Managerial Finance Exam 2
True or False: The weights used in WACC should be determined using book values, not market values.
True
True or False: There seems to a positive correlation between an industry's beta and its cost of equity.
True
True or False: When a market is efficient, its prices will adjust quickly and accurately to new information.
True
True or False: When non-conventional cash flows exist, the IRR method may produce multiple rates of return.
True
What investment is considered to be the most "risk-free"?
U.S. T-Bills
What type(s) of risk do T-bonds have that T-bills do not?
More long term thus they have more inflation risk and also more interest rate risk.
Does Warren Buffet support technical analysis?
NO, he thinks it is crazy to invest in this way.
True or False: If long-term financing is raised from several different sources, each with different costs, then to determine the overall cost of financing, some sort of weighted-average cost must be calculated.
True
True or False: If the information is available, then both methods of equity financing should be used to calculate the cost of equity, and their results should be averaged.
True
True or False: If unsystematic risk can be diversified away, then systematic risk is the only risk that a large portfolio manager must deal with. (Note: The portfolio is large, but the manager may not be.)
True
True or False: Investments with a spread-out, flat distribution are riskier than ones with a tall, narrow distributions.
True
True or False: Leverage (debt) magnifies gains and losses, making a return on investment riskier.
True
True or False: Leverage involves borrowing money to lever up the return on equity, which is one reason firms often take on too much debt (see instructor notes on advantages of debt.)
True
True or False: Striking the right balance between too little debt and too much debt is what capital structure is all about.
True
True or False: The EMH is supported by the fact that investment managers can't consistently beat the market.
True
True or False: The Security Market Line (SML) is the same line that was on the risk-return graph discussed in Ch. 10
True
True or False: The WACC represents the minimum return required if the company wants to at least break even.
True
The evidence indicates that markets are most closely aligned with which form of EMH?
Fairly efficient; semi strong efficiency.
True or False: A good investment is one where the return on investment (ROI) is smaller than the WACC.
False
True or False: The capital structure determines the weights in the WACC formula.
True
True or False: The following are interchangeable terms: required return, cost of capital, appropriate discount rate.
True
True or False: The internal rate of return is the discount rate that makes NPV equal to zero
True
True or False: Although the Ladies admit their returns were not as great as initially claimed, the Ladies today continue to be wildly popular as they visit the TV talk shows and publish new best sellers on homespun investing strategies.
False
True or False: An investment should be accepted if its profitability index is less than one.
False
True or False: The main purpose of the CAPM is that it helps measure the return an investor should expect given a certain level of risk.
True
True or False: Based on surveys of corporate executives, the payback method is currently being used more than other methods, and it has been used more and more every year.
False
True or False: Companies that have been most successful at generating value for shareholders (EVA) include GM, Time Warner, and Goodyear Tire & Rubber.
False
True or False: If you were rich enough to include in your investment portfolio one share of every single stock traded in the U.S. market, your stock portfolio would have beta of zero.
False
True or False: The Beardstown Ladies claimed that their investment club returned 14.9% over a 10-year period, which was considerably more than the S&P500's return of 9.1% over the same period.
False: -They actually claimed they had made 23%, but had actually only made 9.1% and the S&P500 had made 14.9%.
Who is John Bogle and what does he say about the importance of minimizing expense ratios?
Famous American investor who created the first index fund. He said it was important to minimize expense ratios otherwise there was not really any point to buying and trading stocks because no one makes very much money off their investments.
True or False: The more volatile the returns, the higher the standard deviation, which means an increased chance of getting a negative return, which means more risk . . . thus, standard deviation measures risk.
True
True or False: The optimal or target capital structure is one that minimizes WACC.
True
Who are M&M?
Merton Miller and Franco Modigliani were finance/econ professors at University of Chicago. They won a noble prize for their theorems that said if you ignore income tax and financial distress costs, your firm should be worth the same whether it was finances with debt or not. They produced three cases.
True or False: The principle of leverage also applies to an Investopedia portfolio that uses margin.
True
True or False: The profitability index is simply taking the present value of future cash inflows and dividing it by the present value of the initial cash outflow.
True
What type(s) of risk do corporate bonds have that T-bonds do not?
A lot of default risk, especially junk bonds. There is also a little bit if liquidity risk because the markets are smaller.
What is the DJIA?
Average that reflects the price of 30 largest industrial companies in the New York stock exchange.
What type(s) of risk would penny stocks have that large stocks would not have?
Default risk and the chance of getting your money back is up in the air; much riskier.
When a corporation chooses to raise long-term financing by issuing common stock, what are the two approaches (models) that determine the cost of the equity financing?
Dividend Growth Model: C = (D1/P0) +g Capital Asset Pricing Model (CAPM) or SML
Which index reflects most closely the prices of blue-chip and large-industrial stocks?
Dow Jones (DJIA)
What type(s) of risks would a municipal bond have that a T-bond would not?
More default risk. State and local governments can go bankrupt.
What evidence indicates that the strong form of EMH cannot be true?
Insiders would not be able to make profits if this was the case.
What does it mean to sell short?
Investors are expecting stock prices to go down.
Do you think that junk bonds would usually have a return greater or smaller than investment-grade corporate bonds? Why?
Investors will demand higher amounts to compensate for their risk. Investment grade bonds should have a lower return than junk bonds because junk bonds are riskier.
What is capital budgeting? Why is capital budgeting important?
Involves how a business determines and evaluates large investments and expenses. This is done by looking at a companies cash inflows and outflows.
According to Mark Twain, which month of the year is the safest in which to speculate in stocks?
October is particularly risky. But every month is risky to an extent.
What does the Nasdaq Composite represent?
Represents all 3,000 some stocks in the NASDAQ market.
What does the Dow Jones U.S. Total Stock Market Index represent?
Represents every single stock traded in U.S exchanges
What type(s) of risk would real estate investments have that large stocks would not have?
Risk of liquidity
What type(s) of risks would a 30-year T-bond have that a 30-year municipal bond would not have?
Risk of more tax-ability
Which index is usually preferred by academics and analysts?
S&P 500
Why do stocks not have maturity (or interest-rate) risk?
Stocks do not have fixed rates and do not mature.
What is the difference between technical and fundamental analysts?
Technical analysts are simply looking at the price of the stock whereas fundamental analysts look at other factors of a company like their performance, balance sheets, etc.
What are the major sectors in the S&P500?
Technology, Financial, Services, Basic Materials, Healthcare, Industrial Goods, Consumer Goods, Utilities.
Risk Premium
The added compensation for the added risk. EX: Large stocks are returning 10% and T-Bills are returning only 5%. Large stocks are receiving a higher rate due to risk premium to compensate investors for the added risk to those stocks.
True or False: The so-called "pros" might be able to beat the market for short periods of time (i.e. they got lucky) but it is very difficult to consistently beat the market over a long period (unless they're Warren Buffet).
True
True or False: The utilities (electricity, natural gas, water) and food industries have low betas because these are stable industries (everyone needs food and electricity).
True
Which index has the broadest representation of the overall U.S. equity market?
Total market index
True of False: Traders located closer the stock market are able to get information faster and therefore can see trends before anyone else.
True
True or False, in your opinion: Unless you want to be CEO of a Fortune 500 company, getting an MBA at your regular state university will likely give you just as much bang for your buck as an Ivy League school.
True
True or False: A Nobel Prize in Economics was awarded to William F. Sharpe in 1990 for the CAPM.
True
True or False: A higher WACC is not necessarily bad, as long as the company is able to generate returns (EVA) in excess of WACC, resulting in a positive net return.
True
True or False: According to the instructor notes, more than half of nearly 42,000 companies surveyed in 2015 did not generate high enough return to cover their cost of capital (i.e., their medium return was 3.1% less than their cost of capital).
True
True or False: Although HG traders account for only a small percent of traders, they account for about 2/3rds of stock market transactions.
True
True or False: Although international diversification should reduce the standard deviation of a portfolio to some degree, the effect of international diversification is becoming less pronounced as markets become more globalized.
True
True or False: Because finding IRR is mostly a matter of trial and error, performing the calculations by hand can be very tedious, so spreadsheets or financial calculators are generally used.
True
True or False: Because interest paid on debt is tax deductible, the true cost is an after-tax interest rate.
True
True or False: Briggs & Stratton, Coca-Cola, and Toys 'R' Us are examples of companies that use EVA as a way to measure corporate performance.
True
True or False: By the time there are ten different stocks in a portfolio, most of the benefit of diversification has been realized; and by the time there are 30 stocks, there is little benefit remaining from diversification.
True
True or False: Competition among many knowledgeable investors makes stock markets efficient because any mispriced stock is quickly identified and its price corrected, based on the rules of supply and demand.
True
True or False: Despite its weaknesses, the IRR method is even more popular than the NPV method.
True
True or False: Generally, the companies with higher stock price standard deviations also have higher costs of debt.
True
True or False: Generally, the stocks with low betas have smaller standard deviations.
True
True or False: The value of the firm is maximized when the WACC is minimized.
True
What does the following expression mean: "If you can't beat the market, then join it."
You should buy in the index
What does a positive EVA mean?
You're costs are lower than your return and you are getting a return. (ROI>WAC)
