Question

9.A risk premiumis defined as

1. the total market rate of return for the financial asset that an investor pays
2. the risk-free rate
3. the market return minus the S&P 500
4. the additional return over and above the risk-free rate resulting from bearing risk.

10. What is the profitable index (PI)if you invest $40,000 today and the sum of the time value of money future Cash Flows from Assets (CFFA) is $30,500? Should you accept or reject the project?

A)  0.238 / Reject

B)  0.762 / Accept

C)  0.762 / Reject

D)  1.31 / Accept

E)   $30,500 / Accept

11.      IRR and Profitability Index accept/reject decision might differ from NPV when  

A) all negative cash flows

B) mutually exclusive projects

C) independent projects

D) inflation adjusted cash flows

12.      The “relevant”risk of a given stock for determining its market equilibrium expected return is:

A)  the market risk premium.

B)  diversifiable risk.

C)  Beta risk.

D)  the standard deviation (or variance)

Answer 1

Ques-9) Risk Premium = (Return on Stock - Risk Free return)

Thus, Option D Risk premium is the additional risk that is earned over risk free rate.

Ques-10)

Profitability Index = Present value of Future cash flows/Initial Investment

= $30,500/$40,000

= 0.7625 times

Since, Profitability Index is less than 1, the project should not be accepted.

Hence, option C

Ques-11)

Ans- Option B Mutual Exclusive projects.

In mutual exclusive projects, only one projects has to be selected out of no of projects and while selecting one project may be accepted because of higher NPV than other Project but at the same time its IRR may be less than other Project thus rejecting on IRR grounds. Hence, conflicts arrises when    IRR and Profitability Index accept/reject decision might differ from NPV.

Ques-12)

Ans- Option C

Relevant risk for a given stock is determined by Stock's Beta and while determing the expected return in the market equilibrium Beta is used to compute the return.]

Hence, Beta risk

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