Recent Question/Assignment
Semester 2-2014
ASSIGNMENT
Question 2. (8 marks)
Lumber Ltd is evaluating a new machine with a life of 2 years. The machine costs $3,000 and future after-tax cash flows depend on demand for the company's products. The tabular illustration of a probability tree of possible future cash flows associated with the new saw is given below:
Year 1 Year 2 Branch
Initial Net Conditional Net
Probability Cash Probability Cash
P(1) Flow P(2/1) Flow
0.25 1000 1
0.45 1500
0.25 1500 2
0.5 2000 3
0.4 2000 4
0.55 2500
0.2 2500 5
0.4 3000 6
a) What are the joint probabilities of occurrence of the various branches?
b) If the risk-free rate is 10 per cent, what is (i) the net present value of each of the 6 complete branches; and (ii) the expected value and standard deviation of the probability distribution of possible net present values?
c) Assuming a normal distribution, what is the probability that the actual net present value will be less than 0 (zero)? What is the significance of this probability?
Question 3. (7 marks)
Discuss the major differences between the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT): Does one outperform the other?
ASSIGNMENT
Question 2. (8 marks)
Lumber Ltd is evaluating a new machine with a life of 2 years. The machine costs $3,000 and future after-tax cash flows depend on demand for the company's products. The tabular illustration of a probability tree of possible future cash flows associated with the new saw is given below:
Year 1 Year 2 Branch
Initial Net Conditional Net
Probability Cash Probability Cash
P(1) Flow P(2/1) Flow
0.25 1000 1
0.45 1500
0.25 1500 2
0.5 2000 3
0.4 2000 4
0.55 2500
0.2 2500 5
0.4 3000 6
a) What are the joint probabilities of occurrence of the various branches?
b) If the risk-free rate is 10 per cent, what is (i) the net present value of each of the 6 complete branches; and (ii) the expected value and standard deviation of the probability distribution of possible net present values?
c) Assuming a normal distribution, what is the probability that the actual net present value will be less than 0 (zero)? What is the significance of this probability?
Question 3. (7 marks)
Discuss the major differences between the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT): Does one outperform the other?
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