Question

Which one of the following should NOT be included in the project analysis of the manufacturing of a new product? A) Expenses that have already been incurred and cannot be recovered B) Change in net working capital related to implementing a new project C) The cash flows of a new project that come at the expense of a firm's existing cash flows D) The alternative that is forfeited when a fixed asset is utilized by a project E) The differences in a firm's cash flows with and without a particular project

Let x = the last digit of you Username. The risk-free rate is 1%. The expected market rate of return is 10%. If you expect stock ABC with a beta of 0.6 to offer a rate of return of (x+1)%, you should A) buy stock ABC because it is overpriced. B) sell short stock ABC because it is overpriced. C) sell short stock ABC because it is underpriced. D) buy stock ABC because it is underpriced. E) None of the above, as the stock is fairly priced

Answer 1

The answer is

A) Expenses that have already been incurred and cannot be recovered

These are sunk costs and hence, are not relevant

All other expenses must be considered as they are incremental or opportunity costs

Required return as per CAPM = risk free rate + beta*(Market return – risk free return)

= 1% + 0.6(10%-1%)

= 6.4%

If x+1 is greater than 6.4%, should buy because it is underpriced i.e. D

If x+1 is lower than 6.4%, sell short stock ABC because it is overpriced i.e. B

If it is equal, E) None of the above, as the stock is fairly priced