1. Having risen from virtually nothing in the early 1980s, stocks and stock options comprised roughly half of the average CEO compensation in public US firms in 1995. [Source: The Economist, May 4, 1996, p. 80] While this increase in pay for performance helps to align the interests of managers and shareholders, it also makes managers more focused on the short-term and more risk averse. (True, False, Uncertain and explain your response)
2. JJ Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $800,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 150,000 thumb drives per year with each costing $0.10 to make. Each will be sold at $2.00. Assume JJ Enterprises uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should JJ Enterprises make the purchase?
3. VBN is a microcap stock included in the Wilshire 5000 index. The following lists the actual returns on VBN and the Wilshire 5000 index for 6 recent years.
Year VBN Wilshire
20X1 -18.0% 13.0%
20X2 -10.0% -8.0%
20X3 15.0% 1.0%
20X4 60.0% 32.0%
20X5 15.0% 27.0%
20X6 28.0% 13.0%
i) Calculate the covariance between the returns on VBN and the Wilshire 5000 index.
ii) Does VBN’s returns move with or against the returns on the Wilshire 5000?
iii) Is VBN highly, moderately, or barely sensitive to fluctuations in the Wilshire 5000?
4. Obsolete Computer Systems, Inc. wants to reemerge as a major producer of computer software. The company has two options: Either it can purchase Upstart Software for $25m now whose products are expected to survive 5 years. Or it can develop an ongoing new line of software via research and development expected to cost $5m per year with implementation costs of $25m in 4 years. Using reasonable cash flow estimates from each product line, the Obsolete CFO has estimated that the internal rate of return from purchasing Upstart Software is 15% and the IRR of in-house R&D is 14%. As a member of Obsolete’s board of directors (and an ERAU alum who knows how misleading IRR analysis can be…hint), you should vote against the CFO’s recommendation to purchase Upstart Software. (True, False, Uncertain and explain your response)