1-4 Market Efficiency 1. A large firm received a loan guarantee from the governm
ID: 1155543 • Letter: 1
Question
1-4
Market Efficiency 1. A large firm received a loan guarantee from the government. Due to the guarantee, the firm can borrow $50 million for five years at 8 percent interest rate per year instead of 10 percent per year. Calculate the value of the guarantee to the firm. (Ignore taxes.) 2. If capital markets are efficient, then the sale or purchase of any security at the prevailing market price is generally (a) a positive-NPV transaction. (b) a zero-NPV transaction. (c) a negative-NPV transaction. (d) No general trend exists for such transactions. 3. Financing decisions differ from investment decisions for which of the following reasons? (a) You cannot use NPV to evaluate financing decisions. (b) Markets for financial assets are more active than for real assets. (c) It is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV (d) You cannot use NPV to evaluate financing decisions, and it is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV 4. Generally, a firm is able to find positive-NPV opportunities among its (a) financing decisions. (b) financing decisions and short-term borrowing decisions. (c) short-term borrowing decisions. (d) capital investment decisions.Explanation / Answer
1) net present value with r= 8%= 0.08
NPV= 50(1+0.08)^5
= 73.46 million
Net present value with r= 10= 0.10
NPV= 50(1+0.10)^5
= 80.52 millon
Value of guarantee to the firm= 80.52-73.46= 7.06 million
2) b is correct
When capital market is efficient sale and purchase of any security is generally zero NPV transactions.
3) b is correct
Financial market for financial assests are more active which makes the decision making different.
4) d is correct
Capital investment decisions generally result in positive NPV
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