MGF405 Quiz 4

2020

Name: Student ID:

1. Which one of the following statements concerning the application of NPV (net present
value) method is NOT correct?
A. With unequal live, NPV rule may give an incorrect decision.
B. Setting NPV equal to zero could help us to set a competitive bid.
C. NPV rule always provides the correct decision.
D. The market value of a project could be regarded as a sum of the value of NPV without
the real option and the value of the real option.
2. Including the real option into your capital budgeting analysis will tend to:
A. extend the duration of a project but not affect the project's NPV
B. increase the NPV of a project
(since the value of the option is always positive.)
C. decrease the NPV of a project
D. have no effect on either a project's cash flows or its NPV
 MGF405 Quiz 4
2020

Name: Student ID:

1. Amazon is analyzing two cities to determine which one it should choose to become the
secondary headquarter. The company requires a rate of return of 14 percent and uses straight-line
depreciation to a zero book value.
 If Amazon chooses City-N, Amazon needs to pay $300,000 to lobby (an initial cost),
annual fees of $20,000 to maintain this relationship, and this political relationship lasts for
3-year life.
 If Amazon chooses City-V, Amazon needs to pay an initial lobby costs $200,000, annual
fees of $18,000, and has a 2-year life relationship.
Whichever city is chosen Amazon will need to renew the political relationship at the end of its
useful life. Which city should Amazon choose and why?

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 MGF405 Quiz 4
2020

Name: Student ID:

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 MGF405 Quiz 4
2020

Name: Student ID:

2. Try to find the net income; operating cash flow for different scenario in Stewart’s case. Tax
rate is 34%.

Scenario Revenue Variable Fixed Depre- NI OCF

costs costs ciation
=(Rev-costs- =NI+dep
dep)*(1-tax)

Optimistic $8,000 $2,500 $1,800 $400 $2,178 $2,578

Expected 7,000 3,000 1,800 400 1,188 1,588

Pessimistic 6,000 3,500 1,800 400 198 598

Net Income for Optimistic = (8000-2500-1800-400)*(1-0.34)+400 = 2178

OCF for Optimistic = NI+Dep = 2178+400

Net Income for Normal = (7000-3000-1800-400)*(1-0.34)+400 =1188

OCF for Normal = NI+Dep = 1188+400

Net Income for Pessimistic = (6000-3500-1800-400)*(1-0.34)+400 =198

OCF for Pessimistic = NI+Dep = 198+400

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 MGF405 Quiz 4
2020

Name: Student ID:

3. Suppose we are drilling an oil well. The drilling rig costs $300 today, and in one year the well
would have three outcomes. The outcomes are equally likely. The discount rate is 10%.
Outcome1: Big Success. The PV of this at year one is $575.
Outcome2: Mediocre. The PV of this at year one is $225.
Outcome3: Failure. The PV of this at year one is $0.
We have the option to abandon at year one to sell the rig, and the salvage value of selling the rig
= $250
Q1: What is the market value of this project considering the option?
Q2: What is the value of the option to abandon?

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 MGF405 Quiz 4
2020

Name: Student ID:

4. The following project can be undertaken in any of the next 4 years. The discount rate is 10
percent. The cost remains the same, but the present value of the sales at the time the project is
launched is increasing. When is the best time to launch this project (to generate the highest
NPV)?

Year Cost PV 𝑁𝑃𝑉𝑡 𝑁𝑃𝑉0

0 $20,000 $25,000 $5,000 $5,000

1 20,000 25,200 5,200 ?

2 20,000 27,000 7,000 ?

3 20,000 28,000 8,000 ?

4 20,000 28,500 8,500 ?