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

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?

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?

You are offered an investment opportunity in which you will receive $25,000 in one year in exchange for paying $23,750 today.Suppose the risk-free interest rate is 6% per year.Should you take this project? The NPV for this project is closest to:

Use the information for the question(s)below. An exchange traded fund (ETF)is a security that represents a portfolio of individual stocks.Consider an ETF for which each share represents a portfolio of two shares of International Business Machines (IBM),three shares of Merck (MRK),and three shares of Citigroup Inc.(C).Suppose the current market price of each individual stock are shown below: -The price per share of the ETF in a normal market is:

Use the information below to answer the following question(s): The owner of the Krusty Krab is considering selling his restaurant and retiring.An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement.The owner is considering the following three alternatives: 1.Sell the restaurant now and retire. 2.Hire someone to manage the restaurant for the next year and retire.This will require the owner to spend $50,000 now,but will generate $100,000 in profit next year.In one year the owner will sell the restaurant for $350,000. 3.Scale back the restaurant's hours and ease into retirement over the next year.This will require the owner to spend $40,000 on expenses now,but will generate $75,000 in profit at the end of the year.In one year the owner will sell the restaurant for $350,000. -If the discount rate is 15%,then the alternative which the owner should choose is:

Use the table for the question(s)below. -If the risk-free rate of interest is 7.5%,then the value of security "B" is closest to:

You have an investment opportunity in Germany that requires an investment of $250,100 today and will produce a cash flow of €208,650 in one year with no risk.Suppose the risk-free rate of interest in Germany is 7% and the current competitive exchange rate is €0.78 to $1.00.What is the NPV of this project? Would you take the project?

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%. -What is the NPV of this project if the film maker invests his own money and does not issue the new security? What is the NPV if the film maker issues the new security?

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?

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?

Suppose you will receive $500 in one year and the risk-free interest rate (rf)is 5%.The equivalent value today is closest to:

Use the table for the question(s)below. Consider the following prices from a McDonald's Restaurant: -A McDonald's Big Mac Extra 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?

Which of the following statements regarding value additivity is FALSE?

Use the information for the question(s)below. An exchange traded fund (ETF)is a security that represents a portfolio of individual stocks.Consider an ETF for which each share represents a portfolio of two shares of International Business Machines (IBM),three shares of Merck (MRK),and three shares of Citigroup Inc.(C).Suppose the current market price of each individual stock are shown below: -An American Depository Receipt (ADR)is a security issued by a U.S.bank and traded on a U.S.stock exchange that represents a specific number of shares of a foreign stock.Siemens AG has an ADR that trades on the NYSE and is equivalent to one share of Siemens AG trading on the Frankfurt Stock Exchange in Germany.If semens trades for $95.19 on the NYSE and for €64.10 on the Frankfurt Stock Exchange,then under the law of one price,the current exchange rate is closest to:

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

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?

Use the table for the question(s)below. -Suppose a risky security pays an average cash flow of $100 in one year.The risk-free rate is 5%,and the expected return on the market index is 13%.If the returns on this security are high when the economy is strong and low when the economy is weak,but the returns vary by only half as much as the market index,then the price for this risky security is closest to:

Rearden Metal needs to order a new blast furnace that will be delivered in one year.The $1,000,000 price for the blast furnace is due in one year when the new furnace is installed.The blast furnace manufacturer offers Rearden Metal a discount of $50,000 if they pay for the furnace now.If the interest rate is 7%,then the NPV of paying for the furnace now is closest to:

Which of the following statements regarding the valuing of costs and benefits is NOT correct?

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?