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Chapter 11 - Investment, Strategy, and Economic Rents
11-1
Chapter 11
Investment, Strategy, and Economic Rents
Multiple Choice Questions
1. One way to uncover forecasting errors in NPV estimates is by looking at:
I) Book values
II) Liquidating values
III) Market values
A. I only
B. II only
C. III only
D. I and II only
2. A new grocery store cost $50 million in initial investment. It is estimated that the store will
generate $5 million after-tax cash flow each year for five years. At the end of 5 years it can be
sold for $60 million. What is the NPV of the project at a discount rate of 10%?
A. $2.42 million
B. $10 million
C. $6.21 million
D. None of the above
3. A new grocery store cost $50 million in initial investment. It is estimated that the store will
generate $5 million after-tax cash flow each year for five years. At the end of 5 years it can be
sold for $55 million. What is the NPV of the project at a discount rate of 10%?
A. $2.42 million
B. $5 million
C. $3.1 million
D. None of the above
Chapter 11 - Investment, Strategy, and Economic Rents
11-2
4. A rental property is providing 13% rate of return. Next year's rent is expected to be $1.0
million and is expected to grow at 3% per year forever. What is the current value of the
property?
A. $7.7 million
B. $10 million
C. $33.3 million
D. none of the above
5. A building is appraised at $1 million. This estimate is based on a forecast of net rent of
$100,000 per year discounted at 10% [PV = 100,000/ 0.1 = 1,000,000]. The rent is the net of
repair and maintenance costs and taxes. Suppose the building is currently in disrepair and it
takes one year and $250,000 to bring it into rent able condition. How much would you be
willing to pay for the building today?
A. $1,000,000
B. $681,818
C. $750,000
D. None of the above
6. USGOLD Company has an opportunity to invest in a gold mine. The initial investment is
$250 million. The mine is estimated to produce 100,000 ounces of gold per year for the next
ten years. The extraction cost of gold per ounce is $150 and it is expected to remain at that
level. The current price of gold is $600 per ounce and it is expected to increase by 4% per
year for the next 10 years. What is the NPV of the project at a discount rate of 10%? (Ignore
taxes.)
A. $ - 3.8 million.
B. $240.8 million.
C. $257.8 million.
D. None of the above.
7. Suppose the current price of gold is $600 per ounce. The price of gold is expected to grow
at 4% per year for the foreseeable future. If the appropriate discount rate is 10%, then the
current value of gold per ounce is:
A. Less than $600 per ounce
B. $600 per ounce
C. Greater than $600 per ounce
D. Not enough information
Chapter 11 - Investment, Strategy, and Economic Rents
11-3
8. Suppose the current price of gold is $650 per ounce. The price of gold is expected to grow
at 5 % per year for foreseeable future. If the appropriate discount rate is 8%, the present value
of gold is:
A. Less than $650 per ounce
B. Greater than $650 per ounce
C. $650 per ounce
D. None of the above
9. Suppose the current price of gold is $600 per ounce and the price of gold is expected to
increase at a rate of 5% per year for the foreseeable future. What is the current value of 0.2
million ounces of gold to be produced each year for the next five years (the discount rate is
8% per year)?
A. $600 million
B. $521.64 million
C. $690.86 million
D. None of the above
10. Goldsmith labs recover gold from printed circuit boards. It has developed new equipment
for the purpose. The following data is given.
(1.) Equipment costs $250,000
(2.) It will cost $200,000 per year to run
(3.) It has an economic life of 5 years and is depreciated using straight-line method
(4.) It will recover 300 ounces of gold per year
(5.) The current price of gold is $600 per ounce and it expected to increase at a rate 4% per
year for the foreseeable future
(6.) The tax rate is 30%
(7.) The cost of capital is 8%
What is NPV of the equipment?
A. $430,400
B. $520,510
C. $470,400
D. None of the above
Chapter 11 - Investment, Strategy, and Economic Rents
11-4
11. The formula Po = Pt/((1 + r)^t) holds good for assets which:
I) Pay no dividends
II) Are traded in a competitive market
III) Cost nothing to hold
A. I only
B. I and II only
C. I,II, and III
D. II and III only
12. Investing in gold is like:
I) Investing in a stock that pays quarterly dividends
II) Investing in a stock that pays annual dividends
III) Investing in Treasury bonds
IV) Investing in a stock that pays no dividends
A. I only
B. II only
C. I,II, and III only
D. IV only
13. When you are using futures prices to estimate the cash flows of a project the discount rate
used is:
I) The cost of capital for the firm
II) The cost of capital for the project
III) The risk free rate
A. I only
B. I and II only
C. III only
D. II only
Chapter 11 - Investment, Strategy, and Economic Rents
11-5
14. When futures prices are used to estimate cash flows, the estimates are:
I) Present value of future cash flows
II) Certainty equivalents
III) Same as the estimates using spot prices
A. I only
B. II only
C. III only
D. I and III only
15. The present value of risky cash flows is calculated as follows:
I) estimate the expected cash flows and discount these at a rate that is consistent with the risk
of the cash flows
II) estimate the certainty-equivalent cash flows and discount these at the risk-free rate
III) estimate the expected cash flows and discount these at the risk-free rate
A. I only
B. II only
C. I and II only
D. III only
16. Use of certainty-equivalent cash flows is advantageous in the following ways:
I) there is no need to estimate future prices
II) there is no need to estimate the discount rate
III) there may be large errors introduced because prices in a competitive market fluctuate
randomly
A. I only
B. II only
C. I and II only
D. I, II and III
17. Economic rents are:
A. Returns that are in excess of the opportunity cost of capital
B. Returns that are equal to the opportunity cost of the capital
C. Returns that are less than the opportunity cost of capital
D. None of the above
Chapter 11 - Investment, Strategy, and Economic Rents
11-6
18. The following are some of the competitive advantages that can last longer:
I) patents
II) brand names
III) economies of scale
A. I only
B. II only
C. I and II only
D. I, II and III
19. The following are some of the competitive advantages that can last longer:
I) proprietary technology
II) protected markets with high barriers to entry by other firms
III) strategic assets that competitors cannot easily duplicate
A. I only
B. II only
C. I and II only
D. I, II and III
20. Which of the following is an example of a strategic asset?
A. trucks
B. diesel engine
C. rail road containers
D. rail road lines
Chapter 11 - Investment, Strategy, and Economic Rents
21. As a 19
th
century economist, you are faced with the following problem. The world's
shipping fleet consists of steamships and sailing ships. Each can be used to carry cargo or
passengers. The ships have similar sailing capacities but differ in their annual operating costs
as follows:
Assume: (i) Fares are competitively determined, (ii) demand is not expected to change, (iii)
each vessel has a life of 15 years, (iv) current salvage value of either ship (sailing or steam) is
$114,091, and (v) Cost of capital is 10%, (vi) no taxes. What is the present value of a steam
ship?
A. $190,152
B. $251,326
C. $609,486
D. None of the above
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