AGEC 4403 Final Exam

What is the main question the IRR answers?

annual growth rate

1. Which ratio measures solvency? a. current ratio b. debt to equity ratio c. quick ratio d. inventory turnover

b. debt to equity ratio

Stock A comprises 30% of your portfolio with a beta of 1.4. You anticipate earning 24% on your investment in that stock. Which of the following terms applies to the 30%? a. stock risk in the portfolio b. stock weight in the portfolio c. stock expected return d. portfolio beta

b. stock weight in the portfolio

The NPV profile depicts how the NPV is affected by Select one: a. the real rate of return b. the discount rate c. the compound rate d. the IRR

b. the discount rate

The internal rate of returns (IRR) is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? a. the initial outlay is negative b. one of the time periods within the investment period has a 0 cash flow c. the investment is mutually exclusive with another investment under consideration d. the NPV is positive

c. the investment is mutually exclusive with another investment under consideration

Agricultural operations are subject to 5 main types of risk. These are: a. production, financial, marketing, legal, family b. product, financial, marketing, legal, family c. product, financial, marketing, liability, human d. production, financial, marketing, legal, human

d. production, financial, marketing, legal, human

The discounting approach ___________________________ at the required return while any cash inflows _______________________.

discounts future outflows to present; remain at the time at which they occur.

The payback period is biased towards long-term projects.T/F

F - short term bias

The NPV profile depicts how the NPV is affected by a. the discount rate b. the internal rate of return c. the compound rate d. the real rate of return

a. the discount rate

1. How do you calculate net working capital? a. Total Assets - Total Liabilities b. Current Assets - Current Liabilities c. Current Assets/Current Liabilities d. Current Liabilities - Current Assets

b. Current Assets - Current Liabilities

which of the following capital budgeting methods take into consideration the time value of money principle? a. payback period, NPV and PI b. payback period, NPV, and IRR c. NPV, IRR, and PI d. NPV, IRR, and ARR

c. NPV, IRR, and PI

What is the main question the Payback Period answers?

How long will it take to recover initial investment

NPV or PI? Do you expect to get the same investment decision based on the two instruments?

No

SWOT stands for

Strengths, Weaknesses, Opportunities, Threats

1. What does a high Beta coefficient represent? a. risky b. conservative c. low value d. easy money

a. risky

1. What is used to determine long term ability to pay debts. a. Liquidity b. Solvency c. vertical analysis

b. Solvency

How is NPV computed?Math formula, using tables or financial calculator

cash flows are discounted to the present value

What is the main question the NPV answers?

weighted average cost of capital

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset? A. Squared deviation B. Beta coefficient C. Standard deviation D. Mean E. Variance

B. Beta coefficient

A riskier project is expected to have a lower beta coefficient.

F - higher return = higher risk = higher beta

The best method to use when you have unconventional cash flows is the NPV.

T

The Net Present Value (NPV) of an investment represents the difference between the investment's Select one: a. cost and its market value b. cost and its net profit c. cash flows and its profits d. cash inflows and outflows

a. cost and its market value

Portfolio diversification eliminates which one of the following a. unsystematic risk b. systematic risk c. market risk d. total risk

a. unsystematic risk

The reinvestment approach compounds all cash flows except

the first out to the end of the project's life

Standard deviation measures ________ risk while beta measures __________________ risk

total; systemic

When you decide to abandon a project, its NPV value is negative.

F

The investment tool most closely related to the NPV profile is the IRR.

F - PI => benefits/cost => NPV profile

The interest rate used to compute the Present Value of a future cash flow is called a. discount rate b. compound rate c. prime rate d. premium rate

a. discount rate

common size financial statement presents all income statements account values as percentage of a. sales b. total equity c. gross profit d. total liabilities

a. sales

ag business XYZ, generates $3.5 in sales for every $1 the firm has invested in fixed assets. Which one of the following ratios would reflect this relationship? a. return on fixed assets b. returns on sales c. fixed asset turnover d. total asset turnover

c. fixed asset turnover

A firm has a current ratio of 1.5 and a quick ratio of 0.9. Given this, you know for certain that the firm a. pays cash for its inventory b. has more cash than inventory c. has positive net working capital d. has more than half its current assets invested in inventory

c. has positive net working capital

You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. One stock has a beta of 1.5. What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market?

1/3(0) + 1/3(1.5) + 1/3(x) = 1.0 x = 1.5

Mutually exclusive projects will always have NPV profiles that cross.

F - not always

The payback period ignores the time value of money. T/F

T

You are assigned the task of computing the expected return on a portfolio containing several individual stocks. Which one of the following statements is correct concerning this task? A. The expected rate of return on the portfolio must be positive. B. The portfolio beta must be 1.0. C. The summation of the return deviation from the portfolio expected return for each economic state must equal zero. D. The standard deviation of the portfolio must equal 1.0.

C. The summation of the return deviation from the portfolio expected return for each economic state must equal zero.

A stock is expected to return 15 percent in an economic boom, 11 percent in a normal economy, and 4 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock? A. An increase in the rate of return in a recessionary economy B. An increase in the probability of an economic boom C. A decrease in the probability of a recession occurring D. A decrease in the probability of an economic boom E. An increase in the rate of return for a normal economy

D. A decrease in the probability of an economic boom

The Beta coefficient is found using financial ratios.

False- Financial ratios can tell us more about the inter working for a business, which will give us more insight into the riskiness of the stock.

The beta coefficient shows the relationship between risk and the return on an investment. T/F

False. The beta coefficient only shows the risk of an investment compared to the rest of the market.

The expected return on a security is currently based on a 22% chance of a 15% return given an economic boom and a 78% chance of a 12% return given a normal economy. Which of the following changes will decrease the expected return on this security? I. An increase in the probability of an economic boom II. A decrease in the rate of return given a normal economy III. An increase in the probability of a normal economy IV. An increase in the rate of return given an economic boom

II. A decrease in the rate of return given a normal economy III. An increase in the probability of a normal economy

The capital structure of a firm how a firm finances its overall operations and growth by using different sources of funds. T/F

T

The PI equals 1 when NPV=0.

T NPV => Benefits - Costs = 0 PI => Benefits/Costs = 1

Which of the following should not be included when computing free-cash flows for an investment? Select one: a. increase in sunk cost b. depreciation c. decrease in sales d. tax rates decrease

a. increase in sunk cost

Ag Econ, Insurance offers a perpetuity that pays annual payments of $300,000. This contracts sells for $1,000,000 today. What is the interest rate? a. 0.03 b. 0.33 c. 0.3 d. 3.33

c. 0.3

When is Payback Period preferred to NPV?

investment has conventional cash-flows; annuity

The payback period considers the timing and amount of all of a project's cash flows.

F - It does not consider past the set payback period

An example of systematic risk is 'increase in agricultural exports." T/F

F - The fact that it affects only one industry is not true. Plus there are so many partners in that industry and also farm operators.

The payback rule states that you should accept a project if the payback period is less than two years. T/F

F - payback period is set by you

The risk that is of importance when you make investment decisions on a project is the project standing-alone risk. After all, you only need to consider the cash flows that are generated by that project.

F - take into consideration what else is there

A longer payback period is preferred over a shorter payback period. T/F

F - time value of money, a dollar today is worth more then a dollar tomorrow

Projects with conventional cash flows have multiple internal rates of return.

F - unconventional

Rough Turf Corporation, a national provider of lawn care equipment, inputs, services for installation and maintenance, is considering a large capital outlay for development of a new tool to remove old sod with less damage to the soil than conventional methods. After running the project numbers, the finance team reports the Profitability Index (PI) for the project is 0.875, which lets management know that this endeavor will be risky concerning payback period, but is still a worthwhile investment with potential to generate sizable returns. T/F

F--Any project with a PI of less than 1 should be ruled out as a reasonable investment, because the logical minimum accepted PI is 1, implying that the present value of future cash flows is sufficient to cover the money initially invested.

You own a $45,000 portfolio comprised of four stocks. The values of Stocks A, B, and C are $7,600, $16,700, and $11,000, respectively. What is the portfolio weight of Stock D?

ValueD = $45,000 - $7,600 - $16,700 - $11,000 = $9,700 WeightD = $9,700/$45,000 = 21.56 percent

Which of the following will increase the future value of a lump sum investment? a. increasing the interest rate and increasing the time period b. decreasing the interest rate and increasing the time period c. increasing the interest rate and decrease the time period d. decreasing the interest rate and decreasing the time period

a. increasing the interest rate and increasing the time period

Which one of the following statements concerning the balance sheet is correct? a. total assets equal total liabilities plus total equity b. current assets are equal to total assets minus net working capital c. assets are listed in ascending order of liquidity d. net working capital is equal total assets minus total liabilities

a. total assets equal total liabilities plus total equity

How the Payback Period is computed?

add the cashflows until investment is paid back

1. Human risks can be broken down into four main categories: a. Transition planning, what services to use, how to price, and when and how to deliver. b. Human health and well-being, family and business relationships, employee management, and transition planning. c. Employee management, family and business relationships, human health and well-being, and laws and regulation. d. Law and regulations, public policy and attributes, business organization, and transition planning.

b. Human health and well-being, family and business relationships, employee management, and transition planning.

1. Which of the following is considered to be the best method for investments with unconventional cash flows? a. IRR b. NPV c. ARR d. Profitability Index

b. NPV

1. Which one is a measure of short term solvency? a. Debt to Asset Ratio b. Quick Ratio c. Equity Multiplier d. Return on equity

b. Quick Ratio

1. The ___________ illustrates the relationship between the beta coefficient and the expected return of an investment. a. Market risk line b. Security market line c. Beta coefficient line d. Stock return line

b. Security market line

1. What's the formula for the debt to equity ratio? a. Total debt/total assets b. Total debt/total equity c. Current assets/current liabilities d. Current assets-inventories/current liabilities

b. Total debt/total equity

Which one of the following best describes a portfolio? Select one: a. investment in a risk-free bond b. group of assets held by an investor c. group of bonds held by a company d. risky assets

b. group of assets held by an investor

Ignoring the option to wait a. may overestimate the internal rate of return on a project b. may underestimate the net present value of a project c. is the same as ignoring the option to abandon a project d. ignores the value of discontinuing a project early

b. may underestimate the net present value of a project

You are comparing three investments: Annuity A pays $350 at the end of each month for 10 years, Annuity B pays $350 at the beginning of each month for 10 years, perpetuity pays $350 each month. each investment has a 6% rate of return. Which one of the following statements is correct? a. the present value of annuity A = the present value of annuity b b. annuity B will pay less than annuity A will c. Annuity B has a higher present value than Annuity A d. the perpetuity has a higher future value than Annuity B

c. Annuity B has a higher present value than Annuity A

The security market line displays the relationship between Select one: a. systematic and unsystematic risk b. risk premium and beta c. beta and expected return d. beta and standard deviation

c. beta and expected return

The security market line is a positively sloped line that depicts the relationship between a. required rate of return and beta b. risk-free rate and expected return c. expected return and beta d. risk-free rate and beta

c. expected return and beta

Farmers Coop has $70,000 in current assets and $30,000 in current liabilities. These values are referred to as the firm's a. net profit b. net assets c. net working capital c. cash flows

c. net working capital

which of the following indicates that an investment is expected to create value for its owners? a. payback period greater than the cutoff point b. profitability index less than 1 c. positive net present value d. positive average account rate of return

c. positive net present value

Which of the following is the correct formula for computing the present value of $1,000 to be received in 8 years if the rate is 5%? a. pv= $1,000 (1+5)^8 b. pv= $1,000 (1+0.05)^8 c. pv= $1,000 / (1+0.05)^8 d. pv= $1,000 / [(1+0.05) x 8

c. pv= $1,000 / (1+0.05)^8

The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to Select one: a. offset its fixed expenses b. produce a positive annual cash flow c. recoup its initial cost d. offset its total expenses

c. recoup its initial cost

Which one of the following describes systemic (systematic) risk? Select one: a. risk that affects only stocks b. asset specific risk c. risk that affects a large number of assets d. risk that affects only bonds

c. risk that affects a large number of assets

Financial statement analysis a. is primarily used to identify account values that meet accounting standards b. provides information that can serve as a basis of comparing results to those of a firm's peers but not comparing results to prior periods c. provides information that can serve as a basis of comparing results to those of a firm's peers but not forecasting future performance d. provides information that can serve as a basis of comparing results to those of a firm's peers and comparing results to prior periods

d. provides information that can serve as a basis of comparing results to those of a firm's peers and comparing results to prior periods

When the NPV=0 then Select one: a. the profitability index (PI) is greater than 1 b. the IRR equals 0 c. the profitability index (PI) is equals 0 d. the IRR equals the required rate of return

d. the IRR equals the required rate of return

Standard deviation measures ______________ risk, while beta measures ___________ risk. a. systematic; unsystematic b. total; unsystematic c. unsystematic; systematic d. total; systematic

d. total; systematic

The Modified Internal Rate of Return (MIRR) is specifically designed to address the problems associated with Select one: a. mutually exclusive projects b. crossover points when NPV schedules cross c. long-term projects d. unconventional cash flows

d. unconventional cash flows

The modified internal rate of return is designed to address problems with a. negative net present values b. long-term projects c. cross-over net present value profiles d. unconventional cash flows

d. unconventional cash flows

What type of risk do we face in capital budgeting decisions?

- Project standing-alone risk - Contribution-added risk - Systematic risk• Which one should we care about and why?

Why is NPV the preferred method?

Accounts for time value of money, all cash-flows, and adjusts for risk

1. In 2 years you are to receive 10,000. If the interest rate were to suddenly decrease, the present value of that future amount to you would __________ ? A. Fall B. Rise C. Stay the same

B. Rise

The security market line is defined as a positively sloped straight line that displays the relationship between which two of the following variables? A. Beta and standard deviation B. Systematic and unsystematic risk C.Nominal and real returns D. Expected return and beta E. Risk premium and beta

D. Expected return and beta

A portfolio is comprised of 30 assets with varying betas. The lowest beta for an individual asset is 0.7 and the highest of the asset betas of 1.5. Given this information, you know that the portfolio beta: A. must be 1.0 because of the large number of assets in the portfolio. B. must be less than the market beta. C. will be between 0 and 1.0. D. will be greater than or equal to 0.7 but less than or equal to 1.5.

D. will be greater than or equal to 0.7 but less than or equal to 1.5.

AG stock has an expected return of 13%. The risk-free rate is 3% and the market risk premium is 8%. What is the stock's beta?

E(R) = 0.13 = 0.03 + β(0.08) β = 1.25

Solvency ratios are used to determine ability to make short term payments when they are due. T/F

F

The Payback Period is biased towards long term projects. T/F

F

When the internal rate of return is greater than the required return, the net present value is positive.

F

An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to zero.

False, because the profitability index has to be greater than or equal to one not zero

Standard Deviation represents systematic risk, whereas Beta represents total risk. T/F

False, it's the opposite. Standard Deviation represents total risk, while Beta represents systematic risk.

The Current Ratio is a better indicator compared to the quick ratio for examining how liquid an operation is. T/F

False, quick ratio is the better indicator because it includes inventory and gives a better understanding of short-term liquidity.

The net present value (NPV) is the ratio of the present value of the benefits to the present value of the costs. T/F

False,That is Profitability index. NPV uses the time value of money by discounting future benefits and costs back to the present.

A stock has an expected return of 17% and a beta of 1.6. The risk-free rate is 5%. What is the slope of the security market line?

Slope = (0.17 - 0.05)/1.6 = 7.5%

The beta coefficient can be used for a project to show how risky it is.

T

discounts outflows back to present; compound inflows to the end of the project.

The combined approach

The net present value of a project generally decreases as the required rate of return increases

True, because more of the money made goes back into the investment rather than into profits

A business typically passes through four stages in its life cycle. T/F

True, the four stages are: 1.) Establishment, 2.) Growth, 3.) Consolidation and Maturation, and 4.) Transfer of ownership.

Suppose you want to finance a friend's business. You will be receiving $1,000 at the end of each year at a 4% interest rate. You want to figure out how much this is worth to you today. a. $4,452 b. $4,630.06 c. $5,416 d. $5632.64

a. $4,452

A risky security has less risk than the overall market. What must the beta of this security be? Select one: a. >0 but <1 b. 1 c. >1 d. 0

a. >0 but <1

Which of the following indicators offers the best assurance that a project will produce value for its investors? Select one: a. Positive NPV b. Positive IRR c. Positive AAR d. Short payback period

a. Positive NPV

Risks that threaten the financial health and stability of a business include a. cost and availability of capital and ability to meet financial obligations b. cost and availability of capital and selecting a business structure for the operation c. cost and availability of capital and ability to select which markets the operation needs to enter d. ability to grow equity and ability to manage employee relations

a. cost and availability of capital and ability to meet financial obligations

1. All of the following EXCEPT which are different types of risk? a. Pure risk b. Systematic risk c. Shock risk d. Speculative risk

c. Shock risk

The expected return on a project is currently based on a 30% chance of a 20% return given an economic boom, and a 70% chance of a 35% return given a normal economy. Which of the following changes will decrease the expected return on this project? a. an increase in the probability of an economic boom b. an increase in the return of the normal economy c. an increase in the probability of the normal economy d. an increase in the probability of the normal economy

d. an increase in the probability of the normal economy

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset? Select one: a. gamma coefficient b. squared deviation c. IRR d. beta coefficient

d. beta coefficient

Which one is a measure of solvency? a. acid ratio b. return on assets c. total asset turnover d. debt-to-equity ratio

d. debt-to-equity ratio

Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk? Select one: a. portfolio analysis b. security market line c. systemic diversification d. diversification

d. diversification

1. If an asset has a beta of 1.2 it's risk is: a. the asset is risk-free b. more risky than the market ​average, but will certainly yield greater returns c. as risky as average assets on the market d. more risky than market average

d. more risky than market average

Which of the following statements correctly applies to a sole proprietorship? a. the business has an unlimited life b. the ownership can easily be transferred to another person c. the owner enjoys limited liability for the firm's debts d. obtaining additional equity is dependent on the owner's personal

d. obtaining additional equity is dependent on the owner's personal

1. Discounted cash flow valuation is the process of discounting an investment's: a. assets b. future profits c. liabilities d. costs e. future cash flows.

e. future cash flows.

What is the main question the PI answers?

measures the benefit per unit cost based on the time value of money

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted when we are considering ______________________ or investments with ________________________. For that reason, the best alternative is to use the _______________.

mutually exclusive investments; unconventional cash flows, NPV