Question 1:

1) The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement. The owner is considering the following three alternatives:

1. Sell the restaurant now and retire.

2. Hire someone to manage the restaurant for the next year and retire. This will require the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one year the owner will sell the restaurant for $350,000.

3. Scale back the restaurant's hours and ease into retirement over the next year. This will require the owner to spend $40,000 on expenses now, but will generate $75,000 in profit at the end of the year. In one year the owner will sell the restaurant for $350,000.

a) If the interest rate is 7%, what is the NPV of alternative #1?

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b) If the interest rate is 7%, what is the NPV of alternative #2?

c) If the interest rate is 7%, what is the NPV of alternative #3?

d) If the interest rate is 7%, what is the alternative with the highest NPV and what is its NPV?

e) If the interest rate is 7%, what is the alternative with the lowest NPV and what is its NPV?

Question 2:

14) You are offered an investment opportunity in which you will receive $25,000 in one year in exchange for paying $23,750 today. Suppose the risk-free interest rate is 6% per year. Should you take this project? Calculate the NPV to justify your answer.

Question 3:

Use the table for the question(s) below.

Consider the following prices from a McDonald's Restaurant:

Big Mac Sandwich	$2.99
Large Coke	$1.39
Large Fry	$1.09

a) A McDonald's Big Mac Extra Value Meal consists of a Big Mac Sandwich, Large Coke, and a Large Fry. Assuming that there is a competitive market for McDonald's food items, at what price must a Big Mac value meal sell to ensure the absence of an arbitrage opportunity and uphold the law of one price?

b) A McDonald's Big Mac Extra Value Meal consists of a Big Mac Sandwich, Large Coke, and a Large Fry. Assume that there is a competitive market for McDonald's food items and that McDonald's sells the Big Mac value meal for $4.79. Does an arbitrage opportunity exist and if so how would you exploit it? How much would you make on one extra value meal?

Question 4:

An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20 million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year. Suppose the risk-free rate of interest is 10%.

a) Without issuing the new security, the NPV for this project is closest to what amount? Should the film maker make the investment?

b) Assuming that the film maker issues the new security, the NPV for this project is closest to what amount? Should the film maker make the investment?

c) What is the NPV of this project if the film maker invests his own money and does not issue the new security? What is the NPV if the film maker issues the new security?

Question 5:

Does market price always equal value? Under what circumstances does this hold true? In the real-world securities market, explain why price does not always equal value and give a numerical example.

Question 6:

Use the following information to answer the question(s) below.

An exchange traded fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each share represents a portfolio of two shares of Apple Inc. (APPL), one share of Google (GOOG), and ten shares of Microsoft (MSFT). Suppose the current stock prices of each individual stock are as shown below:

Stock	Price
APPL	$200.23
GOOG	$570.51
MSFT	$29.61

a) What is the price per share of this ETF in a normal market?

b) If the ETF sold for $1,350, what arbitrage opportunity is available and what trade would you make?

Question 7

An American Depository Receipt (ADR) is a security issued by a U.S. bank and traded on a U.S. stock exchange that represents a specific number of shares of a foreign stock. Siemens AG has an ADR that trades on the NYSE and is equivalent to one share of Siemens AG trading on the Frankfurt Stock Exchange in Germany. If Siemens trades for $95.19 on the NYSE and for 64.10 on the Frankfurt Stock Exchange, then under the law of one price, what is the current exchange rate?

Question 8

Suppose that a security with a risk-free cash flow of $1000 one year from now trades for $930 today. If there are no arbitrage opportunities, then what is the current risk-free rate?