Question 1

If the risk-free interest rate is 10%,then of the four projects listed,if you could only invest in one project,which one would you select?

Accepted Answer

A)Eenie has highest NPV
NPV Eenie = -10 + 15/1.1 = 3.64
NPV Meenie = 10 - 8/1.1 = 2.73
NPV Mighty = -15 + 20/1.1 = 3.18
NPV Moe = 10 - 15/1.1 = -3.64

Question 2

A McDonald's Big Mac value meal consists of a Big Mac Sandwich,Large Coke,and a Large Fry.Assume that there is a competitive market for McDonald's food items and that McDonald's sells the Big Mac value meal for $4.79.Does an arbitrage opportunity exists and if so how would you exploit it and how much would you make on one extra value meal?

Accepted Answer

A)Buy value meal and sell Big Mac,Coke and Fries
-4.79 + 2.99 + 1.39 + 1.09 = 0.68 (so arbitrage exists)

Question 3

Consider two securities,A & B.Suppose a third security,C,has the same cash flows as A and B combined.Given this information about securities A,B,& C,which of the following statements is INCORRECT?

Accepted Answer

The statement in option A is incorrect because if the total price of A and B is cheaper than the price of C, then buying A and B and selling C would yield a profit, not the other way around.

Question 4

Which of the following statements regarding arbitrage is the most correct?

Accepted Answer

Arbitrage refers to the practice of taking advantage of price discrepancies in different markets by buying and selling equivalent goods. Therefore, option D correctly defines this term. Option A is incorrect because arbitrage involves taking advantage of price differentials, which involves some level of risk. Option B is also incorrect because making a profit through arbitrage usually requires some investment. Option C is incorrect because an arbitrage market is one in which there are no profit opportunities resulting from price disparities, not the other way around.

Question 5

Walgreen Company (NYSE: WAG)is currently trading at $48.75 on the NYSE.Walgreen Company is also listed on NASDAQ and assume it is currently trading on NASDAQ at $48.50.Does an arbitrage opportunity exists and if so how would you exploit it and how much would you make on a block trade of 100 shares?

Accepted Answer

B)Yes,buy 100 shares × 48.50 and sell 100 shares × 48.75 = $25.00

Question 6

Which of the following statements regarding the Law of One Price is INCORRECT?

Accepted Answer

This statement is actually incorrect. The Law of One Price requires that there is the possibility of arbitrage between markets to ensure that prices remain equivalent. If there is no possibility of arbitrage, then prices can differ between markets, violating the Law of One Price.

Question 7

Use the table for the question(s)below.
Consider the following prices from a McDonald's Restaurant: 
-A McDonald's Big Mac value meal consists of a Big Mac Sandwich,Large Coke,and a Large Fry.Assuming that there is a competitive market for McDonald's food items,at what price must a Big Mac value meal sell to ensure the absence of an arbitrage opportunity and uphold the law of one price?

Accepted Answer

C)2.99 + 1.39 + 1.09 = 5.47

Question 8

Assuming that the film maker issues the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?

Accepted Answer

C)NPV = -10 + (25 - 11)/1.10 = 2.7 million,since NPV > 0 then invest

Question 9

If the risk-free interest rate is 10%,then of the four projects listed,if could only invest in two of these projects,which two projects would you select?

Accepted Answer

A)Eenie & Mighty have the highest NPVs
NPV Eenie = -10 + 15/1.1 = 3.64
NPV Meenie = 10 - 8/1.1 = 2.73
NPV Mighty = -15 + 20/1.1 = 3.18
NPV Moe = 10 - 15/1.1 = -3.64

Question 10

You have an investment opportunity in the United Kingdom that requires an investment of $500,000 today and will produce a cash flow of £320,000 in one year with no risk.Suppose the risk-free rate of interest in the U.K is 6% and the current competitive exchange rate is $1.70/£.What is the NPV of this project? Would you take the project?

Accepted Answer

The answer of You have an investment opportunity in the...

Question 11

Which of the following statements is FALSE?

Accepted Answer

The statement C is false because in financial theory, it is possible to separate a firm's investment decision (which projects to invest in, based on their expected returns and risks) from the financing decision (how to raise the capital to fund those projects, e.g., through debt or equity). This principle is known as the separation theorem or the Modigliani-Miller theorem, under certain conditions.

Question 12

If the risk-free interest rate is 10%,then of the four projects listed,which project would you never want to invest in?

Accepted Answer

D)Moe has negative NPV
NPV Eenie = -10 + 15/1.1 = 3.64
NPV Meenie = 10 - 8/1.1 = 2.73
NPV Mighty = -15 + 20/1.1 = 3.18
NPV Moe = 10 - 15/1.1 = -3.64

Question 13

Use the table for the question(s)below. 
-Assume that the risk-free interest rate is 10%.Rank each of the four projects from most desirable to least desirable based upon NPV.Which project would you invest in first? Are there any projects that you wouldn't invest in?

Accepted Answer

The answer of Use the table for the question(s)below. 
-Assume...

Question 14

Advanced Micro Devices (NYSE: AMD)is currently trading at $20.75 on the NYSE.Advanced Micro Devices is also listed on NASDAQ and assume it is currently trading on NASDAQ at $20.50.Does an arbitrage opportunity exists and if so how would you exploit it and how much would you make on a block trade of 1000 shares?

Accepted Answer

The answer of Advanced Micro Devices (NYSE: AMD)is currently trading...

Question 15

Use the information for the question(s)below.
An independent film maker is considering producing a new movie.The initial cost for making this movie will be $20 million today.Once the movie is completed,in one year,the movie will be sold to a major studio for $25 million.Rather than paying for the $20 million investment entirely using its own cash,the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year.Suppose the risk-free rate of interest is 10%.
-Without issuing the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?

Accepted Answer

C)NPV = -20 + 25/1.10 = $2.7 million,since NPV > 0 take the investment

Question 16

Which of the following statements regarding arbitrage and security prices is INCORRECT?

Accepted Answer

When a bond is underpriced, the arbitrage strategy involves buying the bond and hoping to sell it later at a higher price. The statement in choice C is incorrect because it suggests selling the bond instead of buying it.

Question 17

You are up late watching TV one night and see an ad from Ronco for the Dial-o-matic food slicer.You learn that the Dial-o-matic sells for $29.95.But wait,there is more.Ronco is also including in this deal a set of Ginsu steak knives worth $10.95 and another free gift worth $7.95.Assuming that there is a competitive market for Ronco items,at what price must Ronco be selling this three item Dial-o-matic deal to insure the absence of an arbitrage opportunity and uphold the law of one price?

Accepted Answer

The answer of You are up late watching TV one...

Question 18

If the risk-free interest rate is 10%,then the NPV for Moe is closest to:

Accepted Answer

A)NPV = 10 - 15/1.1 = -3.64

Question 19

Suppose that Bondi Inc.is a holding company that owns both Pizza Hut and Kentucky Fried Chicken Franchised Restaurants.If the value of Bondi is $130 million,and the Pizza Hut Franchises are worth $70 million,then what is the value of the Kentucky Fried Chicken Franchises?

Accepted Answer

A)value KFC = value of Bondi - value of Pizza Hut = 130 - 70 = $60 million

Question 20

Which of the following statements regarding value additivity is FALSE?

Accepted Answer

This statement is false because value additivity has important consequences for the value of the entire firm, not just on portfolios of firms. Value additivity means that the value of a whole is equal to the sum of the values of its parts, so decisions that increase the NPV of individual projects or investments will increase the overall value of the firm. Therefore, managers should make decisions that maximize NPV to maximize the value of the entire firm.

Quiz 3: Financial Decision Making and the Law of One Price