Two mutually exclusive projects each have a cost of $10,000

Two mutually exclusive projects each have a cost of $10,000

Subject: Business    / Finance   
Question

Use the following information for the next three questions (1 to 3).

Two mutually exclusive projects each have a cost of $10,000. The total undiscounted cash inflows from Project L are $15,000, while the undiscounted cash inflows from Project S total $13,000. The IRR for Project L is 10%, while the IRR for Project S is 5%. Their NPV profiles cross at a discount rate of 15%.

1. If the required rate of return is 20%, which project should be chosen, according to the IRR decision rule?
A. Project L only
B. Project S only

C. Both L and S

D. Either L or S

E. Neither L nor S

2. If the required rate of return is 7%, which project should be chosen, according to the NPV decision rule?

A. Project L only

B. Project S only

C. Both L and S

D. Either L or S

E. Neither L nor S

3. Which of the following statement(s) best describe(s) this situation?

I. Project S should be selected at any required rate of return.
II. Project L should be selected at any required rate of return.
III. ThereisnorankingconflictbetweentheNPVandtheIRRmethodatanyrequired rate of return.
IV. There is a ranking conflict between the NPV and the IRR method for a required rate of return being less than 15%.

A. I and III only

B. II and III only

C. II and IV only

D. III only

E. I and IV only
Microsoft Word – Final (2015).doc

4. Assume you are looking at a graph depicting the security market line. If the market risk premium increases, then the:
A. market rate of return will plot at a lower point on the vertical axis.
B. intercept point of the security market line will rise up the vertical axis.

C. point depicting the market rate of return will shift to the right parallel to the horizontal axis.

D. slope of the security market line will rise while the intercept point remains constant. E. slope of the security market line will rise as the intercept point rises up the vertical

axis.

5. According to the capital asset pricing model:
A. there is an inverse relationship between risk and return.
B. a stock which earns a higher rate of return than the market should have a beta which is

greater than 1.0.
C. an increase in the risk-free rate without a corresponding increase in the market rate of

return indicates that the risk premium for a stock with a beta of .8 will increase.
D. a stock with a beta of 1 will see its expected rate of return increase by 20% if its beta

rises to 1.2, all else constant.
E. a stock with a beta of 2.0 will see its return decline by 2 percent should the risk-free

rate decline from 3 percent to 2 percent, all else constant.
Microsoft Word – Final (2015).doc

6. Andrew believes that he currently owns a portfolio which is adequately diversified. If he is correct, then the addition of a _____ asset to the portfolio will have minimal, if any, effect on the portfolio’s _____.

A. risk-free; beta
B. risk-free; rate of return C. risky; rate of return
D. risky; beta
E. risky; standard deviation

7. Which one of the following statements is correct?

A. A beta of 1.2 indicates that a security has less risk than the overall market.
B. A stock with a beta of 1.4 has less systematic risk than a stock with a beta of 0.9. C. The risk premium associated with a stock will decrease as the beta of the stock

increases.
D. The beta of a diversified portfolio will approach zero as the number of stocks in the

portfolio is increased.

E. None of the above