# Fight Finance

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A project's NPV is positive. Select the most correct statement:

Question 345  capital budgeting, break even, NPV

 Project Data Project life 10 yrs Initial investment in factory $10m Depreciation of factory per year$1m Expected scrap value of factory at end of project $0 Sale price per unit$10 Variable cost per unit $6 Fixed costs per year, paid at the end of each year$2m Interest expense per year 0 Tax rate 30% Cost of capital per annum 10%

Notes

1. The firm's current liabilities are forecast to stay at $0.5m. The firm's current assets (mostly inventory) is currently$1m, but is forecast to grow by $0.1m at the end of each year due to the project. At the end of the project, the current assets accumulated due to the project can be sold for the same price that they were bought. 2. A marketing survey was used to forecast sales. It cost$1.4m which was just paid. The cost has been capitalised by the accountants and is tax-deductible over the life of the project, regardless of whether the project goes ahead or not. This amortisation expense is not included in the depreciation expense listed in the table above.

Assumptions

• All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
• All rates and cash flows are real. The inflation rate is 3% pa.
• All rates are given as effective annual rates.

Find the break even unit production (Q) per year to achieve a zero Net Income (NI) and Net Present Value (NPV), respectively. The answers below are listed in the same order.

In Australia in the 1980's, inflation was around 8% pa, and residential mortgage loan interest rates were around 14%.

In 2013, inflation was around 2.5% pa, and residential mortgage loan interest rates were around 4.5%.

If a person can afford constant mortgage loan payments of \$2,000 per month, how much more can they borrow when interest rates are 4.5% pa compared with 14.0% pa?

Give your answer as a proportional increase over the amount you could borrow when interest rates were high $(V_\text{high rates})$, so:

$$\text{Proportional increase} = \dfrac{V_\text{low rates}-V_\text{high rates}}{V_\text{high rates}}$$

Assume that:

• Interest rates are expected to be constant over the life of the loan.
• Loans are interest-only and have a life of 30 years.
• Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates (APR's) compounding per month.

The standard deviation and variance of a stock's annual returns are calculated over a number of years. The units of the returns are percent per annum $(\% pa)$.

What are the units of the standard deviation $(\sigma)$ and variance $(\sigma^2)$ of returns respectively?

Hint: Visit Wikipedia to understand the difference between percentage points $(\text{pp})$ and percent $(\%)$.

Which of the below formulas gives the payoff $(f)$ at maturity $(T)$ from being short a put option? Let the underlying asset price at maturity be $S_T$ and the exercise price be $X_T$.

In the dividend discount model (DDM), share prices fall when dividends are paid. Let the high price before the fall be called the peak, and the low price after the fall be called the trough.

$$P_0=\dfrac{C_1}{r-g}$$

Which of the following statements about the DDM is NOT correct?

Which of the following is NOT a money market security?

Which of the following statements about an asset’s standard deviation of returns is NOT correct? All other things remaining equal, the higher the asset’s standard deviation of returns:

A common phrase heard in financial markets is that ‘high risk investments deserve high returns’. To make this statement consistent with the Capital Asset Pricing Model (CAPM), a high amount of what specific type of risk deserves a high return?

Investors deserve high returns when they buy assets with high:

If a call option is out-of-the-money, then the spot price ($S_0$) is than, than or to the call option's strike price ($K_T$)?