnings
c. Equal to the one calculated using book earnings
17. The accounting break-even point occurs when:

a. The total revenue line cuts the fixed cost line
b. The present value of inflows line cuts the present value of outflows line
C. The total revenue line cuts the total cost line
18. The NPV break-even point occurs when:

A. The present value of inflows line cuts the present value of outflows line
b. The total revenue line cuts the fixed cost line
c. The total revenue line cuts the total cost line
48
19. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the accounting break-even level? (Approximately) (Assume no
taxes.)
A. 300,000 units
b. 150,000 units
c. 381,777 units
20. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is12%, what is the approximate
break-even level (accounting) of annual sales? (Assume no taxes.) (Approximately)
a. $133,334 units
b. $272,117 units
C. $244,444 units
21. Taj Mahal Tour Company proposes to invest $3 million in a new tour package project. Fixed
costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per
package to tourists. This tour package is expected to be attractive for the next five years. If
the cost of capital is 20%, what is the NPV break-even number of tourists per year? (Ignore
taxes, give an approximate answer)
a. 1000
B. 2000
c. 15000
22. Hammer Company proposes to invest $6 million in a new type of hammer-making

equipment. The fixed costs are $0.5 million per year. The equipment is expected to last for
five years. The manufacturing cost per hammer is $1and the selling price per hammer is $6.
Calculate the break-even (i.e. NPV = 0) volume per year. (Ignore taxes.)
A. 500,000 units
b. 600,000 units
c. 100,000 units
49
23. Hammer Company proposes to invest $6 million in a new type of hammer-making

equipment. The fixed costs are $1.0 million per year. The equipment is expected to last for
five years. The manufacturing cost per hammer is $1 and the selling price per hammer is $6.
Calculate the break-even (i.e. NPV = 0) volume per year. (Ignore taxes.)
a. 500,000 units
B. 600,000 units
c. 100,000 units
24. Everything else remaining the same, an increase in fixed costs: I) Increases the break-even
point based on NPV II) Increases the accounting break-even point III) Decreases the break-
even point based on NPV IV) Decreases the accounting break-even point
a. I and III only
b. III and IV only
c. II and III only
D. I and II only
25. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of
a deep-sea oil rig at a cost of $50 million (I 0 ) and is expected to remain constant. The price of
oil is $50 /bbl and the extraction costs are $20 /bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
taxes). Calculate the NPV to invest today
A. +10,000,000
b. +6,000,000
c. +4,000,000
year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore
taxes). Suppose the oil price is uncertain and can be $70 /bbl or $40 /bbl next year and then
expected NPV of the project if postponed by one year is:
a. +10,000,000
B. +25,000,000
c. +5,000,000
50
year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore
taxes). Suppose the oil price is uncertain and can be $70 /bbl or $40 /bbl next year. If the
project if postponed by one year, calculate the value of the option to wait for one year:
(approximately)
A. +15,000,000
b. +40,000,000
c. +10,000,000
28. You are planning to produce a new action figure called "Hillary ". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows
of $10 million per year for 2 years (starting next year). There is an equal chance that it will
be a hit or failure (probability = 50%) You will not know whether it is a hit or a failure until
the first year's cash flows are in. You have to spend $80 million immediately for equipment
and the rights to produce the figure. If the discount rate is 10%, calculate the NPV without
the abandonment option.
A. -9.15
b. +13.99
c. +9.15
d. -14.4
29. You are planning to produce a new action figure called "Hillary". However, you are very
and the rights to produce the figure. If you can sell your equipment for $60 million once the
first year's cash flows are received, calculate the NPV with the abandonment option. (The
discount rate is 10%)
a. -9.1
b. +9.1
C. +13.99
d. -14.4
51
30. You are planning to produce a new action figure called "Hillary". However, you are very
and the rights to produce the figure. .If you can sell your equipment for $60 million once the
first year's cash flows are received, calculate the value of the abandonment option. (The
discount rate is 10%)
a. -9.15
b. +13.99
C. +23.14
31. Given the following net future values for harvesting trees: (one time harvest):
If the cost of capital is 15%, calculate the optimal year to harvest:

a. Year 1
b. Year 2
C. Year 3
d. Year 4
32. The Consumer-Mart Company is going to introduce a new consumer product. If brought to
market without research about consumer tastes the firm believes that there is a 60% chance
that the product will be successful. If successful, the project has a NPV = $500,000. If the
product is a failure (40%) and withdrawn from the market, then NPV = -$100,000. A
consumer survey will cost $60,000 and delay the introduction by one year. If the survey is
successful, then there is an 80% chance of consumer acceptance, in which case the NPV =
$500,000. If, on the other hand the survey is a failure, then NPV = -$100,000. The discount
rate is 10%. By how much does the marketing survey change the expected net present value
of the project? (Approximately)
A. Increase the NPV by $25,455
b. Decrease the NPV by $5950
c. Decrease the NPV by $8955
d. Decrease the NPV by $25,455
52
Introduction to Risk and Return
1. Which of the following portfolios have the least risk?

A. A portfolio of Treasury bills
b. A portfolio of long-term United States Government bonds
c. Portfolio of U.S. common stocks of small firms
2. If the average annual rate of return for common stocks is 11.7%, and for treasury bills it is
4.0%, what is the market risk premium?
a. 15.8%
b. 4.1%
C. 7.7%
3. Spill Oil Company's stocks had -8%, 11% and 24% rates of return during the last three years
respectively; calculate the average rate of return for the stock.
a. 8% per year
B. 9% per year
c. 11% per year
4. Given the following data: risk-free rate = 4%, average risk premium = 7.7%. Calculate the
required rate of return:
a. 5.6%
b. 7.6%
C. 11.7%
d. None of the given answers
5. Mega Corporation has the following returns for the past three years: 8%, 12% and 10%.
Calculate the variance of the return and the standard deviation of the returns.
a. 64 and 8%
b. 124 and 11.1%
C. 4 and 2%
6. Macro Corporation has had the following returns for the past three years, -10%, 10%, and
30%. Calculate the standard deviation of the returns.
a. 10%
B. 20%
c. 30%
53
7. Sun Corporation has had returns of -6%, 16%, 18%, and 28% for the past four years.
Calculate the standard deviation of the returns.
a. 11.6%
B. 14.3%
c. 13.4 %
8. A statistical measure of the degree to which securities' returns move together is called:
a. Variance
B. Correlation Coefficient
c. Standard Deviation
9. The type of the risk that can be eliminated by diversification is called:

a. Market risk
B. Unique risk
c. Interest rate risk
d. Default risk
10. The unique risk is also called the:

a. Unsystematic risk
b. Diversifiable risk
c. Firm specific risk
D. All of the above
11. Market risk is also called: I) Systematic risk, II) Undiversifiable risk, III) Firm specific risk.
a. I only
b. II only
c. III only
D. I and II only
12. Stock A has an expected return of 10% per year and stock B has an expected return of 20%.
If 40% of the funds are invested in stock A, and the rest in stock B, what is the expected
return on the portfolio of stock A and stock B?
a. 10%
b. 20%
C. 16%
13. As the number of stocks in a portfolio is increased:

A. Unique risk decreases and approaches to zero
b. Market risk decreases
c. Unique risk decreases and becomes equal to market risk
d. Total risk approaches to zero
54
14. Stock M and Stock N have had the following returns for the past three years of -12%. 10%,
32%; and 15%, 6%, 24% respectively. Calculate the covariance between the two securities.
a. -99
B. +99
c. +250
15. Stock P and stock Q have had annual returns of -10%, 12%, 28% and 8%, 13%, 24%
respectively. Calculate the covariance of return between the securities.
a. -149
B. +149
c. 100
16. Stock X has a standard deviation of return of 10%. Stock Y has a standard deviation of return
of 20%. The correlation coefficient between stocks is 0.5. If you invest 60% of the funds in
stock X and 40% in stock Y, what is the standard deviation of a portfolio?
a. 10%
b. 20%
C. 12.2%
17. If the correlation coefficient between stock C and stock D is +1.0% and the standard
deviation of return for stock C is 15% and that for stock D is 30%, calculate the covariance
between stock C and stock D.
a. +45
b. -450
C. +450
18. The range of values that correlation coefficients can take can be:
a. Zero to +1
B. -1 to +1
c. -infinity to +infinity
d. Zero to +infinity
19. If the covariance between stock A and stock B is 100, the standard deviation of stock A is
10% and that of stock B is 20%, calculate the correlation coefficient between the two
securities.
a. -0.5
b. +1.0
C. +0.5
55
20. For a two-stock portfolio, the maximum reduction in risk occurs when the correlation
coefficient between the two stocks is:
a. +1
b. -0.5
C. -1
d. 0
21. In the case of a portfolio of N-stocks, the formula for portfolio variance contains:
A. N variance terms
b. N(N - 1)/2 variance terms
c. N2 variance terms
22. In the case of a portfolio of N-stocks, the formula for portfolio variance contains:
a. N covariance terms
B. N(N - 1)/2 covariance terms
c. N2 covariance terms
23. The "beta" is a measure of:

a. Unique risk
b. Total risk
C. Market risk
24. The beta of market portfolio is:

A. + 1.0
b. +0.5
c. 0
d. -1.0
25. For each additional 1% change in the market return, Amazon stock return on the average
changes by:
a. 1.26%
b. 1.59%
C. 2.2%
26. The beta of Nestle measured relative to its home market is:
A. 0.17
b. 1.54
c. 1.01
56
27. If the standard deviation of returns of the market is 20% and the beta of a well-diversified
portfolio is 1.5, calculate the standard deviation of the portfolio:
A. 30%
b. 20%
c. 10%
28. The correlation coefficient between stock A and the market portfolio is +0.6. The standard
deviation of return of the stock is 30% and that of the market portfolio is 20%. Calculate the
beta of the stock.
a. 1.1
b. 1.0
C. 0.9
d. 0.6
29. Historical nominal return for stock A is -8%, +10% and +22%. The nominal return for the
market portfolio is +6%, +18% and 24%. Calculate the beta for stock A.
A. 1.64
b. 0.61
c. 1.0
30. The annual return for three years for stock B comes out to be 0%, 10% and 26%. Annual
returns for three years for the market portfolios are +6%, 18%, 24%. Calculate the beta for
the stock.
a. 0.74
B. 1.36
c. 1.0
31. The correlation coefficient between stock B and the market portfolio is 0.8. The standard
deviation of the stock B is 35% and that of the market is 20%. Calculate the beta of the
stock.
a. 1.0
B. 1.4
c. 0.8
d. 0.7
57
Portfolio Theory and Capital Asset Pricing Model
1. Portfolio Theory was first developed by:

a. Merton Miller
b. Richard Brealey
c. Franco Modigliani
D. Harry Markowitz
2. The distribution of returns, measured over a short interval of time, like daily returns, can be
approximated by:
A. Normal distribution
b. Lognormal distribution
c. Binomial distribution
3. Florida Company (FC) and Minnesota Company (MC) are both service companies. Their
historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%.
Calculate the mean of returns for each company.
a. FC: 12% MC: 6%
B. FC: 10%, MC: 12%
c. FC: 20%, MC: 32%
Calculate the variances of return for FC and MC.
a. FC: 100 MC: 256
b. FC: 350 MC: 96
C. FC: 175 MC: 48
Calculate the covariance between the returns of FC and MC.
A. 60
b. 80
c. 40
58
Calculate the standard deviation (S.D.) of return for FC and MC.
a. FC: 10% MC: 12%
b. FC: 18.7% MC: 9.8%
C. FC: 13.2% MC: 6.9%
Calculate the correlation coefficient between the return of FC and MC.
a. 0.0
b. -0.655
C. +0.655
historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%. If FC
and MC are combined in a portfolio with 50% of the funds invested in each, calculate the
expected return on the portfolio.
a. 12%
b. 10%
C. 11%
historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%.What is
the variance of the portfolio with 50% of the funds invested in FC and 50% in MC
(approximately)?
A. 85.75
b. 111.50
c. 55.75
historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%. What is
the standard deviation of the portfolio with 50% of the funds invested in FC and 50% in
MC?
a. 10.6%
b. 14.4%
C. 9.3%
59
11. Investments A and B both offer an expected rate of return of 12%. If the standard deviation
of A is 20% and that of B is 30%, then investors would:
A. Prefer A to B
b. Prefer B to A
c. Prefer a portfolio of A and B
d. Cannot answer without knowing investor's risk preferences
12. Investments B and C both have the same standard deviation of 20%. If the expected return on
B is 15% and that of C is 18%, then the investors would
a. Prefer B to C
B. Prefer C to B
c. Reject both B and C
13. The efficient portfolios: I) Have only unique risk II) Provide highest returns for a given level
of risk III) Provide the least risk for a given level of returns IV) Have no risk at all
a. I only
B. II and III only
c. IV only
d. II only
14. By combining lending and borrowing at the risk-free rate with the efficient portfolios, we can
I) extend the range of investment possibilities II) change efficient set of portfolios from being
curvilinear to a straight line III) provide a higher expected return for any level of risk except
the tangential portfolio
a. I only
b. I and II only
C. I, II, and III
15. Suppose you invest equal amounts in a portfolio with an expected return of 16% and a
standard deviation of returns of 20% and a risk-free asset with an interest rate of 4%;
calculate the expected return on the resulting portfolio:
A. 10%
b. 4%
c. 12%
16. Suppose you invest equal amounts in a portfolio with an expected return of 16% and a
standard deviation of returns of 20% and a risk-free asset with an interest rate of 4%;
calculate the standard deviation of the returns on the resulting portfolio:
a. 8%
B. 10%
c. 20%
60
17. Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in
a portfolio with an expected return of 16% and a standard deviation of returns of 20%. The
risk-free asset has an interest rate of 4%; calculate the expected return on the resulting
portfolio:
a. 20%
b. 32%
C. 28%
18. Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in
a portfolio with an expected return of 20% and a standard deviation of returns of 16%. The
risk-free asset has an interest rate of 4%; calculate standard deviation of the resulting
portfolio:
a. 28%
b. 40%
C. 32%
19. If the covariance of Stock A with Stock B is -100, what is the covariance of Stock B with
Stock A?
a. +100
B. -100
c. 1/100
d. Need additional information
20. The correlation measures the:

a. Rate of movements of the return of individual stocks
b. Direction of movement of the return of individual stocks
C. Direction of movement between the returns of two stocks
d. Stock market volatility
21. If the correlation coefficient between Stock A and Stock B is +0.6, what is the correlation
between Stock B with Stock A?
A. +0.6
b. -0.6
c. +0.4
d. -0.4
22. The correlation between the efficient portfolio and the risk-free asset is:
a. +1
b. -1
C. 0
d. Cannot be calculated
61
23. In the presence of a risk-free asset, the investor's job is to: I) invest in the market portfolio II)
find an interior portfolio using quadratic programming III) borrow or lend at the risk-free rate
IV) read and understand Markowitz's portfolio theory
a. I and II only
B. I and III only
c. II and IV only
d. IV only
24. Sharpe ratio is defined as:

A. (r P - r f )/σ P
b. (r P - r M )/σ P
c. (r P - r f )/β P
25. Beta of Treasury bills is:

a. +1.0
b. +0.5
c. -1.0
D. 0
26. Beta of the market portfolio is:

a. Zero
b. +0.5
c. -1.0
D. +1.0
27. The capital asset pricing model (CAPM) states that:

A. The expected risk premium on an investment is proportional to its beta
b. The expected rate of return on an investment is proportional to its beta
c. The expected rate of return on an investment depends on the risk-free rate and the market
rate of return
d. The expected rate of return on an investment is dependent on the risk-free rate
28. The graphical representation of CAPM (Capital Asset Pricing Model) is called:
a. Capital Market Line
b. Characteristic Line
C. Security Market Line
29. Beta measure indicates:

a. The ability to diversify risk
B. The change in the rate of return on an investment for a given change in the market return
c. The actual return on an asset
d. A and C
62
30. The security market line (SML) is the graph of:

a. Expected rate on investment (Y-axis) vs. variance of return
b. Expected return on investment vs. standard deviation of return
C. Expected rate of return on investment vs. beta
d. A and B
31. If the beta of Microsoft is 1.13, risk-free rate is 3% and the market risk premium is 8%,
calculate the expected return for Microsoft.
A. 12.04%
b. 15.66%
c. 13.94%
d. 8.65%
32. If the beta of Amazon.com is 2.2, risk-free rate is 5.5% and the market risk premium is 8%,
calculate the expected rate of return for Amazon.com stock:
a. 15.8%
B. 14.3%
c. 35.2%
d. 23.1%
33. If the beta of Exxon Mobil is 0.65, risk-free rate is 4% and the market rate of return is 14%,
calculate the expected rate of return from Exxon:
a. 12.6%
B. 10.5%
c. 13.1%
d. 6.5%
34. A stock with a beta of zero would be expected to:

a. Have a rate of return equal to zero
b. Have a rate of return equal to the market risk premium
C. Have a rate of return equal to the risk-free rate
d. Have a rate of return equal to the market rate of return
35. A stock with a beta of 1. 25 would be expected to:

A. Increase in returns 25% faster than the market in up markets
b. Increase in returns 25% faster than the market in down markets
c. Increase in returns 125% faster than the market in up markets
d. Increase in returns 125% faster than the market in down markets
36. If the market risk premium is (r m - r f ) is 8%, then according to the CAPM, the risk premium
of a stock with beta value of 1.7 must be:
a. Less than 12%
b. 12%
C. Greater than 12%
d. Cannot be determined
63
37. The main shortcoming of CAPM is that it

a. Ignores the return on the market portfolio
b. Uses too many factors
C. Requires a single risk measure of systematic risk
d. Ignores risk-free rate of return
38. If a stock is overpriced it would plot:

a. Above the security market line
B. Below the security market line
c. On the security market line
d. On the Y-axis
39. If a stock is underpriced it would plot:

A. Above the security market line
b. Below the security market line
c. On the security market line
d. On the Y-axis
40. Given the following data for a stock: beta = 1.5; risk-free rate = 4%; market rate of return =
12%; and Expected rate of return on the stock = 15%. Then the stock is:
A. Overpriced
b. Underpriced
c. Correctly priced
a. Overpriced
B. Under priced
c. Correctly priced
a. Overpriced
b. Under priced
C. Correctly priced
43. A "factor" in APT is a variable that:

a. Is pure "noise"
b. Correlates with risky asset returns in an unsystematic manner
C. Affects the return of risky assets in a systematic manner
d. Affects the return of a risky asset in a random manner
64
44. Given the following data for a stock: risk-free rate = 4%; factor-1 beta = 1.5; factor-2 beta =
0.5 factor-1 risk-premium = 8%; factor-2 risk-premium = 2%. Calculate the expected rate of
return on the stock using the two-factor APT model.
a. 13%
B. 17%
c. 10%
45. The three factors in the Three-Factor Model are: I) Market factor II) Size factor III) Book-to-
market factor
a. I only
b. I and II only
C. I, II, and III
d. III only
46. Given the following data for the a stock: risk-free rate = 5%; beta (market) = 1.5; beta (size)
= 0.3; beta (book-to-market) = 1.1; market risk premium = 7%; size risk premium = 3.7%;
and book-to-market risk premium = 5.2%. Calculate the expected return on the stock using
the Fama-French three-factor model.
A. 22.3%
b. 7.8%
c. 11.5%
47. Given the following data for the a stock: risk-free rate = 5%; beta (market) = 1.4; beta (size)
= 0.4; beta (book-to-market) = -1.1; market risk premium = 7%; size risk premium = 3.7%;
and book-to-market risk premium = 5.2%. Calculate the expected return on the stock using
the Fama-French three-factor model.
a. 22.3%
b. 7.8%
C. 10.6%
65
Risk and Cost of Capital
1. The company cost of capital is the appropriate discount rate for a firm's:
a. Low risk projects
b. High risk projects
C. Average-risk projects
d. All of the above
2. Cost of capital is the same as cost of equity for firms:

a. Financed entirely by debt
b. Financed by both debt and equity
C. Financed entirely by equity
3. The cost of capital for a project depends on:

a. The company's cost of capital
B. The use to which the capital is put, i.e. the project
c. The industry cost of capital
d. All of the above
4. Using the company cost of capital to evaluate a project is: I) Always correct II) Always
incorrect III) Correct for projects that are about as risky as the average of the firm's other
assets
a. I only
b. II only
C. III only
d. I and III only
5. If a firm uses the same company cost of capital for evaluating all projects, which of the
following is likely? I) Rejecting good low risk projects II) Accepting poor high risk projects
III) Correctly accept projects with average risk
a. I only
b. I and II only
C. I, II, and III
d. II only
6. If firms use the company cost of capital for evaluating all of their projects, which of the
following is likely? I) Accepting poor low risk projects II) Rejecting good high risk projects
III) Correctly accept projects with average risk
a. I only
b. II only
C. III only
d. I, II and III
66
7. Which of the following types of projects have the highest risk?

A. Speculation ventures
b. New products
c. Expansion of existing business
d. Cost improvement, (known technology)
8. A firm might categorize its projects into: I) Cost improvement projects II) Expansion projects
(existing business) III) New products projects IV) Speculative ventures
a. III only
b. I, II and III only
c. II and IV only
D. I, II, III, and IV
9. Which of the following type of projects has the lowest risk?

a. Speculation ventures
b. New products
c. Expansion of existing business
D. Cost improvement
10. Which of the following type of projects has average risk?

a. Speculation ventures
b. New products
C. Expansion of existing business
d. Cost improvement
11. The market value of Charter Cruise Company's equity is $15 million, and the market value of
its risk-free debt is $5 million. If the required rate of return on the equity is 20% and that on
the debt is 8%, calculate the company's cost of capital. (Assume no taxes.)
a. 20%
B. 17%
c. 14%
12. The market value of Cable Company's equity is $60 million, and the market value of its risk-
free debt is $40 million. If the required rate of return on the equity is 15% and that on the
debt is 5%, calculate the company's cost of capital. (Assume no taxes.)
a. 5%
b. 0%
C. 1%
d. One of the above
67
13. The company cost of capital when debt as well as equity is used for financing is:
a. Cost of debt
b. Cost of equity
C. The weighted average cost of capital (WACC)
14. The after-tax weighted average cost of capital (WACC) is calculated using the formula:
a. WACC = (r D ) (D/V) + (r E ) (E/V) where: V = D + E
B. WACC = (r D ) (1 - T C ) (D/V) + (r E ) (E/V) where: V = D + E
c. WACC = (r D ) (D/E) + (r E ) (E/D)
15. The market value of Charcoal Corporation's common stock is $20 million, and the market
value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and
the market risk premium is 8%. If the Treasury bill rate is 5%, what is the company's cost of
capital? (Assume no taxes.)
a. 5%
b. 4.6%
C. 3%
d. One of the above
16. The market value of XYZ Corporation's common stock is 40 million and the market value of
the risk-free debt is 60 million. The beta of the company's common stock is 0.8, and the
expected market risk premium is 10%. If the Treasury bill rate is 6%, what is the firm's cost
of capital? (Assume no taxes.)
A. 9.2%
b. 14%
c. 8 1%
17. Cost of equity can be estimated using:

a. Discounted cash flow (DCF) approach
b. Capital Asset Pricing Model (CAPM)
c. Arbitrage Pricing Theory (APT)
D. All of the above
18. Cost of equity can be estimated using:

a. The Fama-French three-factor model
b. Capital Asset Pricing Model (CAPM)
c. Arbitrage Pricing Theory (APT)
D. All of the above
68
19. The historical returns data for the past three years for Company A's stock is -6%, 15%, 15%
and that of the market portfolio is 10%, 10% and 16%. Calculate the beta for Stock A.
A. 1.75
b. 1.0
c. 0.57
Solution: Beta = Cov(R A , R M )/Var(R M ) = 21/12 = 1.75
20. The historical returns data for the past three years for Company A's stock is -6.0%, 15%,
15% and that of the market portfolio is 10%, 10% and 16%. If the risk-free rate of return is
4%, what is the cost of equity capital (required rate of return of company A's common stock)
using CAPM?
A. 18%
b. 14%
c. 12%
Solution: r M = (10 + 10 + 16 )/3 = 12%; r = 4 + 1.75 (12 - 4) = 18%
21. The historical data for the past three years for the market portfolio are 10%, 10% and 16%. If
the risk-free rate of return is 4%, what is the market risk premium?
a. 4%
B. 8%
c. 16%
22. The historical returns data for the past three years for Company A's stock is -6.0%, 15%,
15% and that of the market portfolio is 10%, 10% and 16%. According to the security market
line (SML), the Stock A is:
A. Over priced
b. Under priced
c. Correctly priced
d. Need more information
23. The historical returns data for the past three years for Stock B and the stock market portfolio
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the expected
return for Stock B and the market portfolio.
A. Stock B 16%, Market Portfolio: 14%
b. Stock B 14%, Market Portfolio: 16%
c. Stock B 24%, Market Portfolio: 12%
69
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the variance of
the market portfolio returns.
a. 192
b. 128
C. 28
Solution: Variance = [(10 - 14)^2 + (12 - 14)^2 + (20 - 14)^2]/2 = 28
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the covariance of
returns between Stock B and the market portfolio.
A. 24
b. 28
c. 292
Solution: Cov(R B , R M ) = [(24 - 16)(10 - 14) + (0 - 16)(12 - 14) + (24 - 16)(20 - 14)]/2 = 24
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the beta for
Stock B.
A. 0.86
b. 1.0
c. 0.125
Solution: Using answers for (24) and (25), beta = 24/28 = 0.86
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. If the risk-free rate is 4%,
calculate the market risk premium.
a. 18.1%
b. 14%
C. 10%
28. On a graph with common stock returns on the Y-axis and market returns on the X-axis, the
slope of the regression line represents the:
a. Alpha
B. Beta
c. R-squared
d. Adjusted beta
70
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the required rate
of return (cost of equity) for Stock B using CAPM. (The risk-free rate of return = 4%)
a. 8.6%
B. 12.6%
c. 14.3%
30. The historical returns data for the past four years for Stock C and the stock market portfolio
returns are: Stock C: 10%, 30%, 20%,20%; Market Portfolio: 5%, 15%, 25%, 15%. Calculate
the beta for the stock:
a. 0.86
B. 0.5
c. 1.5
Solution:
Cov(R C , R M ) = [(5 - 15)(10 - 20) + (15 - 15)(30 - 20) + (25 - 15)(20 - 20) + (15 - 15)(20 -
20)]/(4 - 1) = 33.3
Var(R M ) = [(5 - 15)^2 + (15 - 15)^2 + (25 - 15)^2 + (15 - 15)^2]/(4 - 1) = 66.6
Beta = 33.3/66.6 = 0.5
31. The historical returns data for the past four years for Stock C and the stock market portfolio
returns are: Stock C: 10%, 30%, 20%,20%; Market Portfolio: 5%, 15%, 25%, 15%. If the
risk-free rate of return is 5%, calculate the required rate of return on the Stock C using
CAPM.
a. 5%
B. 10%
c. 15%
Solution: Using CAPM and he beta from (30)
32. The beta of the computer company is 1.7 and the standard error of the estimate is 0.3. What
is the range of values for beta, that has 95% chance of being right?
A. 1.1 - 2.3
b. 1.4 - 2.0
c. 1.5 - 2.0
33. Generally, the value to use for the risk-free interest rate is:
A. Short-term Treasury bill rate
b. Long-term Corporate bond rate
c. Medium-term Corporate bond rate
71
34. A project has an expected risky cash flow of $200, in year 1. The risk-free rate is 6%, the
market rate of return is 16%, and the project's beta is 1.5. Calculate the certainty equivalent
cash flow for year 1.
A. $175.21
b. $164.29
c. $228.30
a. $622.04
b. $164.29
C. $401.90
a. $622.04
B. $360.33
c. $401.90
37. A project has an expected cash flow of $300 in year 3. The risk-free rate is 5%, the market
risk premium is 8% and the project's beta is 1.25. Calculate the certainty equivalent cash flow
for year 3.
A. $228.35
b. $197.25
c. $300
72

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Junjie Liu – Econ 282 Practice Multiple Choice

b. A safe dollar is worth less than a risky one

22. The opportunity cost of capital for a risky project is

33. The managers of a firm can maximize stockholder wealth by:

Discounted Cash Flow Valuation

2. Present Value is defined as:

3. If the interest rate is 12%, what is the 2- year discount factor?

11. A perpetuity is defined as:

17. An annuity is defined as

39. Which of the following statements is true?

44. Which of the following statements is true?

53. Which of the following statements is true?

54. The concept of compound interest is most appropriately described as:

59. An investment at 10% nominal rate compounded continuously is equal to an equivalent

4. If a bond is paying interest semi-annually, then:

19. The term structure of interest rates can be described as the:

5. The value of a common stock today depends on:

26. Generally high growth stocks pay:

27. A high proportion of the value a growth stock comes from:

Net Present Value and Other Investment Criteria

2. Suppose a firm has a $100 million in excess cash. It could:

6. Which of the following investment rules has value adding-up property?

11. The net present value of a project depends upon:

13. The payback period rule:

15. The main advantage of the payback rule is:

21. Internal rate of return (IRR) method is also called:

25. The IRR is defined as:

40. Profitability index is useful under:

43. Benefit-cost ratio is defined as the ratio of:

Making Investment Decisions

1. Preferably, cash flows for a project are estimated as:

5. Investment in net working capital is not depreciated because:

6. Net Working Capital should be considered in project cash flows because:

14. In the case of freely traded resources, opportunity cost is the:

21. Given the following data for Project M:

Real discount rate = 5%

22. Given the following data for Project M:

Real discount rate = 5%

If the cost of capital is 15%, which project would you accept?

Project Analysis and Evaluation

4. A project has the following cash flows: C 0 = -100,000; C 1 = 50,000; C 2 = 150,000; C 3 =

a. 50, -100, +400

7. A project requires an initial investment in equipment of $90,000 and then requires an

8. A project requires an initial investment in equipment of $90,000 and then requires an

9. A project requires an initial investment in equipment of $90,000 and then requires an

12. The following are drawbacks of sensitivity analysis except:

17. The accounting break-even point occurs when:

18. The NPV break-even point occurs when:

22. Hammer Company proposes to invest $6 million in a new type of hammer-making

23. Hammer Company proposes to invest $6 million in a new type of hammer-making

If the cost of capital is 15%, calculate the optimal year to harvest:

Introduction to Risk and Return

1. Which of the following portfolios have the least risk?

9. The type of the risk that can be eliminated by diversification is called:

10. The unique risk is also called the:

13. As the number of stocks in a portfolio is increased:

23. The "beta" is a measure of: