clearlycanadian

The financial manager at IBFM, a farm implement distributor, is contemplating the following three mutually exclusive projects. IBFM’s required rate of return is 9.5%. Based on the information provided, which should the financial manager select and why?

Project	Investment at t = 0	Cash Flow at t = 1	IRR	NPV @ 9.5%
A	$10,000	$11,300	13.00	$320
B	$25,000	$29,000	16.00	$1,484
C	$35,000	$40,250	15.00	$1,758

A) Project C with the highest net present value.

B) Project A with the lowest initial investment.

C) All of the projects, because they all earn more than 9.5%.

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When projects are mutually exclusive, only one can be chosen. Project selection should be done on the basis of which project will enhance firm value the most. That project, Project C in this case, is the one with the highest NPV.

clearlycanadian

Financial managers should always select the project that provides the highest net present value (NPV) whenever NPV and IRR methods conflict, because maximizing:

A) the shareholders' rate of return is the goal of financial management.

B) shareholder wealth is the goal of financial management.

C) revenues is the goal of financial management.

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Focusing on the maximization of earnings does not consider the differences in risk across projects, while focusing on revenues precludes concern for the expenses incurred. Earning a higher return on a small project provides less of a benefit than earning a slightly lower rate of return on a much larger project.

clearlycanadian

The financial manager at Johnson & Smith estimates that its required rate of return is 11%. Which of the following independent projects should Johnson & Smith accept?

A) Project A requires an up-front expenditure of $1,000,000 and generates an NPV of -$4,600.

B) Project C requires an up-front expenditure of $600,000 and generates a positive internal rate of return of 12.0%.

C) Project B requires an up-front expenditure of $800,000 and generates a positive IRR of 10.5%.

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When projects are independent, you can use either the NPV method or IRR method to make the accept or reject decision. Only Project C has an IRR in excess of 11%. Acceptance of Project A reduces the firm’s value by $4,600.

clearlycanadian

An investor expects a stock currently selling for $20 per share to increase to $25 by year-end. The dividend last year was $1 but he expects this year's dividend to be $1.25. What is the expected holding period return on this stock?

A) 24.00%.

B) 28.50%.

C) 31.25%.

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Return = [dividend + (end − begin)] / beginning price
R = [1.25 + (25 − 20)] / 20 = 6.25 / 20 = 0.3125

clearlycanadian

An investor is considering investing in Tawari Company for one year. He expects to receive $2 in dividends over the year and feels he can sell the stock for $30 at the end of the year. To realize a return on the investment over the year of 14%, the price the investor would pay for the stock today is closest to:

A) $28.

B) $29.

C) $32.

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HPR = [Dividend + (Ending price − Beginning price)] / Beginning price 0.14 = [2 + (30 − P)] / P
1.14P = 32 so P = $28.07

clearlycanadian

Banca Hakala purchases two front row concert tickets over the Internet for $90 per seat. One month later, the rock group announces that it is dissolving due to personality conflicts and the concert that Hakala has tickets for will be the “farewell” concert. Hakala sees a chance to raise some quick cash, so she puts the tickets up for sale on the same internet site. The auction closes at $250 per ticket. After paying a 10% commission to the site on the amount of the sale and paying $10 in shipping costs, Hakala’s one-month holding period return is approximately:

A) 44%.

B) 144%.

C) 139%.

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The holding period return is calculated as: (ending price – beginning price +/- any cash flows) / beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the commission of 0.10 × $250 × 2 tickets = $50 and the shipping cost of $10 (total for both tickets).
Thus, her one-month holding period return is: [(2 × $250) – (2 × $90) – $50 − $10] / (2 × $90) = 1.44, or approximately 144%.

clearlycanadian

An investor buys a 10 3/8 treasury note for 103 11/32 and sells it one year later for 101 13/32. What is the holding period yield?

A) 8.14%.

B) 8.16%.

C) 8.22%.

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103 11/32 = 103.344% or $1,033.44  
101 13/32  = 101.406% or $1,014.06
A coupon of 10 3/8 = 10.375% or $103.75
The rate of return equals the [(ending cash flows − the beginning cash flows) / beginning price] × 100 =  [(1014.06 + 103.75 − 1033.44) / 1033.44] × 100 = 8.16%

clearlycanadian

A bond that pays $100 in interest each year was purchased at the beginning of the year for $1,050 and sold at the end of the year for $1,100. An investor's holding period return is:

A) 10.5%.

B) 14.3%.

C) 10.0%.

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Input into your calculator: N = 1; FV = 1,100; PMT = 100; PV = -1,050; CPT → I/Y = 14.29

clearlycanadian

When Annette Famigletti hears that a baseball-loving friend is coming to visit, she purchases two premium-seating tickets for $45 per ticket for an evening game. As the date of the game approaches, Famigletti’s friend telephones and says that his trip has been cancelled. Fortunately for Famigletti, the tickets she holds are in high demand as there is chance that the leading Major League Baseball hitter will break the home run record during the game. Seeing an opportunity to earn a high return, Famigletti puts the tickets up for sale on an internet site. The auction closes at $150 per ticket. After paying a 10% commission to the site (on the amount of the sale) and paying $8 total in shipping costs, Familgletti’s holding period return is approximately:

A) 182%.

B) 202%.

C) 191%.

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The holding period return is calculated as: (ending price − beginning price +/- any cash flows) / beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the commission of $30 (0.10 × 150 × 2 tickets) and the shipping cost of $8 (total for both tickets). Thus, her holding period return is: (2 × 150 − 2 × 45 − 30 − 8) / (2 × 45) = 1.91, or approximately 191%.

clearlycanadian

An investor sold a 30-year bond at a price of $850 after he purchased it at $800 a year ago. He received $50 of interest at the time of the sale. The annualized holding period return is:

A) 6.25%.

B) 12.5%.

C) 15.0%.

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The holding period return (HPR) is calculated as follows:

HPR = (Pt − Pt-1 + Dt) / Pt
where:
Pt = price per share at the end of time period t
Dt = cash distributions received during time period t.
Here, HPR = (850 − 800 + 50) / 800 = 0.1250, or 12.50%.