Problem 1: Which of the following is correct?
a. NPV will be higher if sunk costs are included in a project's cash flows
b. A good example of a sunk cost is a situation where a company builds a restaurant and that results in lower sales by another of its restaurants.
c. A good example of a sunk cost is a situation where a company builds a restaurant and closes another of its restaurants.
d. A good example of a sunk cost is a situation where a company evaluated a site for a new restaurant last year, expensed the cost on its income statement, and now builds the restaurant
e. None of the above
Problem 2: TUNDRA Corporation's stock sells for $50 per share. A call option on the stock has a strike price of $55. A put option on the stock also has a strike price of $55. Which of the following is correct?
a. The call option is in-the-money
b. The put option is in-the-money
c. Both the call option and the put option are out-of-the money
d. The call option has a value of $5
e. None of the above
Problem 3: A firm plans to purchase equipment for $1.5 million. It will cost 200,000 to modify it for use in the firm's facility. The equipment is in the 3-year MACRS class. Calculate depreciation expense for Year 3.
a. $222,150
b. $251,770
c. $566,667
d. $500,000
e. None of the above
Problem 4: A proposed project is much riskier than average. The best way to account for its added risk is:
a. Ignoring it because project risk cannot be measured accurately.
b. Decreasing the discount rate to account for the higher risk
c. Increasing the discount rate to account for the higher risk
d. Reducing the NPV by 5% to account for the higher risk
e. None of the above
Problem 5: A company needs to decide whether to invest in a project now or wait a year until better information is available. The project has a positive expected NPV, but it could be negative if cash flows are less than expected. No competitors are likely to invest in a similar project if the company decides to wait. Which of the following best describes the issues the company is facing in making its decision?
The more uncertainty about the future cash flows, the more reason to go ahead with the project today.
a. NPV should be even higher by waiting a year, since it is positive today.
b. The project should be adopted now to lock in the expected positive NPV.
c. Waiting would probably reduce the project's risk
d. None of the above
Problem 6: A stock is currently selling for $25. A 6-month call option on the stock has a strike price of $30 and sells for $0.50. Calculate the exercise value of the option?
a. $0.00
b. $4.50
c. $5.00
d. $24.50
e. None of the above
Problem 7: Which of the following is not a real option?
a. The option to switch the type of vehicle manufactured in a plant
b. The option to expand into a foreign country
c. The option to buy shares of stock if its price goes up.
d. The option to abandon a project.
e. None of the above
Problem 8: The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?
a. $2.99
b. $2.70
c. $2.43
d. $3.29
e. $3.62
Problem 9: A company purchases equipment for $5 million, incurs shipping costs of $30,000 and installation costs of $50,000. It also requires additional net working capital of $100,000. What is the depreciable base?
a. $5,000,000
b. $5,180,000
c. $5,080,000
d. $5,030,000
e. None of the above
Problem 10: Which of the following is an example of a real option?
a. An option to buy stock at a specified price for a specified period of time
b. An option to sell stock at a specified price for a specified period of time
c. An option to invest in a project today or to wait a year.
d. An option to buy either an American or European option
e. None of the above