FRL 3000 Exam 2 Concepts

FisherCo is intending to invest in a new project. The ________ is the minimum rate of return the firm will accept on this project

Cost of capital

The slope of the security line

market risk premium

Changes in the net working capital requirements

can affect the cash flows of a project every year of the project's life.

The excess return is computed as the

return on a risky security minus the risk free rate

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?

Risk premium

Which of the following statements are accurate? 1.Nondiversifiable risk is measured by beta. 2.The risk premium increases as diversifiable risk increases. 3.Systematic risk is another name for non-diversifiable risk. 4. Diversifiable risks are market risks you cannot avoid.

1 and 3 only

Of the options listed below, which are examples of diversifiable risk? 1. Wildfires damage an entire town 2. The federal government imposes a $1,000 fee on all business entities 3.Payroll taxes are increased nationally 4. All software providers are required to improve their privacy standards

1 and 4 only

Which of the following statements are accurate? 1.Diversifiable risks can be essentially eliminated by investing in 30 unrelated securities. 2. There is no reward for accepting diversifiable risks. 3. Diversifiable risks are generally associated with an individual firm or industry. 4. Beta measures diversifiable risk.

1, 2 and 3 only

Which of the following items are included when calculating the expected return on a portfolio? 1. Percentage of the portfolio invested in each individual security 2. Projected states of the economy 3. The performance of each security given various economic states 4. Probability of occurrence for each state of the economy

1,2,3,4

Which of the following are assumptions of the capital asset pricing model (CAPM)? 1. A risk-free asset has no systematic risk. 2. Beta is a reliable estimate of total risk. 3. The reward-to-risk ratio is constant. 4. The market rate of return can be approximated.

1,3 and 4 only

Three years ago, Bhojani Windows purchased a machine for a three-year project. The machine is being depreciated straight-line to zero over a five-year period. Assume the firm decided to forego any bonus depreciation. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (TC represents the relevant tax rate.)

Sale price + (Book value − Sale price)(TC)

Which of the following statements best describes the principle of diversification?

Spreading investment across many diverse assets will eliminate some of the total risks

___ measures total risk, and ___ measures systematic risk

Standard deviation

Cerda Diagnostics spent $5,000 last week repairing equipment. This week the company is trying to decide whether the equipment could be better utilized by assigning it to a proposed project. When analyzing the proposed project, the $5,000 should be treated as which type of cost?

Sunk costs

Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:

is underpriced

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

Of the options below which is the best example of unsystematic risk?

A national decrease in consumer spending on entertainment

____ measures the amount of systematic risk present in a particularly risky asset relative to the systematic risk present in an average risky asset.

Beta

___ risk is measured during the standard deviation

Total

The most important reason to diversify a portfolio is to

eliminate asset specific risk

Which one of the following types of costs were incurred in the past and cannot be recouped

Sunk costs

The operating cash flow for a project should exclude which one of the following?

Interest expense

The ____ explains the relationship between the expected return on a security and the level of that security's systematic risk

Capital asset pricing model

The market risk premium equals the

market rate of return minus the risk free return rate

Which of the following statements regarding unsystematic risk is accurate?

It can be eliminated by portfolio diversification

Which one of the following best illustrates erosion as it relates to a snack stand located on the beach

Selling fewer cookies because icecream is added to the menu

An investor who owns a well-diversified portfolio would consider ___ to be irrelevant

Unsystematic risk

The depreciation tax shield is best defined as the

amount of tax that is saved because of the depreciation expense

Given a well-diversified stock portfolio, the variance of the portfolio:

may be less risky than the variance of the least risky stock in the portfolio

The principle of diversification tells us that

spreading an investment across may diverse assets will eliminate some of the total risk

Most financial securities have some level of ___ risk

systematic