Chapter 10/12/13/14 Managerial Finance 3403
Selling furniture to appliance customers
A furniture store is considering adding kitchen appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances?
Initial investment in inventory to support the project
All of the following cash flows are related to a proposed project. Which one of these should be included in the cash flow at Time 0?
A decrease in the firm's beta
Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $2.40 per share and has a beta of 1.42, all else constant, which of the following actions will decrease the firm's cost of equity?
Efficient capital market
Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions?
portfolio.
Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n):
dividend yield
Expressing the dividend as a percentage of the beginning stock price results in the
risks associated with the use of the funds required by the project.
For any given capital project proposal, the discount rate should be based on the:
may be less than the variance of the least risky stock in the portfolio.
Given a well-diversified stock portfolio, the variance of the portfolio:
pro forma statements
Projections of a company's financial statements for up to five years, including balance sheets, income statements, and statements of cash flows, as well as cash budgets.
Volatility
Standard deviation is a measure of which one of the following?
rate of return on a perpetuity.
The cost of preferred stock is equivalent to the:
Incremental cash flows.
The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's:
return on a risky security minus the risk-free rate.
The excess return is computed as the
weighted average of the returns for each economic state.
The expected return of a stock, based on the likelihood of various economic outcomes, equals the:
Opportunity cost
The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?
risk-free rate
To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.
The capital gains yield is positive.
Vanessa purchased a stock one year ago and sold it today for $3.15 per share more than her purchase price. She received a total of $2.60 per share in dividends. Which one of the following statements is correct in relation to this investment?
depends upon how the funds raised for that project are going to be spent.
When evaluating any capital project proposal, the cost of capital:
I, II, III, and IV
Which of the following items are included when calculating the expected return on a portfolio? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy
efficient capital market
a market in which security prices reflect available information
Dividend Growth Model
a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate
efficient markets hypothesis (EMH)
asserts that actual capital markets, such as the NYSE, are efficient
Principle of diversification
implies some of the riskiness with individual assets can be eliminated by forming portfolios
Accelerated cost recovery system (ACRS)
is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.
portfolio
is a group of assets such as stocks and bonds held by an investor
security market line (SML)
is a positively sloped, straight line displaying the relationship between expected return and beta
Systematic risk principle
states the expected return on a riskyasset depends only on that asset's systematic risk
Total Risk
systematic risk + unsystematic risk
required return
usually applied to equity instruments such as common stock; the cost of funds obtained by selling an ownership interest
Systematic Risk
A risk that influences a large number of assets. Also, market risk. Also called nondiversifiable risk or market risk
RISK premium mult choice
Assume that last year T-bills returned 2.2 percent while your investment in large-company stocks earned an average of 8.1 percent. Which one of the following terms refers to the difference between these two rates of return?
the markets are continually reacting to new information.
Efficient financial markets fluctuate continuously because:
The new machine will generate positive operating cash flows.
Ellis-Clay is replacing a machine that has worn out. The replacement machine will not impact sales or operating costs and will not have any salvage value at the end of its five-year life. The firm has a tax rate of 22 percent, uses straight-line depreciation over an asset's life, ignores bonus depreciation options, and has a positive net income. Given this, which one of the following statements is correct?
historical return.
How the investment has actually performed
strong form efficient.
Inside information has the least value when financial markets are:
systematic
Most financial securities have some level of ________ risk.
Investors panic causing security prices around the globe to fall precipitously.
Of the options listed below, which is the best example of systematic risk?
A national decrease in consumer spending on entertainment
Of the options listed below, which is the best example of unsystematic risk?
that state projected values for future time periods.
Pro forma financial statements can best be described as financial statements:
include interest expense.
Pro forma statements for a proposed project should generally do all of the following, except:
portfolio weight.
Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n):
Treasury bills
The rate of return on which type of security is normally used as the risk-free rate of return?
Incremental
The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?
the returns currently required by both debt holders and stockholders.
To determine a firm's cost of capital, one must include:
are based on the market values of the outstanding securities.
When calculating a firm's weighted average cost of capital, the capital structure weights:
market value of the investment in each stock.
When calculating the expected rate of return on a stock portfolio using a weighted average, the weights are based on the:
a mathematical expectation based on a weighted average and not a guaranteed outcome.
When using economic probabilities to compute the expected return on a stock, the result is:
I, II, and III only
Which of the following statements are true of a well-diversified portfolio's expected return? I. It cannot exceed the expected return of the best performing security in the portfolio. II. It must be equal to or greater than the expected return of the worst performing security in the portfolio. III. It is independent of the unsystematic risks of the individual securities held in the portfolio. IV. It is independent of the allocation of the portfolio amongst individual securities.
It is only as reliable as the estimated rate of growth.
Which of the following statements is accurate regarding the dividend growth model?
It can be less than the standard deviation of the least risky security in the portfolio.
Which of the following statements is true of a portfolio's standard deviation?
It is based on the current yield to maturity of the company's outstanding bonds.
Which of the following statements regarding a firm's pretax cost of debt is accurate?
It can be effectively eliminated by portfolio diversification.
Which of the following statements regarding unsystematic risk is accurate?
Next year's annual dividend divided by today's stock price
Which one of the following correctly describes the dividend yield?
$2,000 paid last year to rent equipment
Which one of the following is an example of a sunk cost?
Zero net present values for all stock investments
Which one of the following is most indicative of a totally efficient stock market?
The information was expected.
Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient.
Money already spent for research and development of the new product
Which one of the following should not be included in the analysis of a new product?
All securities in an efficient market are zero net present value investments.
Which one of the following statements best defines the efficient market hypothesis?
Sunk
Which one of the following types of costs was incurred in the past and cannot be recouped?
expected return. mult
While evaluating a stock, you estimate that it will earn a return of 11 percent if economic conditions are favorable, and 3 percent if economic conditions are unfavorable. Given the probabilities of favorable versus unfavorable economic conditions, you conclude that the stock will earn 7.2 percent next year. The 7.2 percent figure is called the:
Over time, the average unexpected return will be zero.
With respect to returns, which one of the following statements is accurate?
cost of debt.
Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the:
unsystematic risk
a risk that affects at most a small number of assets. also called diversifiable risk, unique risk, or asset-specific risk
Portfolio weights
are percentages of a portfolio's total value invested in a particular asset
Capital gains yield
is calculated as the change in the price during the year (the capital gain) divided by the beginning price
Stand-alone principle
is the assumption that evaluation of a project may be based on the project's incremental cash flows.
Geometric average return
is the average compounded return earned per year over a multiyear period•
Capital asset pricing model (CAPM)
is the equation of the SML showing the relationship between expected return and beta
Risk premium
is the excess return required from an investment in a risky asset over that required from a risk-free investment
Arithmetic average return
is the return earned in an average year over a multi year period
Expected Return
is the return on a risky asset expected in the future
Cost of equity
is the return that equity investors require on their investment in the firm
Cost of debt
is the return that lenders require on the firm's debt.No need to estimate a beta for the debt because the cost of debt can normally be observed either directly or indirectly
