Practice Problems – Chapters 11, 12, 13
1)
Mark
the following statements with a T or a F to indicate whether they
are true or false (no explanations required):
a) The price of gold today is $330 per troy ounce and the required return for gold is 10%; if we expect to produce 200 troy ounces of gold one year from now, the PV of that future production is $60,000.
b) The reason that today's gold price represents the PV of gold produced on any future date is that gold is a risky asset that pays no dividends.
c) If a project really has a positive NPV for you, there must be an economic reason for you to be able to use the assets more efficiently than others.
d) If you can use a given set of assets more efficiently than others, this means the assets have a lower cost to you than they have to others.
e) Managers will not always make investment decisions the way stockholders want them to; sometimes they may reject positive NPV projects, and sometimes they may accept negative NPV projects.
f) The risk of a project going bankrupt is part of the project's systematic risk so it's accounted for in the NPV computation; if a project has positive NPV despite a high probability of bankruptcy, stockholders want the project to be accepted.
g) Stockholders and managers have different attitudes to the risk of bankruptcy, since stockholders can diversify away the risk but managers cannot.
h) Between the threat of being fired and the incentives provided to managers to act in the interests of stockholders, the potential agency problems relating to the investment decision disappear.
i) The term "economic rent" means the amount that must be charged for use of an asset each year, such that the PV of the rents equals the cost of purchasing the asset today.
j) One problem in capital budgeting is that some investments do not show up in the capital budget.
k) A firm with many divisions should circulate consensus forecasts of the economy so that different divisions do not make inconsistent forecasts of the same variables.
2)
Mark
the following statements with a T or a F to indicate whether they
are true or false (no explanations required):
a) The statement that "prices follow a random walk" means that "today's price is uncorrelated with yesterday's price".
b) If prices follow a random walk, the concepts of a bull market (one in which prices are expected to keep increasing) or a bear market (one in which they are expected to keep decreasing) make no sense.
c) In practice, price changes are not totally random; positive price changes are more likely than negative price changes.
d) It makes sense for prices to follow a random walk; any predictable patterns that might have existed have to automatically disappear the moment they are recognized and exploited.
e) If investors can use information about past prices to predict future returns, this means the market is not semi-strong form efficient.
f) Only a perfectly functioning market can be strong-form efficient.
g) In an event study, the key evidence of market efficiency is that there should be no systematic increase or decrease in CAR before the announcement.
h) Ultimately, at a pragmatic level, when we judge whether a market if efficient or not, what matters is not whether mis-pricing exists but whether it can be identified and exploited.
i) If a company wants to issue shares and its stock price has fallen over the last few days, it is better for them to wait rather than issue the shares right away.
j) Although stock splits should have no impact of the wealth of stockholders, event studies find that when firms announce stock splits the market treats the announcements as good news.
k) Even though investors desire diversification, they will still not pay more for firms that provide diversification by merging.
l) If a market is semi-strong form efficient, it must also be weak form efficient.