FINA EXAM 3
Debt Financing (Rd)
-commercial banks -Non bank lenders -bond holders -suppliers
payback period cons
-ignores all cash flow after the cut off point. -ignores the time value of money -An arbitrary cutoff payback period.
Standard deviation
-measure of the total risk of an asset, both its systematic and unsystematic risk. -Better for single asset or non-diversified portfolio
Which of the following is NOT a definition of beta?
A measure of risk that can be avoided
When considering expected returns, what is true about the states of the world?
A. They represent all possible outcomes. B. They must have probabilities that sum to 100%. C. They are sometimes simplified into outcomes such as boom, bust, and normal. All of the above are correct
Which of the following statements is true about variance
A. Variance describes how spread out a set of numbers or a value is around its mean or average. B. The larger the variance, the greater the dispersion. C. Variance is essentially the variability from the average. All of the above are true
You wish to diversify your single−security portfolio in a way that will maximize your reduction in risk. Which of the following securities should you add to your portfolio?
Alpha Company stock that has a correlation coefficient of −0.25 with your current security
________ refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings.
Capital Structure
Equity Financing (Rp)
Common stockholders/Retained Earnings
If stock A has a greater standard deviation than stock B then it must also have a greater return.
False
Over the 50−year period from 1950 to 1999, 3−month Treasury bills earned a higher average annual rate of return than long−term government bonds.
False
Which of the statements below is FALSE?
Firms rarely use the payback period for small−dollar decisions.
The Internal Rate of Return (IRR) Model suffers from three problems. What are these problems?
Incorporates the IRR as the reinvestment rate for the future cash flows Multiple IRRs Comparing mutually exclusive projects
The capital budgeting decision model that utilizes all the discounted cash flow of a project is the ________ model, which is one of the single most important models in finance.
NPV
The crossover rate is the discount rate where both projects have the same ________.
NPV
There are two ways to correct for projects with unequal lives when using the NPV approach. Which of the answers below is one of these ways?
One way is to find a common life by extending the projects to the least common multiple of their lives.
________ is a modification of NPV to produce the ratio of the present value of the benefits (future cash inflow) to the present value of the costs (initial investment).
PI index
Which of the following statements about probabilities is INCORRECT?
Probability is associated with an ex−post view.
Two types of investment risk
Stand-alone risk Portfolio risk
IRR
The discount rate that forces a project's NPV to equal zero.
Under which of the following circumstances is the pure play method of estimating a project's beta particularly useful?
The firm is looking to expand its current business operations into a brand new area unlike any of its internal projects.
The cost of debt could be which of the following?
The required return on money borrowed as a long−term loan from a bank The yield−to−maturity on money raised by selling bonds The required return on money borrowed from a venture capitalist
Which of the following investments is considered to be default risk−free?
Treasury Bills
NPV acceptance criteria
accept if positive, reject if negative
An investment banker's fees are part of the ________ realized for issuing new debt or equity.
flotation costs
The hurdle rate should be set so that it reflects the proper risk level for the project. If we have to choose between two projects with similar risk and therefore similar hurdle rates, we would select the project that ________.
has a higher internal rate of return
IRR selection criteria
independent: any project w IRR>WACC M. exc: project w highest IRR>WACC
The cost of retained earnings ________.
is the appropriate cost of capital for the shareholders is the loss of the dividend option for the owners is the cost of issuing new common stock without the flotation costs
Investors ________ for estimating the WACC.
market value
Discount rate/hurdle rate
minimum acceptable rate of return/typically WACC
hybrid equity financing (Rps)
preferred stockholders
The weighted average cost of capital is ________.
the cost of capital for the firm as a whole the average of the cost of each financing component, weighted by the proportion of each component made up of three financing components: the cost of debt, the cost of preferred stock, and the cost of equity
The IRR is the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost equals ________.
the present value of the future benefits or cash inflows
well-diversified portfolio
unsystematic risk is completely eliminated Ex: large mutual fund
cost of debt (Rd)=
yield to maturity on a firms outstanding bonds
A beta of 1.0 is the beta of the ________, while a beta of 0.0 is the measure for a ________.
market; risk−free security.