AGSM MBA (Executive) Program Strategic Management Year

CORPORATE FINANCE Self-assessment Test

July 2008

Instructions:
The following 25 self-assessment questions are related to the key concepts and methodologies on VALUATION, which you have studied in AGSM GDM Corporate Finance subject. These questions will help you review these concepts and methodologies, which will be used in SM1 valuation module. If you achieve a score of less than 60%, you are recommended to review relevant materials (CF units 4, 11 and basic concepts of unit 8) before the SM1 valuation module.

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Self-assessment Questions
1. From the Corporate Finances perspective, the main objective of a firm is a. To maximize profits. b. To maximize market share. c. To maximize shareholders wealth. d. To maximize the income of the chief executive officer.

2. A dollar today is worth more than a dollar tomorrow because a. the dollar today can be invested and will start earning interest immediately b. the dollar today can be spent immediately c. the dollar today is worth more than a dollar yesterday d. the dollar today is cash-in-the-hand

3. If you invest $20,000 now in a term deposit for 3 years at an interest rate of 8% per annum, how much would you have at the end of year 3, assuming interests are given to you rather than being reinvested each year at the same 8%? a. $24,800 b. $25,194 c. $60,000 d. Cannot be determined without additional information

4. If you invest $20,000 now in a term deposit for 3 years at an interest rate of 8% per annum, how much would you have at the end of year 3, assuming interests are also reinvested each year at the same 8%? a. $24,800 b. $25,194 c. $60,000 d. Cannot be determined without additional information

5. Consider the following two questions: What is the present value of $100 to be received in 10 years time if the discount rate is 17 per cent? and How much would I have to invest now in order to receive $100 after 10 years, given an interest rate of 17 per cent? The answers to these two questions are: a. the same. b. different. c. not susceptible to sensible comment. d. the same if different discount rates are used.

6. You just leased a new set of windsurfing equipment. The deal requires you to make 36 end-of-month payments of $600, starting one month from today. In addition, you have to include another $1,000 with your final payment. The contract has an annual rate of 12 percent with monthly compounding. What is the present value of these lease payments? a. $15,796 b. $18,065 c. $18,764 d. None of the above is correct

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7. You are interested in purchasing PHB shares. Suppose that PHB will pay a cash dividend of $1.50 per share in one years time and analyst consensus indicates that PHB will be worth $60 per share a year later. If you require a rate of return of 15% on any share investments, how much would you be willing to pay now for one PHB share? a. $10.00 b. $52.17 c. $53.48 d. $61.50

8. Other things being held constant, what happens to a projects net present value if the discount rate increases? a. It rises. b. It falls. c. It must both rise and fall. d. It cannot change.

9. The risk free interest rate is currently 7.25% per annum. Suppose an asset currently costs $10,000 and will generate a risky cash flow estimated to be $11,215 in one years time. You should: a. Reject this project because it is risky. b. Accept this project because it has a positive net present value. c. Accept this project because the 12.15% return exceeds the 7.25% discount rate. d. Cannot decide without knowing the expected rate of return on equally risky investments.

The following scenario is related to questions 10-13 Your company is evaluating three different investments, each of which will generate cash flows at the ends of year 1, year 2 and year 3. Assume the appropriate discount rate for all investment projects is 13% per year. Investment A B C Cost of investment paid now -$9,000 -$1,200 -$8,600 Cash flows at end of each year: Year 1 Year 2 Year 3 +$2,000 +$5,000 +$6,500 +$ 800 +$ 500 +$ 400 +$3,000 +$7,000 +$5,000

10. If the initial cash flow of a project is negative and subsequent cash flows are positive, one should accept project whose: a. Internal Rate of Return (IRR) is higher than the cost of capital (i.e. the discount rate). b. IRR is lower than the discount rate. c. IRR is positive. d. Cannot decide without knowing whether the project is profitable

11. What is the net present value (NPV) of project A? a. $4,500 b. $2,515 c. $1,190 d. Cannot be determined without additional information

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12. What is the payback period of project B? a. 1 year b. 2 years c. 3 years d. Cannot be determined without additional information

13. What is the net future value, at the end of year 3, of project C? a. $4,332 b. $6,400 c. $16,741 d. Cannot be determined without additional information

The following scenario is related to questions 14-19 Holden International Power Corporation (HIPC) is exploring the value of nuclear powered electricity generation. HIPC has discovered that a new nuclear generator costs $50 million today to construct. Existing tax rules allow for the entire construction costs to be depreciated on a straight-line basis over 5 years, after which no depreciation expense is available. The nuclear plant would generate electricity for 10 years and be worthless at the end of that time. Revenues from electricity generated by the plant are expected to be $15 million per year constant, and begin at the end of this year. Nuclear fuel rods are required to fuel the power generation and must be replaced every year at a cost of $2 million, starting from the end of this year. Other operating costs are 5% of revenues. Assume all expenses are to be paid the end of each year, the HIPCs marginal corporate tax rate is 40%, and an appropriate discount rate is 10%.

14. What is HIPCs annual depreciation in years 1-5? a. $10 million b. $15 million c. $50 million d. Cannot be determined without additional information

15. What is HIPCs annual earnings before interests and taxes (EBIT) in years 1-5? a. $13 million b. $11.25 million c. $2.25 million d. Cannot be determined without additional information

16. What is HIPCs annual net income in years 1-5? a. $11.25 million b. $2.25 million c. $1.35 million d. Cannot be determined without additional information

17. What is HIPCs annual net cash flow in years 1-5? a. $11.35 million b. $7.35 million

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c. $2.25 million d. Cannot be determined without additional information

18. What is HIPCs annual net cash flow in years 6-10? a. $11.35 million b. $7.35 million c. $2.25 million d. Cannot be determined without additional information

19. What is the net present value (NPV) of this investment project? a. $60.33 million b. $38.50 million c. $10.33 million d. -$4.84 million

20. Which of the following is/are true? The cost of capital ______________ I . is an opportunity cost that depends on the use of funds, not the source; II . is the same thing as the required rate of return; III. is the same as the WACC for project with equal risk to the firm as a whole. IV. is also known as the appropriate discount rate. a. b. c. d. II, III and IV II, III and IV only II and IV only I, II, III, and IV

21. Financial leverage impacts the cost of equity of a firm by: a. increasing the volatility of the firm's earnings before interest and tax (EBIT) b. increasing the financial risk equity holders face c. increasing the volatility of the firm's net income d. both (b) and (c) are correct

22. Financial leverage impacts the cost of capital of a firm by: a. Cost of debt is typically lower than cost of equity b. Financial leverage benefits the firm because interest payments are tax deductible c. Costs of financial distress increases in financial leverage d. All of the above statements are correct.

23. A local retail store allows the shoppers to return the merchandise they purchased and get their money back any time up to 30 days after the purchase date. The store has, in effect, provided each shopper with ____________ options a. European call b. European put c. American call d. American put

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24. Value of a European call option will increase if: a. The price of the underlying asset increases. b. If exercise price (i.e. strike price) decreases. c. If the volatility of the returns of the underlying asset increases. d. All of the above statements are correct.

25. Value of a European put option will increase if: a. The price of the underlying asset increases. b. Exercise price (i.e. strike price) decreases. c. The volatility of the returns of the underlying asset increases. d. All of the above statements are correct.

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