Question 1
Mary purchases a U.S. Treasury bond; the bond is:
An asset for the government but a liability for Mary.
An asset of the U.S. government as well as an asset for Mary.
A liability of the U.S. government and an asset for Mary.
An asset for Mary but not a liability of the U.S. Government.
Question 2
More detailed financial instruments tend to be:
More costly because they will cost more to create.
Less costly because they can be standardized more easily.
More desirable than less detailed ones, no matter what the price.
Less costly because all possible contingencies are covered
Question 3
Considering the value of a financial instrument, the more likely it is the payment will be made:
The less valuable is the financial instrument because it is highly liquid.
The more valuable the financial instrument.
The greater the uncertainty; therefore the less valuable is the financial instrument
The less valuable is the instrument because risk is lower.
Question 4
Most of the buying and selling in primary markets:
Is done by the Federal Reserve.
Is in the public view.
Involves an investment bank.
Is highly transparent and closely monitored by the SEC.
Question 5
Derivative markets exist to allow for:
Cash receipts from the sale of bonds.
Reduced information asymmetry.
Direct transfers of common stocks for bonds.
Reduced risk from volatile prices.
Question 6
Compound interest is the idea:
That you get an interest deduction for paying your loan off early.
That you get an interest deduction if you take out a loan for longer than one year.
That interest rates will rise on larger loans.
That you get interest on interest
Question 7
Suppose Paul borrows $4000 for one year from his grandfather who charges Paul 7% interest. At the end of the year Paul will have to repay his grandfather:
$4,280
$4,350
None of the above
$4,290
Question 8
The value of $100 left in a certificate of deposit for four years that earns 4.5% annually will be:
$119.25
$145.00
$120.00
$117.00
Question 9
The relationship between present value and the interest rate could best be described as:
A direct relationship, they both move together
An inverse relationship, as i increases, PV decreases.
None of the above.
An unclear relationship, whether it is direct or inverse depends on the interest rate.
Question 10
At any fixed interest rate, an increase in time, n, until a payment is made:
Has no impact on the present value since the interest rate is fixed.
Reduces the present value.
None of the above.
Increases the present value.
Question 1
Mary purchases a U.S. Treasury bond; the bond is:
| An asset for the government but a liability for Mary. | |
| An asset of the U.S. government as well as an asset for Mary. |
| A liability of the U.S. government and an asset for Mary. | |
| An asset for Mary but not a liability of the U.S. Government. |
Question 2
More detailed financial instruments tend to be:
| More costly because they will cost more to create. | |
| Less costly because they can be standardized more easily. |
| More desirable than less detailed ones, no matter what the price. | |
| Less costly because all possible contingencies are covered |
Question 3
Considering the value of a financial instrument, the more likely it is the payment will be made:
| The less valuable is the financial instrument because it is highly liquid. | |
| The more valuable the financial instrument. |
| The greater the uncertainty; therefore the less valuable is the financial instrument | |
| The less valuable is the instrument because risk is lower. |
Question 4
Most of the buying and selling in primary markets:
| Is done by the Federal Reserve. | |
| Is in the public view. |
| Involves an investment bank. | |
| Is highly transparent and closely monitored by the SEC. |
Question 5
Derivative markets exist to allow for:
| Cash receipts from the sale of bonds. | |
| Reduced information asymmetry. |
| Direct transfers of common stocks for bonds. | |
| Reduced risk from volatile prices. |
Question 6
Compound interest is the idea:
| That you get an interest deduction for paying your loan off early. | |
| That you get an interest deduction if you take out a loan for longer than one year. |
| That interest rates will rise on larger loans. | |
| That you get interest on interest |
Question 7
Suppose Paul borrows $4000 for one year from his grandfather who charges Paul 7% interest. At the end of the year Paul will have to repay his grandfather:
| $4,280 | |
| $4,350 |
| None of the above | |
| $4,290 |
Question 8
The value of $100 left in a certificate of deposit for four years that earns 4.5% annually will be:
| $119.25 | |
| $145.00 |
| $120.00 | |
| $117.00 |
Question 9
The relationship between present value and the interest rate could best be described as:
| A direct relationship, they both move together | |
| An inverse relationship, as i increases, PV decreases. |
| None of the above. | |
| An unclear relationship, whether it is direct or inverse depends on the interest rate. |
Question 10
At any fixed interest rate, an increase in time, n, until a payment is made:
| Has no impact on the present value since the interest rate is fixed. | |
| Reduces the present value. |
| None of the above. | |
| Increases the present value. |
Related questions
Pete Slokowsky and Mary Jackson are facing an important decision. After having discussed different financial scenarios into the wee hours of the morning, the two computer engineers felt it was time to finalize their cash flow projections and move to the next stage â decide which of two possible projects they should undertake.
Both had a bachelor degree in engineering and had put in several years as maintenance engineers in a large chip manufacturing company. About six months ago, they were able to exercise their first stock options. That was when they decided to quit their safe, steady job and pursue their dreams of starting a venture of their own. In their spare time, almost as a hobby, they had been collaborating on some research into a new chip that could speed up certain specialized tasks by as much as 25%. At this point, the design of the chip was complete. While further experimentation might improve the performance of their design, any delay in entering the market now may prove to be costly, as one of the established players might introduce a similar product of their own. The duo knew that now was the time to act if at all.
They estimated that they would need to spend about $5,000,000 on plant, equipment and supplies. As for future cash flows, they felt that the right strategy at least for the first year would be to sell their product at dirt-cheap prices in order to induce customer acceptance. Then, once the product had established a name for itself, the price could be raised. By the end of the fifth year, their product in its current form was likely to be obsolete. However, the innovative approach that they had devised and patented could be sold to a larger chip manufacturer for a decent sum. Accordingly, the two budding entrepreneurs estimated the cash flows for this project (call it Project A) as follows:
| Year | Project A Expected Cash flows ($) |
| 0 | (5,000,000) |
| 1 | 200,000 |
| 2 | 875,000 |
| 3 | 2,140,000 |
| 4 | 3,100,000 |
| 5 | 3,100,000 |
An alternative to pursuing this project would be to immediately sell the patent for their innovative chip design to one of the established chip makers. They estimated that they would receive around $300,000 for this. It would probably not be reasonable to expect much more as neither their product nor their innovative approach had a track record.
They could then invest in some plant and equipment that would test silicon wafers for zircon content before the wafers were used to make chips. Too much zircon would affect the long-term performance of the chips. The task of checking the level of zircon was currently being performed by chip makers themselves. However, many of them, especially the smaller ones, did not have the capacity to permit 100% checking. Most tested only a sample of the wafers they received.
Pete and Mary were confident that they could persuade at least some of the chip makers to outsource this function to them. By exclusively specializing in this task, their little company would be able to slash costs by more than half, and thus allow the chip manufacturers to go in for 100% quality check for roughly the same cost as what they were incurring for a partial quality check today. The life of this project too (call it project B) is expected to be only about five years.
The initial investment for this project is estimated at $ 4,500,000. After taking into account the sale of their patent, the net investment would be $4,200,000. As for the future, Mary and Pete were pretty sure that there would be sizable profits in the first couple of years. But thereafter, the zircon content problem would slowly start to disappear with advancing technology in the wafer industry. Keeping all this in mind, they estimate the cash flows for this project as follows:
| Year | Project B Expected Cash flows ($) |
| 0 | (4,200,000) |
| 1 | 2,500,000 |
| 2 | 2,000,000 |
| 3 | 905,000 |
| 4 | 550,000 |
| 5 | 250,000 |
Mary and Pete now need to make their decision. For purposes of analysis, they plan to use a required rate of return of 15% for both projects. Ideally, they would prefer that the project they choose have a payback period of less than 4 years and a discounted payback period of less than 5 years.
Below are the results of the analysis they have carried out so far:
| Metrics | Project A | Project B |
| Payback period (in years) | 3.58 | 1.85 |
| Discounted payback period (in years) | 4.64 | 2.86 |
| Net Present Value (NPV) | $556,306 | $520,011 |
| Internal Rate of Return (IRR) | 18.35% | 22.51% |
| Profitability Index | 1.11 | 1.12 |
| Modified Internal Rate of Return (MIRR) | 17.45% | 17.72% |
One of the concerns that Mary and Pete have is regarding the reliability of their cash flow estimates. All the analysis in the table above is based on âexpectedâ cash flows. However, they are both aware that actual future cash flows may be higher or lower.
Suppose that Pete and Mary have hired you as a consultant to help them make the decision. Please draft an official memo to them with your analysis and recommendations.
Your submission should cover the following questions:
1.Briefly, summarize the key facts of the case and identify the problem being faced by our two budding entrepreneurs. In other words, what is the decision that they need to make?
An excellent paper will demonstrate the ability to construct a clear and insightful problem statement while identifying all underlying issues.
2.What are some approaches that can be used to solve this problem? What are some various criteria or metrics that can be used to help make this decision?
An excellent paper will propose solutions that are sensitive to all the identified issues.
3.a) Rank the projects based on each of the following metrics: Payback period, Discounted payback period, NPV, IRR, Profitability Index, and MIRR.
b) Mary believes that the best approach to make the decision is the NPV approach. However, Pete is not so sure that ignoring the other metrics is a good idea. Which of the approaches or metrics would you propose? In other words, would you prefer one or more of these approaches over the others? Explain why.
An excellent paper includes an evaluation of solutions containing thorough and insightful explanations, feasibility of solutions, and impacts of solutions.
4.a) Which of these projects would you recommend? Explain why.
b) Briefly state the limitations of the approach you used in making this decision, and outline what further analysis you would recommend.
