F10_Midterm_B_Answers - York University Economics 4400B,...

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Unformatted text preview: York University Economics 4400B, Midterm Examination November 4, 2010 Instructions. Write your name and student number at the top of this page. Answer four out of seven questions below. Each question answered is worth 10 points, the total is 40 points. Be clear what formulas you use to arrive at a solution, the actual numerical answers are not important. If you think a question is ambiguous or not enough information is provided to answer it, explain why.You have 75 minutes. 1. Brie&y evaluate the following statements.True/False/It Depends? Explain your answers brie&y. (a) Under perfect capital markets, a person¡s time preference does not a¢ect the person¡s investment decisions. (b) Under imperfect capital markets, investor¡s choice between alternative income streams based only on comparing their net present values. (c) Under perfect capital markets, investment decisions are not a¢ected by interest rate. (d) Assume capital market are imperfect: the lending interest rate is 3%, the borrowing interest rate is 10%. Should a company implement a business project where rate of return on investment is 2%? 7%? 12%? (e) Assume capital markets are imperfect and consider two individuals A, B. A is more patient of the two: A¡s inter-temporal utility function puts greater weight on future consumption, relative to B¡s utility function. Evaluate the following claim: In such setting, if B implements an investment project, A always implements it, too. (a) True. This is the separation property we went over in class. (b) Not true. There is no unique interest rate so PV is not even properly de£ned under imperfect. (c) False. Of course they are a¢ected. You only invest in anything if expected return beats rate of return available to you in £nancial markets, which is the interest rate (possibly plus some risk premium). So interest rate is a relevant factor. (d) 12% - yes, always. 2% - never. 7% - only if £rm is a net saver, that is if it does not need to borrow funds at ten percent to invest in project that yields 7%. (e) Not necessarily true. Even if A is more patient, B¡s income stream may be more front-loaded, making A a net borrower, B a net saver. In such case, the fact that an investment is pro£table to B does not mean it would be pro£table to A. 1 2. Answer all four questions.No more than 10 lines per question. (a) Explain the di/erence between Cash Flow and Net Income. Give two examples of items that contribute to one but not the other. (b) Explain how you can &nd &rm¡s leverage from its &nancial statements. Give one reason why high leverage may be bene&cial to &rm. Give one reason why high leverage may be a disadvantage. (c) Describe circumstances in which a &rm¡s Market Book ratio may be smaller than 0.3. Describe circumstances in which a &rm¡s Market Book ratio may be greater than 5. Be brief....
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This note was uploaded on 02/05/2012 for the course ECON 4140 taught by Professor A during the Spring '11 term at York University.

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F10_Midterm_B_Answers - York University Economics 4400B,...

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