Question 1

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 2

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 one would you select?

Accepted Answer

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

Question 3

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

Accepted Answer

Arbitrage involves buying and selling equivalent goods in different markets to take advantage of a price difference. It may involve some risks and requires an investment, so options A and B are incorrect. Option C is also incorrect as an arbitrage market refers to a market in which there are no profitable arbitrage opportunities, not just a competitive market.

Question 4

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

Accepted Answer

This statement is incorrect. The Law of One Price only holds in markets where arbitrage is possible. If arbitrage is not possible, then equivalent goods or securities may trade at different prices in different markets.

Question 5

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 6

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 7

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 8

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

To ensure the absence of an arbitrage opportunity, the price of the Big Mac value meal should be equal to the sum of the prices of the individual items. Adding the prices of a Big Mac sandwich, large coke, and large fry from the table, we get $5.47. Therefore, the Big Mac value meal should sell for $5.47 to uphold the law of one price.

Question 9

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 10

Which of the following statements regarding value additivity is FALSE?

Accepted Answer

This statement is false as value additivity has important consequences for the value of the entire firm as well as portfolios of firms. The value of the entire firm is indeed equal to the sum of the values of all projects and investments within the firm, and managers should make decisions that maximize NPV to maximize the value of the entire firm. Therefore, options A, B, and C are all true statements regarding value additivity.

Question 11

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 12

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

To determine the project that you would never want to invest in, you need to calculate the net present value (NPV) of each project using the given risk-free interest rate of 10%. The project with a negative NPV should always be rejected as it would result in a loss. Among the four projects, only Project D has a negative NPV at a 10% discount rate, indicating that it would result in a loss if invested in. Therefore, the correct answer is D.

Question 13

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

This statement is incorrect because if A and B have the same cash flows as C combined, then the prices should be equal. Therefore, it would not be possible to make a profit by selling A and B and buying C. This violates the law of one price.

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

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

The answer of Suppose that Bondi Inc.is a holding company...

Question 16

Which of the following statements is FALSE?

Accepted Answer

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

Question 17

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 18

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

To calculate the NPV, we need to find the present value of the cash flows from the movie:
PV(Cost of making the movie) = -$20 million
PV(Sale price of the movie) = $25 million / (1+10%) = $22.73 million
PV(Payment to investors) = -$11 million / (1+10%) = -$10 million

NPV = PV(Sale price of the movie) - PV(Cost of making the movie) - PV(Payment to investors)
= $22.73 million - $20 million - $10 million = $2.73 million

Therefore, the NPV for this project is $2.73 million, which is closest to option C, and the filmmaker should make the investment as the NPV is positive.

Question 19

Without issuing the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?

Accepted Answer

Without issuing the new security, the film maker's cash flow would be:

Year 0: -$20 million
Year 1: $25 million

Using a discount rate of 10%, the NPV of this cash flow would be:

NPV = (-$20 million) + ($25 million / 1.1) = $2.73 million

Therefore, the NPV without issuing the new security is closest to $2.7 million. Since the NPV is positive, the film maker should make the investment.

If the film maker decides to issue the new security, the cash flow would be:

Year 0: -$20 million + $11 million = -$9 million
Year 1: $25 million

Using a discount rate of 10%, the NPV of this cash flow would be:

NPV = (-$9 million) + ($25 million / 1.1) = $4.54 million

Therefore, the NPV with the new security is higher than without issuing the security. Thus, the film maker should issue the new security to raise additional funds.

Question 20

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.

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

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 one would you select?

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

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 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. -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?