Finance Exam 2 Study Guide

How much are you willing to pay for one share of Jumbo Trout stock if the company just paid a $0.70 annual dividend, the dividends increase by 2.5% annually, and you require a 10% rate of return

$0.70 x (1+ .025)/ 0.10- .025= $9.57

Miller Brothers Hardware paid an annual dividend of $0.95 per share last month. Today. the company announced that future dividends will be increasing by 2.6 percent annually. If you require a 13% rate of return, how much are you willing to pay to purchase one share of this stock today?

$0.95 x(1+ .026)/0.13- .026= $9.37

University Corp. issued five-year bonds that pay a coupon of 6.5 percent semiannually. The current market rate for similar bonds is 5.5 percent. How much will you be willing to pay for the bond today? Round to the nearest dollar.

$1,043

You want to estimate the price of a share of preferred stock that receives an annual dividend of $6.25. You predict that the stock will be called in 8 years and you will be paid $110 for your share. If you require a 7% rate of return on your investment, what is the maximum price you will pay for the stock?

$101.34

The Smart Start Corporation recently paid a dividend of $3.00 per share. Management expects dividends to grow at a constant rate of 10% per year.. If the required rate of return on the company's stock is 14%, how much would the stock be worth at the end of three years from today?

$109.81

PRE Utilities preferred stock has an annual dividend payment of $8, a stated (par) value of $100, and an effective maturity of 30 years. If similar preferred stock issues have market yields of 7 percent, what is the value of the preferred stock?

$112

Fifth Second Banc Corp. has issued preferred stock with no maturity date. It has a par value of $100 and pays a quarterly dividend of $3 per share. If the required rate of return is 10%, this stock is currently worth

$120.

The WedLink Company is considering the possibility of developing a new wedding planning website. The cost of development is assumed to be $250,000 and the company expects to generate after-tax cash flows of $70,000 per year for the next 5 years from subscribers. If the firm's discount rate is 12%, the NPV of this project is

$2,334.33.

The Stagnant Growth Corporation has paid a constant dividend of $2.50 per year for the past 3 years and is expected to continue paying the same dividend per share for the foreseeable future. If the required rate of return on its common stock is 12%, the most an investor should pay per share is

$20.83.

An investor predicts that, one year from today, Acme Inc. will pay a common stock dividend of $1.75 and the price per share will be $35. If the investor's required rate of return is 10%, how much should she expect to pay for the stock today?

$33.41

Denver Shoppes will pay an annual dividend of $1.46 a share next year with future dividends increasing by 4.2 percent annually. What is the market rate of return if the stock is currently selling for $42.10 a share?

$42.10= $1.46/ (R-.042) . R= 7.67%

The XYZ Corporation is expected to grow at a rate of 30% for the next two years and then settle at the industry median constant growth rate of 10%. If the company's last paid dividend was $1.50 per share, and the required rate of return is 15%, how much is the stock worth today?

$45.78

You are considering purchasing a share of preferred stock that pays an annual dividend of $4.50. If you require an 11% rate of return on your investment, what is the maximum price you will pay for the stock?

$5.00

A client has expressed interest in a ten-year zero coupon bonds with a face value of $1,000. His opportunity cost is 7 percent. Assuming annual compounding, what would be the current market price of these bonds? Round to the nearest dollar.

$508

A machine costs $1,000 and has a 3-year life. The estimated salvage value at the end of three years is $100. The project is expected to generate after tax-cash flows of $600 per year. If the required rate of return is 10%, what is the NPV of the project?

$567

The Buckeye Corporation expects to pay a dividend of $3.15 per share at the end of next year. The firm expects the dividend to continue growing at the rate of 8% per year for the foreseeable future. If you require a return of 13% per year, the most you should pay for this stock is

$63.00.

A share of common stock just paid a dividend of $3.25. It is expected that the stock will grow at a rate of 18 percent. If investors require a rate of return of 24 percent, what should be the price of the stock?

$63.92

Amsted, Inc. is considering a project that will increase revenues by $2.5 million, cash operating expenses by $700,000, and depreciation and amortization by $300,000 during 2011. For this project, the firm will purchase $800,000 of equipment during the year while decreasing its inventory by $200,000 (with no corresponding decrease in current liabilities). The marginal tax rate for Amsted is 35 percent. What is this project's incremental after-tax free cash flow for 2011?

$675,000

A bond with a $1,000 face value and an 8 percent annual coupon pays interest semiannually. The bond will mature in 15 years. The yield to maturity is 11 percent. The price of the bond should be

$781.99

7.5 percent coupon bonds with a semiannual payments and a yield to maturity of 7.68 percent. The bond matures in 6 years. What is the market price per bond if the face value is 1,000

$991.47

You are evaluating projects that are independent and have conventional cash flows. Rank each of the following analysis methods in order of the preference from a financial viewpoint in relation to these projects. List the most valuable method first

1. Net Present Value, 2. Internal Rate of Return 3. Payback 4. Average Accounting Return

If John buys a 5-year bond with a 9% coupon rate paid semiannually and $1000 par value for $925, his yield to maturity would be closest to

10.99%.

The RST Corp. is considering the purchase of some new equipment which will cost $120,000, last for 5 years, and generate after-tax cost savings of $45,000, $37,000, $25,000, $20,000, and $20,000 respectively per year. The firm's cost of capital is 10%. The IRR of this project is

12%

Boomer Biscuit Inc. needs to automate its production line. The project costs $275,000 and is expected to provide after-tax cash flows of $73,306 for eight years. Management estimates its cost of capital as 12 percent. What is the project's MIRR?

16%

The market price of a 10-year, $1,000 bond is $1,158.91. Interest on this bond is paid semiannually and the YTM is 14%. What is the bond's annual coupon rate?

17%

The Easton manufacturing Company is looking to replace its conveyor belt system. A new system will cost $345,000, and will result in cost savings of $220,000 in the first year, followed by savings of $100,000 per year over the following 3 years. The payback period for this project is closest to

2.25 years.

The Easton manufacturing Company is looking to replace its conveyor belt system. A new system will cost $345,000, and will result in cost savings of $220,000 in the first year, followed by savings of $100,000 per year over the following 3 years. If the firm's cost of capital is 9%, the discounted payback period for this project is closest to

2.76

Initial Outlay Cash Flow in Period CF0 CF1 CF2 CF3 CF4 -$20,000 $7,730.85 $7,730.85 $7,730.85 $7,730.85 The IRR is approximately

20%

Three years ago, Joe bought a 5-year, 10% coupon paid semiannually bond for $1000. Currently, with interest rates having risen sharply, the bond is selling for $800 and you decide to sell it off. If you had re-invested the semi-annual coupons as you received them, what would your realized yield be over the 3-year holding period?

3.63%.

Longordia Foods is expecting to generate after-tax income of $1,558,888, $2,933,312, and $3,261,712 for each of the next three years. The equipment used will have an average book value of $8,375,000 over that period. What is the accounting rate of return (ARR)?

31%

The Fox-Trot Film Co. is interested in calculating the MIRR of a music video production site which will cost $300,000 to set up in Year 0 and $60,000 to tear down in Year 3. During Years 1 and 2, it will generate cash flows of $380,000 and $280,000 respectively. If the firm's cost of capital is 10%, this project's MIRR is closest to

33.13%

What is the payback period for a $20,000 project that is expected to return $6000 for the first two years and $3000 for years three through five?

4.67 years

Mary just bought a 20-year bond with an 8% coupon rate (paid semi-annually) and $1000 par value for $1050. She is expecting an effective annual yield (EAY) of

7.65%

Generic Inc. issued bonds in 1988 that will mature 16 years from the date of issue. The bond pays a 14.375 percent coupon and the interest is paid semiannually. Its current price is $1,508.72. What is the yield to maturity on the bonds?

8.5%

Which of the following transactions occurs in the primary market

A purchase of newly issued stock from AT&T

You should accept a project when the:

AAR is greater than the required return

Which statement below best describes how fixed costs per unit and variable costs per unit impact operating cash flows?

As output increases, fixed costs per unit decline and variable costs per unit increase.

The Dividend Growth Model

Assumes dividends increase at a constant rate forever, can be used to compute a stock price at any point in time, can be used to value zero- growth stocks, requires the growth rate to be less than the required rate of return

A bond that is payable to whomever has physical possession of the bond is said to be in:

Bearer Form

Which of the following is the rate at which a stock's price is expected to appreciate?

Capital Gains Yield

If a firm can undertake only some of the value-adding projects available to it because of limited funds, the firm must engage in

Capital Rationing

Which of the following is a weakness of the payback period?

Cash flows are not discounted.

Which of the following has a right to vote in the election of the board of directors of a company?

Common Stockholders

Which of the following rates should be used to calculate a project's net present value?

Cost of Capital

Which of the following cash flows would be considered part of the initial investment in a project?

Cost of Installing the project

Which one of the following markets is a type of secondary market for securities in the US?

Dealer, General public distribution is a type of primary market transaction, where securities are directly bought from issuer. Dealer market is a secondary market.

Walthers Company has a semi annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?

Decrease the market price

Which of the following steps is necessary when computing the value of a common stock?

Determining the required rate of return based on the riskiness of the cash flows

In which of the following types of security markets do sellers often rely primarily on word-of-mouth communication to find interested buyers?

Direct Search

A bond pays a coupon interest rate of 7.5 percent. The market rate on similar bonds is 8.4 percent. The bond will sell at _____.

Discount

An increase in which of the following will increase the current value of a stock according to the dividend growth model?

Dividend Amount, Number of Future Dividends- provided the current number is less than infinite, Dividend Growth Rate

What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate and the applicable discount rate

Dividend Growth

The next dividend payment by Hillside Markets will be $2.35 per share. The dividend are anticipated to maintain a 4.5% growth rate forever. The stock currently sells for $65 per share. What is the dividend yield?

Dividend Yield = $2.35/ $65= 3.62%

Which of the following is a simplifying assumption that is made when applying the dividend discount model to common stock valuation?

Dividends remain constant over time, Dividends grow at a constant rate forever, Dividend growth rate is not equal to the required rate of return.

Which of the following is one of the steps necessary for conducting a capital budgeting analysis of a project?

Estimating the project's future cash flows

If a corporation does not declare and pay preferred dividends as scheduled, it is technically in default and can be forced into bankruptcy by preferred stockholders.

FALSE, Companies have no obligation to pay dividends to either common or preferred stockholders.

T/F- When faced with mandatory contingent projects, it is best to evaluate each project independently on its own merits.

FALSE, Since mandatory contingent projects are legal requirements, companies have to implement the project without evaluation irrespective of the merits.

T/F The constant growth dividend model cannot be applied to value the stock of a company whose dividends are declining at a constant rate.

FALSE, The constant growth dividend model can be applied to value the stock of a company whose dividends are either growing or declining at a constant rate.

T/F- The cost of capital for a project is its return on equity.

FALSE, The cost of capital is the rate of return that a capital project must earn to be accepted by management.

T/F- The net present value of a project equals the value of the assets used in the project.

FALSE, The net present value of a project equals the difference between its cost and the present value of its expected cash flows.

The yield curve that is most commonly observed in the US capital markets tends to slope downwards.

FALSE, The yield curve that is most commonly observed in the US capital markets tends to slope upwards because yields are higher for longer-term securities than for shorter-term securities.

Preferred stock is legally a form of debt of a corporation.

FALSE, Though many of the features of preferred stock, like fixed periodic payments and credit rating, it is not legally considered as a form of debt.

T/F The accounting rate of return is better than the payback period since it does not ignore the time value of money.

FALSE- Both accounting rate of return and payback period ignores the time value of money.

T/F- Incremental after-tax free cash flows of a project are equal to the operating cash flows from the project.

FALSE- Incremental after-tax free cash flows for a project is defined as the total after-tax free cash flows that a firm would produce with the project, less the total after-tax free cash flows that the firm would produce without the project.

The cost arising from using a building that could have been leased out is an example of a sunk cost.

FALSE- It is an example of an opportunity cost. Opportunity costs refer to the cost of giving up the next best opportunity.

Other things held constant, the use of accelerated depreciation rates would make the NPV of a project smaller.

FALSE- Other things held constant, the use of accelerated depreciation rates would make the NPV of a project smaller. This is because accelerated depreciation methods enable a firm to deduct depreciation charges sooner, thereby realizing the tax savings sooner and increasing the present value of the tax savings.

The IRR and NPV methods always rank projects in the same order.

FALSE- The IRR and NPV methods can give conflicting results.

T/F- The IRR is the discount rate that makes the NPV positive.

FALSE- The IRR is the discount rate that makes the NPV equal to zero.

T/F- The MIRR is the interest rate that equates the present value of the project's cash outflows to the present value of its cash inflows.

FALSE- The MIRR is the interest rate that equates the project's cost or cash outflows with the future value of the project's cash inflows at the end of the project.

T/F- The impact of a project on a firm's overall value or on its stock price depends on how the project affects the company's accounting earnings.

FALSE- The impact of a project on a firm's overall value or on its stock price does not depend on how the project affects the company's accounting earnings. It depends only on how the project affects the firm's FCF.

Variable cost per unit of production always increases as output increases.

FALSE- Variable cost per unit of production decreases as output increases.

A bond's coupon rate is equal to the annual interest divided by which one of the following?

Face Value

The yield to maturity of a bond never changes.

False, A yield to maturity of a bond changes as and when interest rates change.

Corporate convertible bonds are those that can be turned back to the company for cash.

False, Corporate convertible bonds are those that can be exchanged for common stock at a predetermined ratio at the discretion of bondholders.

Short-term bonds have more interest rate risk than long-term bonds.

False, Long-term bonds have more interest rate risk compared to short term bonds. Long-term bonds receive most of their cash flows farther into the future, and because of the time value of money, these cash flows are heavily discounted.

Prices in the corporate bond market tend to be less volatile than prices of securities sold in markets with greater trading volumes.

False, Prices in the corporate bond market tend to be more volatile than prices of securities sold in markets with greater trading volumes because a few large trades can have a larger impact on a security's price than numerous trades of various sizes.

Which is a characteristic of common stock

Fixed Dividends

Which of the following theorems is one of the theorems explaining the relationship between interest rates and bond prices?

For a given change in interest rates, the prices of long-term bonds will change more drastically than the prices of short-term bonds.

Which of the Following Statements are correct concerning the internal rate of return (IRR)

IRR is the discount rate that makes the net present value equal to zero & there can be multiple IRRs if the cash flows are unconventional

Why should the recovery of working capital in the terminal year of a project's life be included in the capital budgeting analysis?

Ignoring the recovery of working capital underestimates a project's NPV.

Which one of the following is an advantage of the NPV method of analyzing capital projects?

It uses a discounted cash flow technique to adjust for the time value of money.

The tax rate that should be used when forecasting cash flows from operations is the

Marginal Tex Rate

The secondary market is best defined by which of the following?

Market where outstanding shares of stock are resold

In order to calculate the price of a bond which of the following inputs is needed?

Maturity Period

Which of the following capital budgeting technique ignores the time value of money?

Modified Internal Rate of Return

What is an example of an OTC Market?

NASDAQ is an OTC market

When doing capital budgeting analysis, we must discount

NEITHER real cash flows with the real cost of capital nor nominal cash flows with the nominal cost of capital.

What is the net present value of the proposed project? YEAR . Cash Flow 0 . -$135,000 1 . $28,000 2 . $65, 500 3 . $71,900 Required PayBACK PERIOD: 3 years Required Return: 8.50 Percent

NPV= -$135,000+$28,600/ (1+.085)^1 +$65,500/ (1+.085)^2 + $71,900/(1+.085)^3 . NPV= $3,289.86

Which of the following capital budgeting techniques is the most appropriate one for evaluating projects?

Net Present Value

Which of the following are negative covenants that might be found in a bond indenture?

No debt senior to this issue can be issued and the company cant leave any major assets without approval by the leader

Municipal bonds-

Pay interest that is federally tax free

Preferred stock is considered to be a special type of debt rather than equity because

Preferred stockholders receive a fixed dividend

Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and face value of 1000. Bonds are paid in 10 years and will be sold at par- The bonds will sell at a ? if the market rate is 5.5 percent

Premium

A bond that has a market price that exceeds its face value-- which of the following features currently apply to this bond?

Premium Price and Yield to Maturity that is less than the coupon rate

The US has a _____ tax system.

Progressive

Which of the following is an example of an incremental capital expenditure?

Purchase of additional machinery

The preferred stock of Rail Lines Inc. pays an annual dividend of $12.25 and sells for $59.70 a share. What is the rate of return on this security?

R= $12.25/ $59.70= 20.52%

Morristown Industries has an issue of preferred stock outstanding that pays a 12.60 dividend every year perpetuity. What is the required return if this issue currently sells for $80 per share?

R= $12.60/ $80= 15.75%

Which of the following represents an example of key reasons for making capital expenditures?

Replacing production equipment

Who owns the NYSE

Shareholders

The difference between the price that a dealer is willing to pay and the price at which he or she will sell is called the

Spread

The capital-budgeting process starts with a firm's

Strategic Plan

When estimating the incremental after-tax free cash flows for a project, we include

Sunk Costs

T/F Growth stocks typically pay little or no dividends.

TRUE, A growth stock company typically pays little or no dividends on its stock because management believes that the company has a number of high-return investment opportunities and that both the company and its investors will be better off if earnings are reinvested rather than paid out as dividends.

T/F - Capital budgeting decisions are the most important ones managers make because they help to select investments in long-term assets that increase the value of a firm.

TRUE, Capital budgeting decisions are the most important investment decisions made by management. The objective of these decisions is to select investments in productive assets that will increase the value of the firm.

Interest rate risk always adds an upward bias to the slope of the yield curve.

TRUE, The presence of interest rate risk affects the shape of the yield curve. The interest rate risk always adds an upward bias to the slope of the yield curve.

The value of a firm's equity is calculated as the sum of the present value of all expected future cash flows.

TRUE, The value of a firm's equity is calculated as the sum of the present value of all expected future cash flows.

The value of a stock that experiences supernormal growth can be calculated as the present value of all dividends during the period of supernormal growth plus the present value of a constantly growing dividend.

TRUE, The value of a stock that experiences supernormal growth can be calculated as the present value of all dividends during the period of supernormal growth plus the present value of a constantly growing dividend.

A financial analyst should consider the impact on a chain's existing restaurants when the company is evaluating the feasibility of opening another restaurant.

TRUE- If a product associated with another project is expected to affect sales of one or more other products at the firm, the expected impact of the new project on the cash flows from the other products must be included when computing the FCFs.

T/F- When estimating the cash flows associated with investments, we must include tangible assets, intangible assets, and current assets.

TRUE- Investments can be required to purchase long-term tangible assets, such as property, plant, and equipment, to purchase intangible assets, such as patents, mailing lists, or brand names, or to fund current assets, such as accounts receivables and inventories.

T/F- Profitability index (PI) is a measure of the value a project generates for each dollar invested in that project.

TRUE- Profitability index (PI) is a measure of the value a project generates for each dollar invested in that project.

T/F- The valuation of real assets is less straightforward than the valuation of financial assets.

TRUE- The valuation of real assets is less straightforward than the valuation of financial assets.

Which of the following statements is correct

The capital gains yield is the annual rate of change in a stock's price

For the constant growth rate dividend model to work, which of the following assumptions must hold?

The growth rate must be less than the required rate of return.

Which is correct? * Payback period is also referred to as the benefit- cost ratio * Internal rate of return can be reliably used for all the independent projects * The profitability index is used when the investment funds are limited * The next PV should not be used to rank mutually exclusive projects

The profitability index is used when the investment funds are limited

Which of the following is true of capital budgeting decisions?

They create value for a firm when the value of the selected productive assets is worth more than their cost, They can involve substantial cash outlays, which once made are not easily reversed, They define a firm's lines of business and its inherent business risk.

Which of the following is a major role of secondary markets?

To provide good marketability for securities

T/F The bid price is the price that a dealer pays for security

True

The corporate bond market is thin compared to the market for money market securities or corporate stocks.

True

T/F . Common stockholders are owners of a corporation

True, Common Stockholders are investors having ownership in a corporation

The default risk premium is based on the probability that a bond issuer will not fulfill all of a bond's contractual provisions.

True, Default risk refers to the risk that the borrower will not be able to pay its debt obligations as they come due. The default risk premium is based on the probability that a bond issuer will not fulfill all of a bond's contractual provisions.

T/F The NYSE and NASDAQ are two of the three largest exchanges in the world based on the value of shares traded.

True, The NYSE and NASDAQ are the largest exchanges in the world based on the value of shares traded.

The dealer's selling price of a given stock is also known as the ask price.

True, The ask price is the price at which a securities dealer seeks to sell a given stock.

If a corporate bond's rating changes from AAA to AA, it means that its default risk has gone up.

True, The highest-grade bonds, those with the lowest default risk, are rated AAA. If a corporate bond's rating changes from AAA to AA, it means that its default risk has gone up.

The market value of a zero-coupon bond equals the present value of a single future cash flow.

True, The market value of a zero-coupon bond equals the present value of the principal at maturity, as they have no coupon payments.

The term structure of interest rates is influenced by the real rate of interest.

True, The relation between yield to maturity and term to maturity is known as the term structure of interest rates. The real rate of interest, the expected rate of inflation, and interest rate risk affect the level and the shape (the slope) of the yield curve over time.

Sunk costs should not be considered when calculating a project's incremental cash flows.

True- A firm using accelerated depreciation method, compared to the straight-line depreciation method, has higher depreciation expenses in the initial years resulting in higher tax savings.

An example of variable cost is the labor cost to assemble each product.

Variable costs refer to the costs that vary directly with the number of units sold.

You cannot attend the shareholder's meeting for the Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called?

Voting by Proxy

Which of the following is a key disadvantage of the IRR method?

With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.

Should the project be accepted based in the internal rate of return (IRR)? Why or why not? What is the net present value of the proposed project? YEAR . Cash Flow 0 . -$135,000 1 . $28,000 2 . $65, 500 3 . $71,900 Required PayBACK PERIOD: 3 years Required Return: 8.50 Percent

Yes-- The project should be accepted because the IRR of 9.69% is greater than the required return of 8.5%.

Currently, the bond market requires a return of 11.6 percent on the 10 year bonds issued by Winston Industries. The 11.6 percent is referred to as

Yield to Maturity- interest rate required in the market in a bond (bond's yield)

Of the four capital budgeting techniques, the one that managers use the least is

accounting rate of return.

A corporate bond's coupon

annual coupon payment / the bond's par value

An agent who arranges a transaction between a buyer and a seller of equity securities is called a

broker

A bond that can be paid off early at the issuer's discretion is referred to as being

callable

Interest rate risk premium is the

compensation investors demand for accepting interest rate risk

Bond's issued by US gov

considered to be free of default risk

If a project's IRR exceeds its _____, the project should be _____.

cost of capital; accepted

MACRS enables a firm to

deduct depreciation charges sooner, thereby realizing the tax savings sooner and increasing the present value of the tax savings.

Cash flows over a project's life should include

depreciation expense.

Capital budgeting is the process of

determining which capital investments a firm should make.

If a person finds a buyer for the 100 shares of a company she owns, this is a

direct search market transaction

When discounting cash flows,

discount nominal cash flows using a nominal rate of return.

A weakness of the accounting rate of return technique is it

does not distinguish between revenue and cash flows.

In order to calculate expected free cash flows for capital budgeting

each year's free cash flow estimate is multiplied by the probability of receiving it.

Growth stocks are typically defined as the stocks of companies whose

earnings are growing at above-average rates.

A bond will sell at a premium when its coupon interest rate

exceeds the market interest rate on similar bonds.

In regard to interest rate risk, shorter-term bonds

have less interest rate risk than longer-term bonds.

Using the MACRS to calculate depreciation rather than straight-line depreciation results in

higher depreciation expense early in a project's life.

One reason firms issue convertible bonds is the bonds can be sold for

higher prices with lower interest rates.

The value of a share of stock depends on

how often it will pay a dividend.

When estimating the free cash flows for a project we must account for

incremental cash flows from financing.

When we calculate the free cash flows for a project, we first compute the

incremental cash flows from operations.

In capital budgeting analysis, we use cash flows that are

incremental. after-tax. estimated.

The NPV and IRR methods will always agree when you are evaluating _____ projects and the project's cash flows are _____.

independent; conventional

If the yield curve has a positive slope

interest rates are expected to be HIGHER in the future.

A benefit of a callable bond is the

issuer may replace it with a bond that has a lower coupon rate.

One of the main reasons why the discounted payback period is not widely used by managers is that

it ignores all cash flows that occur after the arbitrary cutoff period.

Indenture is

legal agreement between the bond issuer and bondholders

Equivalent annual cost is used to choose between projects that are

lower equivalent annual cost.

The rate used to discount a bond's cash flow stream in bond valuation is the

market interest rate.

The reason we cannot apply the constant growth dividend model in the case where the growth rate, g, is greater than or equal to the required rate, R, is because it would result in the value of the stock becoming

negative.

The incremental cash flow from operations equals

net operating profits after-tax + depreciation and amortization.

Most secondary market transactions for corporate bonds trade in the

over-the-counter market.

A project's salvage value is likely to be ignored in the

payback period technique.

Preferred Stock Resembles a Bond because

preferred dividends are due before common dividends are paid.

Price of a bond is calculated by

present value of principal payment + present value of coupon payments.

Items included in an indenture that limit certain actions of the issuer in order to protect bondholder's interests are referred to as the

protective covenants

Growth stocks tend to not pay dividends. Their value increases because the firms

reinvest earnings to provide dividends in the future.

The term free cash flows of a firm refers to the fact that

the cash flows are left over after the firm has made the necessary investments in working capital and long-term assets.

The yield to maturity for a bond is

the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.

Realized yield is

the interest rate at which the present value of the actual cash flows from a bond equals the bond's price.

Liquidity premium is compensation to investors for

the lack of an active market wherein a bond can be sold for its actual value

Over the life of a project, a firm using the MACRS method rather than the straight-line method will have

the same total taxes.

Cash flows used for analyzing capital budgeting proposals differ from those included in the accounting statement of cash flows in all of the following ways, except that

they ignore how a project is financed, while accounting statement related cash flows do not.

The discount rate that makes the present value of a bond's coupons and principal payment equal to its price is the

yield to maturity.

The bonds that has no coupon payments but promise a single payment at maturity is

zero-coupon bonds.