Question 1

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.
...

Question 2

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 3

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 4

Use the table for the question(s) below.
 
-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 the absence of arbitrage opportunities in order to hold. If arbitrage is possible, it means that traders can buy in one market and sell in another market to make a profit, which will drive prices back to equilibrium. Therefore, if arbitrage is possible, we cannot expect that the price of equivalent goods will be the same in different markets.

Question 5

Use the table for the question(s) below.
 
-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 6

Use the table for the question(s) below.
 
-If the risk-free interest rate is 10%,then of the four projects listed,if you could only invest in one project,which on e 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 7

Which of the following statements regarding value additivity is FALSE?

Accepted Answer

This statement is false because value additivity is an important concept for both portfolios and the value of the entire firm. The value of the entire firm is equal to the sum of the values of all projects and investments within the firm, and managers should make decisions that maximize the NPV of all projects and investments to maximize the value of the entire firm.

Question 8

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 selling short a replicating portfolio of the bond's cash flows.

Question 9

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 10

Use the table for the question(s) below.
 
-Which of the following statements regarding arbitrage is the most correct?

Accepted Answer

The definition of arbitrage is the practice of buying and selling equivalent goods in different markets to take advantage of a price difference. Option A is incorrect because there may be a risk involved, for example, if the price changes before the transaction is complete. Option B is incorrect because most arbitrage opportunities require an investment of some sort. Option C is incorrect because the term "arbitrage market" is not commonly used in finance.

Question 11

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 12

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 that if the total price of A and B is cheaper than the price of C, then we could make a profit selling A and B and buying C is incorrect. If securities A and B have the same cash flows as C, then they should be priced the same as C. Therefore, if A and B are cheaper than C, it would create an opportunity for arbitrage and market forces would cause the prices to adjust accordingly.

Question 13

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%.
-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 14

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 15

Which of the following statements is FALSE?

Accepted Answer

The answer of Which of the following statements is FALSE?
...

Question 16

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.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 17

Use the table for the question(s) below.
 
-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 18

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 insure 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 19

Use the table for the question(s) below.
 
-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 20

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...

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

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?

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?

Use the table for the question(s) below. -Which of the following statements regarding the Law of One Price is INCORRECT?

Use the table for the question(s) below. -If the risk-free interest rate is 10%,then the NPV for Moe is closest to:

Use the table for the question(s) below. -If the risk-free interest rate is 10%,then of the four projects listed,if you could only invest in one project,which on e would you select?

Which of the following statements regarding value additivity is FALSE?

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

Use the table for the question(s) below. -Which of the following statements regarding arbitrage is the most correct?

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?

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?

Which of the following statements is FALSE?

Use the table for the question(s) below. -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?

Use the table for the question(s) below. -If the risk-free interest rate is 10%,then of the four projects listed,which project would you never want to invest in?