,1. A company is considering a new investment project, which requires an
initial outlay of $500,000 and is expected to generate cash flows of
$150,000 annually for 5 years. The company's cost of capital is 10%.
What is the Net Present Value (NPV) of the project?
- A) $250,000
- B) $75,000
- C) -$25,000
- D) $0
Answer: C) -$25,000
Rationale: NPV is calculated as the sum of the present values of
incoming cash flows minus the initial investment. Using the formula NPV
= ∑ (Cash flow / (1 + r)^t) - initial investment, where r is the discount rate
and t is the time period, the NPV of this project is -$25,000, indicating it
may not be a profitable investment.
2. If a firm has a Beta of 1.2, the risk-free rate is 3%, and the expected
market return is 8%, what is the expected return of the firm's stock
according to the Capital Asset Pricing Model (CAPM)?
- A) 9%
- B) 9.6%
- C) 10%
- D) 6%
Answer: B) 9.6%
, Rationale: The CAPM formula is E(R) = Rf + β(Rm - Rf), where E(R) is the
expected return, Rf is the risk-free rate, β is the beta, and Rm is the
expected market return. Plugging in the values, we get an expected
return of 9.6%.
3. What is the effect of an increase in the dividend payout ratio on a
company's Weighted Average Cost of Capital (WACC)?
- A) Increase
- B) Decrease
- C) No change
- D) It depends on the market perception
Answer: D) It depends on the market perception
Rationale: WACC is influenced by the cost of equity and the cost of
debt. An increase in dividend payout could signal strong financial health,
potentially lowering the cost of equity. However, it could also indicate
less reinvestment in the company, which might raise the cost of equity.
Market perception plays a crucial role in determining the effect.
4. A firm is evaluating a project with an IRR of 15%. If the firm's hurdle
rate is 12%, should the project be accepted?
- A) Yes, because the IRR is higher than the hurdle rate.
- B) No, because the IRR is lower than the hurdle rate.
- C) Yes, but only if the NPV is also positive.
- D) The decision should be based on other criteria.
Answer: A) Yes, because the IRR is higher than the hurdle rate.
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