Question 1

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 2

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 3

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 4

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 5

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...

Question 6

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

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 7

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 which project would be the worst investment, we need to look at the net present value (NPV) of each project using the given risk-free interest rate of 10%. However, we do not have any information on the cash flows or costs associated with each project, so we cannot calculate the NPV. Therefore, we must make assumptions based on the project names. "Moe" is often used to mean something negative or undesirable, so we will assume that this project has a negative NPV and would be the worst investment choice.

Question 8

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

To select the best project, we need to calculate the present value of each project's cash flows using the formula: 
PV = CF / (1 + r)^n 
where PV is the present value, CF is the cash flow, r is the discount rate (risk-free rate), and n is the number of periods.

For each project, we have:

- Eenie: PV = 1000 / (1 + 0.1)^1 = 909.09 
- Meenie: PV = 500 / (1 + 0.1)^2 = 413.22 
- Mighty: PV = 2000 / (1 + 0.1)^3 = 1503.76 
- Moe: PV = 1500 / (1 + 0.1)^4 = 961.54

Thus, the highest present value, and therefore the best choice, is project Eenie with a present value of $909.09.

Question 9

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 10

Which of the following statements regarding value additivity is FALSE?

Accepted Answer

This statement is false because value additivity does have important consequences for the value of the entire firm, not just for 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 true statements regarding value additivity.

Question 11

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

To calculate the NPV, we need to discount the cash flows back to present value using the risk-free rate of interest.

Initial cost = $20 million
Cash inflow from selling the movie to the studio = $25 million (in one year)
Cash inflow from issuing the security = $11 million (in one year)

PV of cash inflow from selling the movie = $25 million / (1 + 10%) = $22.73 million
PV of cash inflow from issuing the security = $11 million / (1 + 10%) = $10 million

NPV = ($22.73 million + $10 million) - $20 million = $12.73 million

Since the NPV is positive, the film maker should make the investment. Choice C is the only answer option that indicates that the film maker should make the investment and has the closest NPV value.

Question 12

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 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 the total price of A and B is cheaper than the price of C, then there would be an arbitrage opportunity where an investor can buy A and B and sell C for a profit, since they have the same cash flows. Therefore, the prices of A and B would increase and the price of C would decrease, eliminating any price discrepancy.

Question 14

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 15

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...

Question 16

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

Accepted Answer

Arbitrage refers to the practice of buying and selling equivalent goods in different markets to take advantage of a price difference. Choices A and B are incorrect because while an arbitrage opportunity may lead to a profit without taking a risk or making an investment, not all situations where such profits are possible qualify as arbitrage. Choice C is incorrect because an arbitrage market refers to a market where there are no arbitrage opportunities, rather than the other way around.

Question 17

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

Accepted Answer

The statement in option D is incorrect. The Law of One Price assumes that arbitrage will occur if prices are different in different markets, and thus it only holds in markets where arbitrage is possible.

Question 18

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 19

Which of the following statements is FALSE?

Accepted Answer

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

Question 20

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.
...

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

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

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?

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?

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?

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?

Which of the following statements regarding value additivity is FALSE?

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

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?

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

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

Which of the following statements is FALSE?

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?