Financial managment
Which of the following statement(s) about the Market Efficiency Hypothesis is (are) correct? i. If investors can consistently beat the market by studying publicly available financial reports, the market is semi-strong form efficient. ii. If a market is strong form efficient, it must be semi-strong form efficient. iii. A market has strong form efficiency if it reflects information more quickly than a semi-strong form market. A) ii only B) iii only C) i and iii D) ii and iii
A) ii only
. A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm: A. automatically gives preferential treatment in the allocation of funds to its riskiest division. B. encourages the division managers to recommend only their most conservative projects. C. maintains the current risk level and capital structure of the firm. D. automatically gives preferential treatment in the allocation of funds to its safest division. E. allocates capital funds evenly among its divisions.
A. automatically gives preferential treatment in the allocation of funds to its riskiest division.
Which one of the following defines the internal rate of return for a project? A) Discount rate that creates a zero cash flow from assets B) Discount rate that results in a zero net present value for the project C) Discount rate that results in a net present value equal to the project's initial cost D) Rate of return required by the project's investors E) The project's current market rate of return
B) Discount rate that results in a zero net present value for the project
Which one of the following is the slope of the security market line? A) Risk-free rate B) Market risk premium C) Beta coefficient D) Risk premium on an individual asset E) Market rate of return
B) Market risk premium
An investment has conventional cash flows (i.e., project cash flows occur at the beginning of each period) and a profitability index of 1.0. Given this, which one of the following must be true? A) The internal rate of return exceeds the required rate of return. B) The net present value is equal to zero. C) The average accounting return is 1.0. D) The net present value is greater than 1.0. E) None of the above
B) The net present value is equal to zero.
Which one of the following is the best example of unsystematic risk? A. Inflation exceeding market expectations B. A warehouse fire C. Decrease in corporate tax rates D. Decrease in the value of the dollar E. Increase in consumer spending
B. A warehouse fire
Which of the following statements is FALSE? A. In an efficient market, the price of an asset responds immediately to new information relevant to the asset. B. If the semi-strong form of market efficiency holds, access to insider information of a company should not provide additional profit. C. If the weak-form of market efficiency holds, an investor should not be able to make additional profit by studying historical patterns of prices. D. Different assets may offer different expected returns. E. If the market is efficient, stock prices should respond to unexpected news
B. If the semi-strong form of market efficiency holds, access to insider information of a company should not provide additional profit.
Which one of the following is the slope of the security market line? A. Risk-free rate B. Market risk premium C. Beta coefficient D. Risk premium on an individual asset E. Market rate of return
B. Market risk premium
The ________ is the yield an individual would receive if the individual purchased the bond today and held the bond to the end of its life. A. current yield B. yield to maturity C. prime rate D. coupon rate E. capital gain yield
B. yield to maturity
Derek's is a brick-and-motar toy store. The firm is considering expanding its operations to include internet sales. Which one of the following would be the best firm to use in a pure play approach to analysing this proposed expansion? A. Another brick-and-motar store that also sells online. B. A wholesale toy distributor C. A toy store that sells online only D. The oldest online retailer of any product E. Derek's own store
C. A toy store that sells online only
A discount bond has a yield to maturity that: A. is equal to the current yield. B. equals the bond's coupon rate. C. exceeds the coupon rate. D. is less than the coupon rate. E. equals zero
C. exceeds the coupon rate.
Historically, the ________ risk an investor is willing to accept the ________ the potential return for the investment A. more, lesser B. less, greater C. more, greater D. less, less E. Historically, the risk/return tradeoff has not played out in any particular manner.
C. more, greater
Which of the following is true about the WACC? A) When computing the weights for different source of capital, the book values are preferable to the market values. B) Cost of debt is the ratio of interest expense in the income statement to the total amount of debt outstanding. C) The effect of taxes increases the cost of debt and makes debt financing less attractive for corporations. D) The cost of equity reflects the riskiness of the project.
D) The cost of equity reflects the riskiness of the project.
Which statement about portfolio diversification is correct? A) Proper diversification can eliminate systematic risk. B) The risk-reducing benefits of diversification do not occur until at least 50-60 individual securities have been purchased. C) Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. D) Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate E) Proper diversification can eliminate both systematic and unsystematic risk.
D) Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate
The rate of return on which one of the following is used as the risk-free rate? A) Long-term government bonds B) Long-term corporate bonds C) Inflation, as measured by the Consumer Price Index D) U.S. Treasury bill E) Large- company stocks
D) U.S. Treasury bill
Anthony and Ian are in the process of setting up their own company. They are considering making it either as a partnership or as a corporation. Eventually they decide to set up the company as a separate legal entity, meaning that they have no personal liability for the firm's debt. They will share ownership of that firm on a 50-50 basis. Which of the following statements are correct descriptions of their business? i. The form of their company is partnership. ii. If their firm is located in the United States, Anthony and Ian should be concerned of the doubletaxation problem, which means both the interest expense and the dividends are taxed by the government. iii. In the event of bankruptcy, Anthony and Ian may lose all their investment since they are last in the line to get back their stakes A) i, ii, and iii B) i and iii C) ii and iii D) iii only
D) iii only
. Portfolio diversification eliminates which one of the following? A. Total investment risk B. Portfolio risk premium C. Market risk D. Unsystematic risk E. Reward for bearing risk
D. Unsystematic risk
1. Which of the following are effective means of aligning management goals with shareholder interests? I. Employee stock options II. Threat of a takeover III. Management bonuses tied to performance goals A. I only B. II only C. III only D. I and II only E. I, II, and III
E. I, II, and III
A corporation's primary objective should be to maximize its market share (T/F)
FALSE. A corporation's primary objective should be to maximize shareholder value (stock price).
An increase in the risk free interest rate tends to increase stock prices by increasing the required rate of return on stocks. (T/F)
FALSE. An increase in the risk free interest rate increases the required rate of return on stocks. Hence the future cash flows are discounted at a higher rate, which decreases stock prices. (Other explanations, such as those based on Gordon Growth model, also get full credit. In the GGM, the required rate of return is in the denominator. As it increases, stock prices decline.)
A corporation's main disadvantage as a form of business organization is that it has unlimited liability. (T/F)
False. A corporation has limited liability, which is one of their advantages.
Any sunk costs incurred in a project should be included when computing the incremental cash flows for that project. (T/F)
False. Sunk costs cannot be recovered and hence should not influence the decision to accept or reject a project.
When ranking investment projects, if there is a conflict between the IRR and the NPV, we should use the IRR to make the decision. (T/F)
False. When there is a ranking conflict, we should use the NPV. The NPV is a better criterion as it uses a realistic discount rate assumption, and measures the increase in wealth as an absolute amount.
The constant growth model of stock valuation assumes that the growth rate of dividends is lower than the required rate of return. (T/F)
True. The constant growth model assumes that the growth rate of dividends is smaller than the required rate of return; otherwise the stock price is not well defined
When a coupon bond's price is above its face value, the yield to maturity is lower than its coupon rate. (T/F)
True. When price equals face value, the yield equals coupon rate. Since price and yield are inversely related, as price goes above face value, yield falls below coupon rate.
Which of the following statements about Net Present Value (NPV) and Internal Rate of Return (IRR) is/are FALSE? Statement 1: A unique IRR always exists for any cash flow pattern. Statement 2: When we are choosing between two mutually exclusive projects, NPV and IRR always give the same decision on which project to choose. a. Only Statement 1 b. Only Statement 2 c. Both Statements 1 and 2 d. Neither Statement is false
c. Both Statements 1 and 2
. Which of the following statements is CORRECT? a. An investor can eliminate virtually all systematic risk if he or she holds a very large and well diversified portfolio of stocks. b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. c. Once a portfolio has about 40 stocks, adding additional stocks will reduce its risk by a large amount. d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well‐diversified portfolio of stocks.
d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well‐diversified portfolio of stocks.
) The Shoe Box is considering adding a new line of winter footwear to its product lineup. Which of the following are relevant cash flows for this project? I. Decreased revenue from products currently being offered if this new footwear is added to the lineup II. Revenue from the new line of footwear III. Money spent to date looking for a new product line to add to the store's offerings IV. Cost of new counters to display the new line of footwear a. I and IV only b. II and IV only c. II and III only d. I, II, and IV only e. II, III, and IV only
d. I, II, and IV only
. Which of the following statements about the Weighted Average Cost of Capital (WACC) is TRUE? a. When computing the weights for different sources of capital, the book values are preferable to the market values. b. The cost of debt for a company is computed as the ratio of interest expense in the income statement to the total amount of debt outstanding. c. The effect of taxes increases the cost of debt and makes debt financing less attractive for corporations. d. It is appropriate to use a company's WACC as the discount rate for projects of average risk.
d. It is appropriate to use a company's WACC as the discount rate for projects of average risk.
Investors require a 4 percent return on risk-free investments. On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called? a. Inflation premium b. Required return c. Real return d. Average return e. Risk premium
e. Risk premium
